The mean teeth of he Great Depression still have bite

To paraphrase T.S. Eliot, the only major British poet born in St. Louis, September 2008 was the cruelest month. As America marks the sixth anniversary of the financial meltdown which began that month and drove the global economy off the cliff and into the worst economic crisis since the 1930s, the damage it did is still being felt. Last year, middle-income families earned 8 percent less, adjusted for inflation, than they did in 2007.

But not everyone was so profoundly affected. Commuter helicopter traffic at the East Hampton airport this summer increased by close to 40 percent over last year. Yet while there is a pretense of recovery and conditions are marginally better, most Americans are still living in the mean teeth of the Great Recession. The U.S. economy is facing many challenges, especially the rising financial inequality between the top 1 percent and everybody else.

You would be right to conclude that the fed’s attempts to deal with the Financial Apocalypse of 2008, reminded you of the note your grade school teacher scrawled on too many report cards: “Could have done better.” To help put this in perspective, here’s a chronology of key events in September 2008.

On Sept. 7, the Federal Housing Finance Agency, backstopped by the Treasury Department, placed Fannie Mae and Freddie Mac into conservatorship. A week later, Merrill Lynch avoided oblivion by hastily selling itself to Bank of America. In the early hours of Sept. 15, Lehman Brothers CEO Dick Fuld, aka the gorilla of Wall Street, announced that his firm was seeking bankruptcy protection after the feds refused to step in and provide financial assistance.

Within hours of the Lehman bankruptcy, the feds rushed forward with an initial $85 billion in taxpayer cash to bail out the giant insurance company American International Group (AIG), essentially nationalizing the firm. AIG had mismanaged itself to the verge of bankruptcy by stuffing its portfolio full of derivative products whose value had collapsed.

Then on Sept. 16, the shares in the world’s oldest money market fund fell below $1 because of losses incurred on the fund’s holdings of Lehman commercial paper and medium-term notes.

To help stabilize the financial system, on Sept. 21 the feds declared Morgan Stanley and Goldman Sachs to be bank holding companies. Five days letter, in the biggest bank failure in American history, the government seized the assets of Washington Mutual, the nation’s sixth largest bank, and its banking operations were sold to JP Morgan Chase.

As the month mercifully wound down, the House of Representatives on the 29th voted down the Bush administration’s Troubled Assets Relief Program (TARP), which would have invested 700 billion taxpayer dollars in troubled banks by purchasing their distressed assets. Needless to say, the stock market reacted with panic to this “failure of democratic government” and suffered one of its worst single-day price declines, with the S&P 500 Index plunging a horrendous 8.8 percent.

Finally, rattled by the market’s obvious panic, Congress passed the Emergency Economic Stabilization Act of 2008 on Oct. 3, which included a cosmetically revamped version of TARP.

The financial markets were still in turmoil over the ensuing weeks. In terms of sheer dollar losses, the “fall of 2008” (along with the fall of many other illusions) was probably the greatest financial disaster in world history. Throughout the world, its cost in terms of shattered wealth and wrecked lives is still being calculated.

The fallout even reached Iceland. The country’s entire banking system collapsed in October when it became apparent that its bank portfolios were stuffed full of American-made toxic derivatives that had little value.

The collapse led to the following exchange on a late-night TV talk show: “What is the capital of Iceland? About $25, give or take.”

Sadly, Iceland was hardly alone.

originally published: September 27, 2014

The day Wall St. failed Main St.

Six years ago this weekend, Wall Street was rocked by the collapse of Lehman Brothers. What began as a banking crisis morphed into something that shook the U.S. economy to its core. Only federal intervention prevented an even more catastrophic result.

How the world’s biggest economy came to the brink of depression is a question that will be debated for a long time, but one could argue that the predicament stemmed from a financial system that was “too interconnected to fail.”

On Sunday, Sept. 14, 2008, Lehman CEO Dick Fuld had run out of options to save one of Wall Street’s grandest institutions. In the early hours of Sept. 15, the company issued a press release announcing that it was seeking bankruptcy protection.

On the day of Lehman’s filing, the Dow Jones Industrial Average plummeted 500 points, its largest decline since Sept. 11, 2001. Adding to the anxiety was the Sept. 14 announcement that America’s best known securities firm, Merrill Lynch, had decided to sell itself to Bank of America for $50 billion amid fears for its own survival.

All hell broke loose within hours of the Lehman bankruptcy. Credit markets froze and banks stopped lending to one another. Lenders no longer knew which borrower was a good risk, so they treated all of them as bad risks.

The Feds made an emergency $85 billion loan to the American International Group because of AIG’s enormous exposure to sub-prime mortgages through the underwriting of credit default insurance. Unlike for Lehman, here the feds opened the checkbook because they determined that the company had to be rescued to protect the financial system and the broader economy. They then allowed Morgan Stanley and Goldman Sachs to become bank holding companies and authorized the Federal Reserve Bank of New York to extend credit to both firms.

