It takes a lot of smoke and rubble to make things clear, but this week brought crystal clarity to a new level.
Wall Street bet the ranch.
Wall Street lost the ranch.
As we see the household names crumble and fall, the landscape of American finance is permanently changed. Add a global market decline and everyone, everywhere, is very scared.
So let me point out a few silver linings.
No one will listen to Wall Street. They have burned down their own houses. Who will take anything from the surviving firms seriously? People are moving their money away from the major brokerage firms. Merrill Lynch, according to reports, had $5 billion in client assets leave in the second quarter. About $11 billion left Smith Barney. And $17.6 billion left Wachovia.
Where did the money go? Fidelity Institutional holds money managed by thousands of independent advisers. It picked up $16.7 billion in the same quarter. Schwab Institutional added $14.5 billion. One nice side effect: Investors will be exposed to less financial garbage in the future.
Don’t get me wrong. We’re not about to enter investment nirvana. But “Wall Street wisdom” is a new oxymoron, right up there with “riskless investment” and “drug-free school zone.”
History indicates we may be near the bottom. In the 1973-74 market crash, the bottom was reached when insurance regulators told insurance companies to restore their reserves, forcing equities to be sold. In effect, insurers got an institutional margin call. That, in spades, is what is happening with the fall of AIG.
Consumer credit is toast. With bank equity impaired, borrowers will become the Rodney Dangerfields of finance. They’ll get no respect, and no money. Personal borrowing will be paid down because banks will require it from all but their most qualified borrowers— those who don’t need to borrow. Low interest rates on bank deposits will cause anyone with the needed income or savings to pay off car loans, home improvement loans and many mortgages.
This won’t happen overnight. But it will happen. Borrowers will discover that they have more purchasing power when they pay cash. The ever-increasing payments of interest to a bloated lending system will decline. Dollars not spent on interest can be spent on goods and services. Expect to see a long decline in consumer borrowing as a percent of income.
The recession won’t be as deep as some expect. Economists generally fear that a decline in consumer borrowing inevitably leads to recession because one family’s consumption is another family’s job. We import so much, however, that our recession may be blunted. Much of our woe will be exported to the countries making the goods we won’t be buying.
Happy-talk economic policies will be reconsidered. The current crisis can be traced to a government policy of the early ‘90s: Expand access to homeownership by reducing lending standards.
It seemed, as they say, like a good idea at the time.
The idea was embraced by Democrats, Republicans and Alan Greenspan. It was also embraced with great enthusiasm by everyone who could make a buck on it— Wall Street, mortgage lenders, mortgage brokers, rating agencies, and home buyers. So it went way too far. Watch for a resurgence in renting as millions of households consider the real risks of homeownership. Homeownership is a great thing, but it isn’t for everyone, all the time.
A new politics is coming. I got a very different message from the Democratic and Republican conventions than the pundits. I saw two candidates desperate to distance themselves from Washington. The candidates may have different policy ideas, but both are running against a Washington that they propose to change through their respective parties.
That means neither gets it. As Peter G. Peterson made clear in “Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It” (Picador, $15), the change we need is change that neither party has been willing to undertake.
If my reader mail is any indication, the November election will be the last two-party presidential election. We’re going to see a third party in America by 2012, regardless of which candidate wins in November.
On the web:
Earlier columns:
Working Stiff Houses. Fat Cat Prices (May 1, 2005)
A Tale of Two Transactions (December 2, 2006)
http://assetbuilder.com/blogs/scott_burns/archive/2006/12/02/A-Tale-of-Two-Transactions.aspx
The Nitwit Sector (August 10, 2007)
http://assetbuilder.com/blogs/scott_burns/archive/2007/08/10/the-nitwit-sector.aspx
Déjà vu, Texas (October 10, 2007)
http://assetbuilder.com/blogs/scott_burns/archive/2007/10/05/d-233-j-224-vu-texas.aspx
The Coming National Yard Sale (December 21, 2007)
http://assetbuilder.com/blogs/scott_burns/archive/2007/12/21/the-coming-national-yard-sale.aspx
Slider Land (January 25, 2008)
http://assetbuilder.com/blogs/scott_burns/archive/2008/01/25/slider-land.aspx
End Insider Rating (March 28, 2008)
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
(c) A. M. Universal, 2008