Wall Street Woes: Who Gets A Bailout?

The Dow dropped a mind-bending 500 points Sept. 15 on news that the federal government would not bail out investment banking giant Lehman Brothers. NPR's Adam Davidson, looks at why some firms get help and others don't.

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NEAL CONAN, host:

This is Talk of the Nation. I'm Neal Conan in Washington. Here are headlines from some of the stories we're following here today at NPR News. Republican presidential candidate John McCain said he would create a 9/11 commission-style panel to study the economic crisis in the United States. His opponent, Democrat Barack Obama, accused McCain of passing the buck. Obama said he would provide real leadership on the issue. And the Federal Reserve decided today to keep interest rates unchanged. Meanwhile, shares of the giant insurer American International Group, or AIG, dropped again as investors questioned whether it would be able to come up with enough money to stay in business. We'll have more on that in just a moment. And you can hear the latest on these stories and of course, much more later today on All Things Considered.

Tomorrow, we're back at the Newseum with Ken Rudin, our political junkie, and two veteran campaign strategists. Both presidential candidates suddenly have a close race on their hands. We'll talk about what it will take to win this election. Plus, find yourself quoting Ken Rudin at the dinner table (unintelligible) on our political addiction. That's tomorrow on Talk of the Nation from NPR News.

Remember when we referred to the slow drip of economic bad news as Chinese water torture? As of yesterday, the news resembles nothing so much as water boarding. After riding out wars and depressions for almost 160 years, Lehman Brothers bought the farm. Another banking sequoia, Merrill Lynch, sold itself to Bank of America. The biggest insurance company in the world totters on the brink, and savings and loan giant Washington Mutual had its credit ratings cut to junk. That's just one thing to be thankful for, it's all time for our weekly visit from the econonaut.

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CONAN: That's right, it seems like a job for NPR's international economics correspondent Adam Davidson. He's with us today from New York. And nice to have you back on the program, Adam.

ADAM DAVIDSON: Hey, Neal, always great to be here.

CONAN: And of course, here's your chance to ask a question about this mess. What does it mean for you? If you have a question about the next to fall and what it means, give us a call, 800-989-8255. Email us, talk@npr.org. You can also join the conversation on our blog at npr.org/blogofthenation. And Adam, the phrase "moral hazard" has gone from a, you know, a question on the Econ 101 test to something that's in the leading paragraph of every other story on the front page of the newspaper.

DAVIDSON: Moral hazard is such an important concept and it's - I'll be honest, I'm very happy that at least one thing has come out of this crisis. This phrase is on a lot more people's lips and in a lot more people's ears.

CONAN: And moral hazard comes up in today's conversation because AIG, the giant insurance company, well, it's in talks and well, earlier today, there was word that the federal government might come to the aid of AIG. The concept was on the table. And the stock market leapt with joy at the news, and then the chairman of the Federal Reserve said, well, wait a minute, I'm sort of opposed to the concept, it would violate the concept of moral hazard. And the stock market went back down.

DAVIDSON: Yeah, and it - let's define moral hazard. It sounds like, I don't know, something that happens in Las Vegas that you never talk about it again. But it's actually something that, you know, applies more to banks and the like. Basically, you and I as citizens, the listener as a citizen, we don't want - we want the people who run banks - I think this is safe to say - we want them to take risks but to bear the burden of those risks. We - that's how capitalism works, that's what creates economic growth. People take risks, and then they get the benefit of the risk. When moral hazard is in - exists, that's when people take risks, like bank presidents and the like. If they make money, if the risk pays off, they get to keep the money. If they fail, then the government, the taxpayer, bails them out. This is bad for several reasons. One is, we as taxpayers don't want our money going to other people. But even worse, it encourages people to take bigger risks because they're not bearing the burden of the downside.

CONAN: One might speculate, dumber risks.

DAVIDSON: Dumber risks, more reckless risks, exactly. So the long-term risk here is that we've bailed out so many institutions, we might bail out another institution in five years from now, 10 years from now. Whoever is running whatever banking institutions are left at that time says hey, I'm going to take that huge risk because if it pays off, I'll get a billion-dollar, you know, bonus. And if it doesn't pay off, I bet the government's going to help me out just like they did back in 2008 with all those other companies. We don't want that. But at the same time, we don't want the whole global economy to collapse, so that's the argument in favor of taking the moral hazard risk and just bailing them out.

