After reading the comments on my previous post, I realized that many readers don’t seem to fully understand the broader implications of the crisis on Wall Street, and how it can affect Main Street, or the average person. We cannot afford to gloat on the collapse of the i-banks, because their loss is our loss too. We are all focusing on the arrogance of investment bankers and their lifestyles, but we don’t realize what investment bank layoffs mean for us. My previous post also did not go into any detail to explain this point. Some commenters have tried to point out this aspect, but I thought it needed to be explained in detail as a blog post.
So I asked one of the commenters, Mango Juice, to write a guest post on the subject – going by MJ’s comment on the previous post, it was obvious MJ had a lot more to say and was quite knowledgeable on the topic. So take it away, MJ !
MJ’s take :
I have read with interest the various comments posted on Lekhni’s piece on the turmoil at Lehman. Most writers have expressed their own perception and their own values and judgements and reflected them in the post. However, what I found glaringly missing from any of the comments was introspection and how the situation can affect your life. Maybe because they were just focusing on one aspect, i.e. the the role of the investment banker, or they don’t have a clear understanding of the implications of the last one week.
So I have a question for all the readers here – have you thought about how the situation is going to affect you, whether you are a worker in the US or a farmer in Russia ?
Here is my view on how this situation could have unraveled and affected everyone in the globe, and it might still happen. Did you realize we were staring at the abyss of a giant Depression? As the events unfolded over the week, there was a small, but very real probability that things can get out of hand, and we were staring at a calamity. Think 50% reduction in home prices, as a starter.
Think about the financial aspect of your life. We drive a car to take our kids to school, go to the shopping mall and swipe our credit cards without thinking twice about happens in the background. The loans on the card you swipe and the car you drive is securitized by the very same investment banks everybody seems to hate, and parceled as securities around the globe. These guys play an effective role of finding where excess money is, and selling these securities to people with the cash, thereby lowering the cost of financing for your credit card company or auto loan company. If such markets don’t exist, you will have to depend on your local bank who is much smaller, and whose ability to raise money is costlier, and this additional burden is passed on to who else but you. So is the case with mortgages and student loans. Every aspect of your life is touched. As the events of last week told us, even what you thought as cash in your money market account was not safe.
One of my friends was feeling very happy about having shifted all his investments to cash – or rather, money market accounts, until I asked him which money market account it was, and then alarm bells started ringing in his mind.
The implications for the average person is wide ranging –
(i) higher interest rates and reduced availability on loans;
(ii) lower rates of return on your personal investments;
(iii) reduced level of government spending as governments and municipalities are affected.
(iv) Higher unemployment as companies tighten their belt.
However, it seems to me that it is fashionable to bash the symptoms (investment banks, hedge funds making money, short selling) rather than the cause. Read this Guardian article about why hedge funds or short sellers are not the cause of the problem.
The cause is imprudent borrowing and gullible lending.
Can you imagine a world where you are a pristine borrower with a 730 or a 740 FICO with no revolving creditcard debt but yet have to pay 8% for your mortgage, 10% for your car loan, where your return on your 401-K is going to 4-5% and your bank account will give you 0% interest. You can translate the same thing to other countries by doubling your current interest rate on loans, and all this with no increase in your current pay. The cost increase to you will be due to lack of availability of funds as folks with money don’t want to lend out for the fear of non-return of Principal.
A Bloomberg story couple of days back said that the 3 month Treasury bill interest went negative. Can you imagine that people are saying to the government – take my money, don’t pay me any interest, give me back 99.99% Principal after 3 months… Investors with cash were running scared.
For you to get a sense of how bad the situation was – read this New York Times article. Strangely, the rest of the world seems to be blissfully unaware as we carry on our normal life of going to a ballgame or visiting the Mall, or our favorite pastime.
My own feelings on this are mixed. While I am not going to shed a tear for the shareholders of Lehman or Fannie Mae, I think this affects us more than the stakeholders of those companies. The life which you and I have been used to, and taken for granted, is going to change dramatically over the next 6 months. The integrity of our financial system was severely tested, and the confidence in the system completely shattered, and it requires the mother of all bailouts to bring some semblance of order. Inspite of this massive government intervention, I personally think that folks in this blog and elsewhere, should start tightening their belts, as we are sure headed for a very rough landing.
There are other areas where I can talk about – the role of government, capital markets, regulation, asset bubbles, deflation and the Fed’s role, disintermediation, but I will leave that for a different post if you are interested in hearing my views.
Which comes back to the original question – should we feel sympathetic to the loss of employees at Lehman? We should not – if it is a stray layoff of a few people. But we should, if it is the loss of the entire firm.
Think of the impact on NYC’s tax revenue. The big fat cat investment banker sure earns a multi-million dollar pay package, but he also pays his taxes. His taxes are what runs the schools, the public service system, the hospitals, so who is going to plug in the missing tax revenue? Obviously, the city of New York only has to cut spending to handle the revenue shortfall, for they can’t issue any more bonds to meet the shortfall. So the vicious cycle continues.
If you say you don’t care about NYC, think about any other small town or city where you live. Whether you know or not, your small town/ city will be issuing muni bonds for their funding needs. You are going to see a reduced availability of such funding, which has a direct impact on the number of new projects – everything from road maintenance to upgrades for old facilities. If you are working in a company, your Treasury department is going to get lesser availability of loans at a higher cost – your company will be postponing new projects and hiring lesser people.
The bottom line – the capital markets are the lubricant which keeps the wheel spinning flawlessly. If some of the larger players fail, the speed of the spinning slows down dramatically, and it’s going to take you longer and harder to reach your destination, with more pain and more energy.
I want you guys to think about yourself – don’t think about Lehman or Bear Stearns or any other investment bank. But think about how this crisis will affect you and your family, or your friends or coworkers. This event is going to affect you, directly or indirectly. So be prepared for a rough landing.
It’s not about the investment bankers, it’s about you. Their loss, directly or indirectly, affects you.