Of the passel of hastily written books now on the shelves discussing the financial crisis and what to do about it, The Wall Street Journal Guide to the End of Wall Street as We Know It by Dave Kansas may have the best title. But like the other members of its micro-genre, it is not likely to become an enduring classic. Kansas is a web and newspaper reporter by trade and the entire book can be usefully thought of as an extended magazine article, what in an earlier age might have been called a pamphlet. It was written over a few weeks in the last months of 2008, was on shelves as a paperback by the end of January, and will probably outlive its usefulness by late summer. It will next be seen many years from now when unearthed by a graduate student doing research into the contemporaneous reaction to the Panic of ’08, or whatever it is that the current crisis winds up being called.
But as a long magazine article, the book has its merits. If you weren’t paying close attention to events in the financial world last year and now feel at a disadvantage at dinner parties, The End of Wall Street will help. Even relatively close readers of news accounts will find tidbits and pieces of the big puzzle they have missed. For example, the book points out that the average FICO scores of sub-prime borrowers actually improved as the housing bubble grew. While the sub-prime borrower of 10 or 15 years ago might have been sub-prime due to a bad credit history, by 2006 a sub-prime borrower typically had adequate credit but was buying more house than he could truly afford.
Kansas also provides a modicum of analysis and reflection, roughly what you would expect from a reporter given a book to fill but only a short time to do it. He deftly points out that the troika at the helm of the government’s handling of the crisis in the fall of 2008 was made of Fed Chairman Ben Bernacke, New York Fed President Tim Geithner and Treasury Secretary Henry Paulson. Kansas does not say it, but he clearly means the reader to notice that the new administration has merely contracted that troika into a duo.
And although he cannot resist blaming the Usual Suspects of crooks and overly clever bankers, Kansas does so with a light hand. The fiasco in mortgage bonds was propelled by the same forces that propel the economy in good times, avarice, and optimism. As Kansas deadpans, “Creating new regulations that will eliminate greed is practically impossible.” Nor, he might have added, is it necessarily a good idea.
The fuse for the powder keg was lit in June 2006 when, according to the S&P Case-Shiller Indexes, house prices in the U.S. peaked, having gone up 190% in ten years. It took some time to play out, but after years of aggressive lending and borrowing on the almost universally held theory that house prices never go down, the result was nearly pre-ordained. There are wrinkles that made it worse, such as the peculiar structure of the mortgage bond market, but as Kansas makes clear, these are complications to the core disease. A truly vast number of bad loans got written and, due to the nature of the beast, they all went south at the same time.
It is what happened next that made our current situation dire. As Kansas tells us, within living memory there have been several large-scale financial crises that failed to destroy Wall Street, and some of those failed even to cause a recession. The tech-telecom bubble burst at the start of this decade, vaporizing trillions in stock market wealth and littering Wall Street with worthless telecom debt. That came only a few years after the Asian Crisis and Russian Default Crisis culminated in the collapse of Long Term Capital Management, which caused dramatic late night meetings of the leaders of Wall Street, but not, apparently, any long term repercussions. And a few years before that, almost the entire S&L industry went up in flames.
Kansas calls these disasters Dog That Didn’t Bark moments, events that historians will realize hold significance for what did not happen rather than what did. Indeed, the fact that no really terrible damage was done only encouraged further risk taking. But in retrospect, the financial system was lucky to weather those storms as well as it did. The seawalls were just strong enough and the ad hoc and somewhat haphazard government rescue efforts were just adequate enough to see us through. When a slightly bigger hurricane made landfall it was revealed just how insufficient the financial system’s defenses had really been all along.
The levees were breached on Monday, September 15, 2008. That was the day Lehman Brothers failed, defaulting on its debt and turning what had been an atmosphere of fear and foreboding into one of panic. Investors reasoned that if the debt of a firm as significant as Lehman could become worthless then nothing was safe. All of a sudden everybody started hoarding cash, refusing to lend to anybody under any circumstances.