CONAN: This was the argument put forward when Fannie and Freddie - this was last week's crisis, ancient history at this point - but when Fannie and Freddie were in danger of going under, there was a sort of wink-wink, nod-nod, nudge-nudge. These are private corporations, but they were created by the government and the government sort of, kind of, sort of stands behind their values. So the heads of those companies took greater risks. They didn't keep as much money on hand to cover potential losses as they might have and well, when they came up, they turned out to be right - there was no moral hazard, the government bailed them out.

DAVIDSON: Well, Fannie and Freddie are creatures of moral hazard. They're different from Lehman Brothers, Bear Stearns, all these others. Fannie and Freddie were created. They are a walking, talking, screaming moral hazard that's been in the American financial system for 70 years because they are exactly what I described - a private company that gets the benefit of any risks, but the government, for 70 years, has told the world - like you said, with a wink and a nudge - we're going to take care of them if anything bad happens. And that's why they took stupid risks. I don't think three years ago, when Lehman Brothers and AIG and Bear Stearns were taking their stupid risks, and let's always remember, they took some really stupid risks, I don't think they were thinking the government will definitely bail them out. But Fannie and Freddie, they were different animals. They always knew the government was there, and so they have been moral hazard to the core from day one. The other one's moral hazard has shown up just in the last few months.

CONAN: And the question of the day - I guess, maybe the question of the week is AIG, the largest insurance company in the world and boy, I saw a couple of ads but I never knew they were this big until this week. Are they too big to fail?

DAVIDSON: Yeah. I mean, I think on Sunday, those - and I'll say those of us because I count myself in this group - who are concerned about this moral hazard issue were glad in a way to see Lehman Brothers be allowed to fail, the government say we're going let them fail. And certainly, Henry Paulson, the Treasury secretary, wanted to make a statement: We're done with the bailout game, you all are on your own. Well now, we're learning that maybe we're not done with the bailout game, that maybe Lehman Brothers just wasn't quite big enough, that they weren't quite risky enough to be bailed out, but AIG is. Now, why would AIG? Why would an insurance company be so big that we have to bail them out?

It has nothing to do with like your auto policy, your life insurance policy, it's something much more obscure and confusing. Of course, it has to be something obscure and confusing in this economic crisis. They insure, and they've gotten really big in this in the last few years, bonds and financial instruments. This is like little, tiny pieces of insurance that they give to investment banks, to other banks, to all sorts of financial institutions around the world. And now, what we're finding out is AIG issued that insurance but doesn't have the money. It's called a credit default swap. It's not actually insurance, but it acts like insurance.

They don't have the money to back up the claim, which actually causes a crisis throughout the banking system because your banks and pension funds and all of these people all over the world who thought they had insurance - just like if you found out today you don't have an auto policy, you don't have an homeowner's policy, that might freak you out a little bit. And I don't want to get into all the complexities in the short time we have here, although we do talk about it on our blog. I'm going to be writing about that at npr.org/money, I'll just mention. But it has the potential to really freeze up the global financial system, and that is as scary as it sounds.

CONAN: All right. We're going to get to some questions. We were talking about the financial situation on the program yesterday, and we had some questions from listeners we didn't have time to get to and well, speaking of retirement plans and 401ks, this is from Sharon in Chicago: Should we be concerned about moving our 401ks from places like Morgan Stanley? Are individual retirement accounts at risk?

DAVIDSON: No. A mutual fund - I mean, the reason that word mutual is there is it is technically, legally as I understand it - and I'm not lawyer - but as I understand it, it is a separate company owned by the people with shares in that company. So if you have your 401k at Lehman Brothers or Merrill Lynch or Tia-cref or whatever, it's not that that company owns it. They're managing it for the owners, and you're one of the owners. So it's your money, you'll get the money back. There's always a possibility when a company is bought or merges or goes bankrupt and someone else picks up the pieces that there will be a short-term disruption as systems are intertwined. But over a few days, weeks, those should be sorted out. So it's your money, you're fine.

CONAN: Let's get Judy on the line. And Judy's with us from Lapeer in Michigan.

JUDY (Caller): Hello. Thank you for taking my call.

CONAN: Go ahead, please.