Lehman’s downfall created widespread panic in financial markets, as investors scrambled to withdraw their money. On Sept. 16, the nation’s largest money market fund was forced to cut its per-share value below the sacred $1 level because a major portion of its portfolio, invested in short-term debt issued by Lehman, was frozen in bankruptcy court.

The announcement brought Wall Street’s problems home to Main Street by undermining the confidence of millions of small investors in money market funds as a safe place to park their savings. That prompted the Treasury to announce a temporary program to guarantee investments in participating funds.

Much has been written about the causes of the crisis and different witnesses provided conflicting accounts. But it may be that being too interconnected to fail counted even more than size.

That’s why the feds decided so many financial institutions had to be bailed out; sold off to others with government guarantees to sweeten the deal, loaned enormous sums of taxpayer money or recapitalized with government equity.

The elaborately interconnected nature of the financial industry greatly increased the speed and efficiency with which money could move through society. But all the sophisticated technology in the world ultimately depends on one sacred principle: A person keeps his or her word. Suddenly people in the financial industry stopped trusting what their counterparts said about the .value of the portfolio being offered as collateral on a loan and a whole host of other avowals.

How can you do business with a person you can’t trust? As a result, the entire financial world melted down. And the feds had to rush in with open checkbooks to stave off the apocalypse.

originally published: September 2014

Looking back – and forward- on collapse of Lehman Brothers

Six years ago this month, Lehman Brothers, a 158-year-old institution and one of the nation’s five largest investment banks, went bankrupt. Its demise produced the equivalent of a global financial blackout and marked the beginning of the biggest economic crisis since the Great Depression.

It was also completely avoidable.

Six years after Lehman’s collapse, the economy is still reeling. In July, more than 10 million Americans were unemployed and another 9.8 million were underemployed. The labor participation rate of 62.9 percent is the lowest since 1978.

Lehman Brothers had become increasingly reliant on fixed-income trading and mortgage securities underwriting. This went hand-in-hand with an increase in its leverage ratio, from 24 to 1 in 2003 to 44 to 1 in 2007. Since much of this leverage took the form of very short-term debt, Lehman had to continuously sweet talk its lenders about the “solid value” of the assets it had pledged as collateral for these “here-today-gone-tomorrow” loans.

But this sweet talk was undermined by continued erosion of the housing and mortgage markets during the summer of 2007. After Lehman’s stock price fell 37 percent from June to August, the firm closed its sub-prime mortgage arm, wrote off $3.5 billion in mortgage-related assets and laid off more than 6,000 employees by the end of the year.

Things only got worse in 2008. In January, Lehman closed its mortgage lending unit and laid off another 1,300 employees in a vain attempt to stem further cash hemorrhages from its sub-prime mortgage operations.

After Bear Stearns collapsed in March, Standard & Poor’s rating arm downgraded its outlook on Lehman from “Stable” to “Negative” on the expectation that its revenues would decline by at least another 20 percent. That caused Lehman’s stock price to plunge by an additional 48 percent.

Lehman attempted to counter this by selling $4 billion in convertible preferred stock. But this fresh cash was quickly soaked up by more write-offs, including Lehman’s $1.8 billion bailout of five of its short­ term debt funds. Ravenous short-sellers (the “Vultures of Capitalism”) began circling and rumors flew that other firms were refusing to trade with Lehman.

With its common stock in virtual free fall, Lehman contemplated taking itself private, but the idea was abandoned when it became clear that the necessary financing wasn’t available. An effort to locate buyers for $30 billion of its commercial mortgages (such as office buildings and shopping malls) met with a similar fate.

The federal government had to step in if Lehman was to be saved. But any such move was complicated by the enormous public outcry that had arisen over the $29 billion “federal bailout” of Bear Steams that March. Voices from all sides of the political spectrum screamed about the feds using taxpayer funds to bail out big Wall Street firms that had caused the mess, while refusing to lift a finger to help American families who were losing their homes.

Since a presidential election loomed in a matter of weeks, Treasury and the Federal Reserve felt that nothing short of a congressional directive to “save Lehman” would allow them to move. But the Bush administration did not approach Congress and the federal government was reduced to trying unsuccessfully to convince other financial giants to bailout Lehman.

On Sept. 15, 2008, Lehman filed the largest Chapter 11 bankruptcy in American history to that point, listing assets of $639 billion and liabilities of $768 billion and leaving its viable businesses to be snapped up at fire-sale prices by sharp-eyed bottom feeders. The federal government’s inaction is generally regarded as its most disastrous financial decision since the early 1930s.

In retrospect, it was political fallout from the Bear Stearns collapse that proved to be Lehman’s death knell. The feds underestimated the impact Lehman’s demise would have on capital and credit markets. Only after the true scope of the problem became clear in the subsequent days and weeks did the feds go to Congress to request the controversial $700 billion Troubled Asset Relief Program to protect other troubled banks from insolvency.

originally posted: September 6, 2014