In the pursuit of good money, good values are importantMarch 1, 2010
Sometime in the mid of the nineteenth century, the son of a cattle merchant from Bavaria migrated to the United States of America and settled in Alabama. He opened up a dry goods store and was joined by his brother a few years later. The firm named as ‘Lehmann Brothers’ started focusing on trading commodities, especially cotton, owing to its high value at that time. With time, the company moved to the Manhattan in New York City and expanded into financial advisory and services. In over a century and a half, it survived two world wars and the great depression to morph into one of the most powerful and admired global financial services firm and by mid of 2008, it had with its 28,600 employees and net revenues of 19.2 Billions US dollars, become one of the most sought after wall street firm for management graduates all over the world. With the boom in the US housing market, Lehmann bet a disproportionate(in hindsight) part of its future on mortage(loans) back securities, which saw surging profits and million dollar bonuses for its executives. For employees and investors alike, it seemed to be a never ending party.
Like Lehmann, its smaller sized competitor, Bear Stearns too found itself amidst a gold mine. The erstwhile fifth largest securities firm in the United States, with an illustrious and enviable legacy of continuous quarter on quarter growth since forever, saw its revenues and profits soar more than ever, making Jimmy Cayne, its chief executive a very rich man on paper, with his personal worth surpassing 1.6 billion US dollars. This prompted Bear to invest more and more of its assets into mortgage backed securities that financed the US housing market, moving away from its traditional but less lucrative wealth management and global clearing services.
Between May and September 2008, the party ended and jump started the financial crisis in the United States, which would soon become a global crisis, setting off the worst economic recession in over seventy years. The stock of Bear, which in its prime reached 172.69 dollars a share got battered in a matter of weeks and though Bear ultimately survived, having been bought over by JP Morgan, made Cayne a much poorer man. Lehmann suffered a much crueler fate and just collapsed into bankruptcy, sending shivers in global financial markets. Investments banks, the darlings of Wall Street and the home of fat salaried bankers, would never be the same again, if not all perish in the aftermath.
The financial crisis and the ensuing recession had, as we know, larger implications than the collapse of investment banks, like Lehmann and Bear Stearns. More banks collapsed, credit tightened, small businesses found it difficult to procure loans, consumer demand retracted, and corporations both big and small saw their profits dip, millions lost their homes and many more across the world lost jobs. It was a vicious circle and dark clouds enveloped the world economy that was looking quite rosy just a few months ago. It may well be argued that this was not due to a few companies like Lehmann and Bear going berserk, but reflective of a larger systemic problem and that they were merely the poster boys of greed that became the whipping boys.
Why did this happen? Are we witnessing the end of capitalism, the capitalism of greed, the capitalism of profligacy, the capitalism of individual good? Probably not. However, there are some important lessons to learn from what is now accepted as reckless behavior by big names of the financial world.
#1: The world is more global than we ever imagined and globalization and free trade is probably not the only answer. In a world so tightly connected, a subprime crisis in the US, an energy crisis in the Middle East, a manufacturing crisis in China or even a sovereign debt crisis in small European countries can cause catastrophic impact on the global economy as a whole. It may be prudent to strike a balance between the local economy and global economy and not tilt too much one way or the other.
#2: Regulations are not always bad. With the benefit of hindsight, it can be said that appropriate regulation of behavior could have averted the crisis or atleast minimized the impact. The investment banks bought loans from banks using sophisticated financial instruments and made the business of loans very attractive for banks. Banks, in their eagerness to lend, relaxed guidelines to potential homeowners. Ordinary people took loans that they could not afford. In the end, the homeowners could not pay the loans and lost their homes, banks had a lot of bad loans on their balance sheet, which crippled them and investment banks suddenly saw their golden goose go kaput. It was a bubble, which could have been avoided had it been for better regulation, if only the rules for lending were more reasonable and incentive for reckless behavior was controlled.
#3: As with most recessions, it has now become clear with the imminent recovery, that banks, companies, and individuals with strong financial foundations have become much stronger. The well behaved banks have become bigger, fundamentally stronger companies are growing at faster rates and individuals with rainy day savings are getting the house they want at bargain prices.