JUDY: My question is in regards to Lehman. If I have Lehman in my portfolio at the brokers and now they've gone under, do I lose that amount of money or is that protected by the FICA?

CONAN: Welcome to moral hazard, Judy.

JUDY: Thank you.

DAVIDSON: You mean you own Lehman stock?

JUDY: Well, perhaps. It's listed on my portfolio with the brokerage firm as something that is part of our portfolio.

DAVIDSON: Yeah, well, you're out of luck.

JUDY: We're out of luck. That amount of money is gone.

DAVIDSON: I mean, if you bought it at a higher price than 20 cents, where it is now, then yeah. The distance between 20 cents and whatever you bought it, that's gone, and that's not insured. That is when you buy stocks, you need to be aware that you're taking on market risk, and this obviously did not go your way.

CONAN: We did hear the last couple of days that Barclays, the big British bank, has some interest in some of the assets of Lehman. If they pick something up, might Judy be in a slightly better situation?

DAVIDSON: Yeah. It's possible, but I wouldn't be buying Lehman stock today. It's at 20 cents, there's no point in selling it. I mean, yeah, hold on to it. But yeah, that's not an attractive stock to own right now.

JUDY: OK. Thank you so much.

CONAN: Judy, good luck. We're talking with NPR's international economics correspondent, Adam Davidson. He's our econonaut on Tuesdays here on Talk of the Nation. And he also, as he suggested, writes at NPR's website. Adam, what's the site again?

DAVIDSON: Npr.org/money.

CONAN: And you can go there. You can also give us a call, 800-989-8255. Email us, talk@npr.org. Stay with us. I'm Neal Conan. You're listening to Talk of the Nation from NPR News. And let's go now to Claudia. Claudia with us from Denver, Colorado.

CLAUDIA (Caller): Hi. I turned on the radio, and I hear Washington Mutual and I hear reduced to junk. So as an individual, I'm thinking, I have two mortgages with them and last week, I was going to put a substantial amount in CDs because they're offering such high, like 5 percent, which is pretty high compared to - and I hear what you're saying and I'm thinking well, I wonder if I have anything to worry about and are the CDs and all that - are those all separate accounts?

DAVIDSON: Yeah. If you put cash in or a CD, as long as you keep it below a 100 grand for all your accounts at one bank, that is FDIC-insured. The FDIC is really good. I mean, they step in and there's not usually even a minute where you don't have access to your money. So, I'm not quite sure I would jump at putting money in Washington Mutual. I mean, I certainly, we're not recommending stocks or anything like that, but I'd say, I don't know. I'm not going to give you advice one way or the other, but that amount is secured by U.S. government insurance.

CLAUDIA: How about mortgages? I don't know quite what I'm asking. Like other people, you hear the name of the place, you have two mortgages there, I'm subjective and I'm thinking, huh, I wonder that means.

DAVIDSON: Yeah. They're going to be sending you your bills and making you pay. There's a decent chance. Washington Mutual is a servicing company that - they don't actually own your mortgage, and it's possible that servicing contract will be sold to someone else, and you'll be getting bills from someone else. We're going to have to see how that plays out. Washington Mutual is alive and well and functioning right now. So, those kinds of things, don't worry. They want your money enough. They're going to let you know who to send the check to.

CLAUDIA: OK. Thank you very much.

CONAN: Some people can hear the footsteps on the stairway of the Bailey Savings & Loan.

DAVIDSON: It's a tough time, and we are going to see more bank failures. I think that's unquestionable. We're going to see a lot of bank failures. But it is a different world than the Great Depression world and the world of Bailey Savings & Loan from "It's a Wonderful Life." The government has gotten pretty good at sorting out, you know. Don't have more than 100 grand at any one bank is smart.

CONAN: Not a problem for most people.

DAVIDSON: Most people are OK. I'm certainly fine with that. Don't own stocks that you don't even know that you own them. That's not a good idea. Most people, in my view - and I don't like to give personal advice - but most people should just buy mutual funds. They shouldn't own individual stocks, especially if they don't know what they are. That's not a good idea.

CONAN: Let's get a question in from Anna. Anna with us from Kansas City in Missouri.

