Wall Street After the Fall

These have been interesting times. America has seen bad times before, but mid-2008 could well go down as the most intimidating turmoil ever witnessed on Wall Street. Not since the Great Depression have the financial markets seen such bedlam without any passion for anyone standing in the way. The monumental loss of confidence changed the world economy, affected the presidential election, forced the government to intervene in the free markets, and all while erasing trillions of dollars worth of wealth.

The spark that started the fire on Wall Street was the debacle of Bear Stearns, which eventually led to a purchase by JP Morgan (JPM). This led to the government seizure of Fannie (FNM) and Freddie (FRE) and the third-degree burns to the nation's housing market. But that was just the beginning. The last quarter of 2008 faired much worse. Lehman Brothers evaporated from short sellers, a lack of capital, and toxic credit instruments. Merrill Lynch was the fate of a Fed-sale to Bank of America (BAC). And AIG was fortuitously saved after the life was sucked right out of them.

Markets fell apart and credit was frozen all to lead up to Congress' vote to turn down the biggest financial bailout in America's history – and continued to fall after, the umm, biggest financial bailout was passed. During this time, hedge funds were frantic to sell whatever they owned leading the Dow to shed 20%. Along with the dismal economy, Morgan Stanley and Goldman Sachs were forced to shift their business model, which have been intact and working for who knows how long.

Looking back, it was the end of "The Big Five Brokerage/Investment Banks" with Bear Stearns and Lehman Brothers gone, Merrill Lynch sold, and Morgan Stanley (MS) and Goldman Sachs (GS) forced to deleverage to turn basically into massive bank holding companies. So we have to look into the financial rubble and see what will fail and what will become stronger.

Now, it's good to assume that a new investment-business model will likely emerge next year. Nothing is telling me that the old one will work, because we have seen that the old models couldn't handle this financial catastrophe. We should rewrite the financial books and old investment models and treat newly graduated financial majors as ill prepared and their education should mean exactly nothing. The only light at the end of the tunnel to these graduates is the experience of this chaos should help them keep an open mind even if the economy seems good. Like the phony wealth of the U.S. housing market, and the loss of wealth when the housing bubble bust.

There still is bad news out there, but for the present, the market and economy seem to be settling. The global economy will slowly but surly catch a spark and pick up steam. But as for now, slow and steady wins the race. No one can deny that the global financial system has been flooded with capital and liquidity, unfreezing the banking industry. This allows banks to lend money again, adding to the liquidity of the system. For the short-term, the global economy in trying to rebound, forced government stimulus and banking plans do help our situation for now. The longer-term is not so "bright-blue with the sun shining."

Yes, I believe that the U.S. economy will suffer from a persistent stretch of inflation as a result of all the money thrown at the problem, but it shouldn't be too much for us to handle. Sure gold will increase in value, the dollar will fall, and commodities will reflate again. But I think this is a worthwhile tradeoff for fending off a spiteful bout of potentially worse deflation. But most importantly will anyone learn anything from this mess? Hopefully.

Good things will rise out of this mess. The failure of the weak companies in the banking system will act as fertilizer for the new banking industry. Things should be learned and the necessary decisions will be made for a stronger industry. For one, some of the big-wigs at the major investment banks will branch out and form their own firms, with a few of these saplings likely turning into the next Merrill, Morgan, and Goldman. Two, hedge funds will likely flourish again. This problematic climate has cut out most of the fat in the hedge fund industry. New funds will be created from the best of breed made available from the financial shake out.

Bad things will also rise. While the short-term seems all fine and dandy, the longer-term ramifications seem cloudy at best. As I said before, inflation will rise from all the money being printed by the government. Hopefully this money will create the long-term growth intended by the new administration. Many people think that we will see some sort of inflation, but the real question is "how much inflation will there be?" We are used to 2-3% inflation, but what if it's worse? Some think we will see 'Zimbabwe-like' inflation with gold going to 10,000 an ounce by 2012.

While I believe inflation is imminent, I think inflation might reach 5-10%. The Federal Reserve notices the threat of inflation, and will hopefully counter it before it gets out of hand. Even though I don't like believing in the Chairman of the Fed, with Ben and Alan creating this mess, I have optimism for the right decisions to be made. Or we could bet that this mess isn't completely over with hyperinflation looming around the corner…

Comments

[mr freddo:]

Thanks for the recap on an unbelievable year. I am hoping that our financial system is capable of weathering this once in a century storm and that we can somehow muddle through. Let's face it. This is no recession. This is Great Depression II. How we respond to the challenge will determine whether the depression lasts 3 years or 10. Hyper inflation is a definite risk as the Fed will be reluctant to slam the breaks on the economy once it starts to show some strength. Interest rates will rise and gold will be the one investment that maintains its value.

Feb 09 07:42 AM

[Deehena:]

Where's the meat!

Feb 09 10:01 AM

[Joseph G. O...:]

Ahh, the bailout. A cup of water for the desert wanderer. A short-term refreshment, however, the real problem still remains.

The bailout will ease the slope of the economic hole that we will be climbing out of for years to come. Stability is crucial before we are able to return to a recession-less economic state, and the bailout is able to offer some level of stability.

Feb 13 08:53 PM