The Thinker

The Wall Street villain in your mirror

Well, who would have thought it possible? Liberals and conservatives are finally united! Not on everything, you understand, but definitely on the plan to bail out Wall Street. By a vote of 228 to 205, the bill was ingloriously defeated today in the U.S. House of Representatives. We agreed: we do not want to bail out Wall Street for its malfeasance with $700 billion or more of our tax dollars.

The stock markets did not react well at the news that no one might be coming to their rescue. The Dow Jones Industrial Average fell like a large jetliner, a 777 in this case, falling 777 points, a new one-day record. Not being an economist, I do not know whether this decision by the House was correct or will ultimately become self defeating, but I know it gave me I short vicarious thrill. If it results in a severe recession or a depression, taxpayers may ultimately wish their congressional representative had gone against their wishes. Nevertheless, when the mail runs 100 to 1 against a bailout and your reelection is but a month away, then you might want to pay attention to your constituents. Oddly, 205 members of Congress voted for the bailout anyhow, perhaps gambling that in the end their votes would look smart.

The biggest danger of inaction is not plunging stock values, but a collapsing credit market. For now, credit markets will be squeezed tighter and tighter. Financial firms, sensing hard times, seek to remain solvent by hording cash. This makes the cost of borrowing money pricier, at least for those on Wall Street. Community banks and credit unions currently seem to be holding their own and are in fact taking in new business. However, their funds are not unlimited. Businesses large and small need access to ready credit for major things like meeting their payrolls. So we may find that by punishing Wall Street we are doing something akin to amputating our own foot. However, if your foot is gangrenous, perhaps its amputation is not a bad idea.

Dr. Paulson, i.e. Secretary of the Treasury Henry Paulson thinks the foot can be saved with the application of $700 billion, or perhaps even more, if only we would stop dickering with him about whether the surgery is needed. Paulson is likely a smart guy, but there are many other economists with different opinions. I doubt any of them really can say for sure how to fix the financial markets because this seems to be a different kind of financial experience.

Well, perhaps it is not entirely new. It bears more than a passing resemblance to the Savings & Loan Crisis of the 1980s, a crisis for which current presidential candidate John McCain bears partial blame. He now claims his involvement with the Keating 5 was the worst mistake of his political life. It is unfortunate that he did not learn from his mistake because he generally voted in lockstep with other Republicans and the Bush Administration who were anxious to “free” the free market. Apparently, the free market does not need as much freedom as we gave it and instead should be kept on a big, thick chain attached to a stake in the ground.

Therefore, our stock portfolios are taking a nosedive. Many of you are probably like me. I have most of our daughter’s college education funds invested in mutual funds. Some were moved into income bond and money market funds months ago, but that was just an ordinary thing to do when your child begins college. We are partly protected, but it is clear that unless markets rebound considerably in the years ahead, we will lose tens of thousands of dollars that we painfully invested for her college education. We feel fortunate that we are not more vulnerable to the stock market. Of course, we own many other funds, but we fully expect in twenty years time when we need to draw from them that their value will have recovered.

Anyhow, we sure hope they recover in time. We may be naïve too. This financial crisis may take us a generation or two to dig out of. It may result in the reordering the financial sector from the ground up. One thing is clear: our houses and our stocks have been overvalued for a long time. We are now discovering their true price.

Why are they worth so much less than we thought? Again, I am no economist but I think we all know the answer in our gut: debt. It is not just our individual debt, but also government debt. We are mostly all leveraged to the max so we can live beyond our means. The effects of our indebtedness could be masked for a while, but not forever. Debt in fact discounts the value of our assets.

Secretary Paulson’s attempt to reopen the credit markets may save the patient for a day, but is unlikely to lead to a full recovery without systemic changes. You can hospitalize a severely obese patient who is in the throes of a bad case of diabetes. Yet, unless they also commit to losing weight, eating healthier and exercising regularly they are unlikely to have many more years ahead of them. My suspicion is if by reopening the credit markets we go back to bad habits then we will find that another financial crisis will not be far off. Perhaps this explains my feelings of shadenfruede at Wall Street after the House vote today. The bastards deserved this vote to go against them! However, to really see the bastards, we have to look in the mirror. Just as we chose to live beyond our means, we also chose to elect people that made it possible for us to live beyond our collective means. We did this to ourselves. We were done in by our own reckless greed.

We have to learn how to live within our means again. Not only that, we must reduce our indebtedness too. This is not a platform that is likely to be good for political careers. It may make President Obama a one-term president. Yet, this appears to be what we have to do. We must learn to embrace austerity. How un-American!

The good news is that like it or not we are all in this together now. Wall Street’s pain is our pain, and our pain is its pain. I think it is fine to limit executive compensation for executives of firms we have to bail out. Perhaps as a result the next generation of financial managers will invest money more prudently. Perhaps they will invest in companies that actually produce useful stuff, rather than become enamored with shady financial instruments like repackaged second rate mortgage debt. The world is learning as well. It is learning that its economy is tied with our own. China is learning that putting its surplus in U.S. dollars is a bad investment.

After the immense pain of the Great Depression, it seemed we could never unlearn its lessons. Yet, our hand has been burned on the hot stove yet again. This time, will we finally learn the lesson?

 

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