Lehman had been widely known to have been in serious trouble for some time, so a person might wonder why its failure could have come as such a shock to the system. As late as the Friday before, the credit default market was pricing the likelihood of a Lehman default in the following year at only 7%. This apparent incongruity can be explained by the fact that almost everybody on Wall Street believed that even though Lehman was probably insolvent, the government would never allow such a key player to default. Of course, that is exactly what happened.
According to Kansas, the Bernanke-Geithner-Paulson troika thought that saving Lehman was unnecessary. “They felt some confidence that they could let Lehman Brothers fail without causing too much of a wider crisis.” If true, this will go down as one of the greatest misjudgments in financial history and suggests a shocking lack of understanding of markets by those supposed to regulate them. But Kansas may be scapegoating the troika for a more systemic problem. Regulators worked hard for weeks to avoid a Lehman failure. But they did so without a clear legal mandate and without any kind of formalized fund to draw on. When the Fed convened what turned out to be a weekend-long meeting of Wall Street’s leadership before the terrible Monday, Geithner kicked it off by announcing that “There is no political will for a Federal bailout.” In other words, elected officials in Washington, afraid of a backlash from voters, would not acquiesce to a bailout and without them the regulators were powerless.
The horrible week that followed Lehman’s death was eventful. Merrill Lynch was absorbed by Bank America. AIG was bailed out. Money market funds experienced panic redemptions. The SEC banned short selling of financial stocks. By Thursday afternoon the stock market was down nearly 10% on the week, before rallying on what turned out to be false hopes of a quick government bailout of the banks. Kansas’ narrative peters out shortly after this, presumably because it is here that he started writing his book.
The second half of The End of Wall Street is taken up with advice for readers on what to do now with their own finances in light of the “new world order.” This personal finance advice is undoubtedly the marketing hook for the book, the reason its creators imagined that people would buy it, and the reason they hired Kansas to write it. (He is Editor at Large at FiLife.com and the author of The Wall Street Journal’s Complete Money and Investing Guidebook.) Unfortunately, it is also the weakest part of The End of Wall Street. The advice is not unsound, indeed with regard to reasonableness it is above average. But it is generic and vague. Pay down your debts, particularly credit cards. Young people should invest mostly in stocks, older folks less so. Do not obsess over the value of your home and think of it as a roof over your head, not as an investment.
Other than starting the occasional sentence with a phrase like “in times such as these” it is difficult to see how this advice is sculpted to the post-apocalyptic world after the end of Wall Street. It would have been just as reasonable and bland five or ten years ago. Indeed, Kansas makes a weak case that Wall Street as we knew it really ended last year. Yes, one of the five largest U.S.-based investment banks is now gone, and two others have been merged into other institutions, but that sort of turnover is not unprecedented. At its most basic level, although fewer people may work there and they may be making much less money than before, Wall Street operates today as it always has.
But the assertion that Wall Street has ended is not the weakest part of the book’s title. That distinction goes to the premise that we, the readership of the book, knew Wall Street to begin with. It is one of the great peculiarities of that institution that, as critical as it is to the larger economy, almost nobody outside the few that work there understands what happens there and why. And in a way, this phenomenon may be at the root of our current problems.
The financial regulatory regime that was in place during the fall of 2008, and which hobbles along still, dates to the 1930s. It was then that the banks of the nation were divided into two groups. The wholesome Main Street or commercial banks became heavily regulated and enjoyed a government guarantee of their principal liabilities. The somewhat sinister Wall Street or investment banks were largely left to do as they pleased, provided that they did not seduce any regular Main Street folk over to the dark side. (Indeed much of what regulation Wall Street was subjected to concerned its intersection with Main Street rather than its internal workings. Retail brokers who handle transactions in the thousands of dollars need to be licensed. Investment bankers who handle transactions in the millions do not.) It was if lower Manhattan was cordoned off as a financial free-fire zone where those strange people could do their strange things as long as they kept to themselves. The commercial banks were understood to be vital to the economy. The investment banks, well, nobody quite knows what they do, but it seems vaguely useful and harmless enough. They were allowed to take as much risk as they could stomach, and did not enjoy a government safety net, because the failure of a Wall Street bank was not thought to have wider economic implications. The past five months have shown this to be the most tragic folly.Powered by Sidelines