ANNA (Caller): Yes. Thank you. I would like to know to what extent the tax cuts that we've recently had the last few years, how did that play into the economy and the debt and all of that? It seems that we're not funding our government by having continued tax cuts and if those continue, does that play into the diminishment of the...

CONAN: How does that play into this crisis that we're seeing on Wall Street?

ANNA: Are they responsible for the debt that we have and that we're building up at an astonishing rate?

DAVIDSON: Yeah. I mean, we have a big debt, and the government is in deficit. And there's a debt that goes up so on a first approximation, the tax cut doesn't cut away from that. I mean, lots of people like to point out the government's spending also adds to it. So you can't talk about one without talking about the other. The general theory is that at some times in some situations, tax cuts can improve economic health overall and actually improve and people are going to write angry letters to me, I know this. I'm not saying just all the time the Laffer curve works or all the time supply-side economics works. But sometimes, tax cuts can improve economic growth and eventually, government tax receipts.

So it's not simply true that you have to raise taxes every time. But right now, the U.S. government has more than enough money or more than enough access to capital to handle this crisis. I'd say the taxes are a longer-term issue. They contributed to the crisis by creating - it gets very complicated - but by creating global imbalances. But I wouldn't say that they are the first- order issue that we need to be addressing right now, right at this moment.

CONAN: Anna, thanks very much for the call. Appreciate it.

ANNA: Thank you.

CONAN: And Adam, we just have a few seconds left but those of who are climbing out on the ledges today and yesterday looking at dismal futures, do you suggest we should climb back into our offices?

DAVIDSON: Look, it seems like it's going to be a tough, a bumpy ride for a while. And it could be a bumpy for another year or so, that seems reasonable. But by bumpy, we're not talking Great Depression bad, we're not talking end-of-our-way-of-life bad. We are talking maybe, possibly an extended slowdown, something like what it was like in the late 1970's, an extended period that's not like the last 20 years, where there's just constant growth and everything's going up. But that will end. And life will continue, and most people will be fine.

CONAN: And Adam will be back with us next week, when we'll sing a duet of "Brother, Can You Spare a Dime?"

DAVIDSON: Right.

CONAN: Adam, thanks very much for your time.

DAVIDSON: Thank you, Neal.

CONAN: Adam Davidson is our econonaut and NPR's international business correspondent. If you have questions we haven't answered today, send them to planetmoney@npr.org. And this is NPR News.

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Q&A: The Rise And Demise of Wall Street Firms

Lehman Brothers' decision to file for bankruptcy and Merrill Lynch's decision to sell itself to Bank of America mark a historic restructuring of Wall Street.

Now — following the sale of Bear Stearns in March — only two of the five largest independent broker-dealer firms are still standing. Here, a look at some of the implications this sea change will have on the financial landscape for consumers.

What happened to Lehman Brothers and Merrill Lynch?

Lehman Brothers, the 158-year-old Wall Street firm, filed for bankruptcy as a result of an unsuccessful quest to find a buyer.

Meanwhile, Bank of America is taking over Merrill Lynch, one of the largest Wall Street brokerages. Bank of America agreed to purchase the firm for $50 billion in an all-stock transaction.

Both Lehman and Merrill suffered large losses in the past year from mortgage-related investments that lost value as home values declined.

What happened to Lehman's search for a buyer?

Reports indicate that companies that were weighing whether to purchase Lehman Brothers got cold feet when they learned that the government would only facilitate discussions and wouldn't commit any cash to help save Wall Street firms.

The Treasury Department and the Federal Reserve engineered the sale of Bear Stearns to JPMorgan Chase in March by guaranteeing some of Bear Stearns' debt as an incentive for the purchase to go through quickly. In the case of Bear Stearns, the government put nearly $30 billion of taxpayer money at risk.

How do I know Bank of America won't fail?

With the purchase of Merrill Lynch, Bank of America — which also recently purchased Countrywide Financial, one of the nation's largest mortgage lenders — is poised to become one of the world's largest financial institutions. Bank of America has sustained losses from mortgage-related investments, but it has deep pockets from different business lines, including its retail banking and credit card businesses, that put it in better financial health than many of the troubled Wall Street investment banks.

A spokesman said Bank of America was "one of the strongest banks in the United States," with second-quarter earnings of $3.4 billion and nearly $163 billion in shareholders' equity.

He said Merrill Lynch's underlying business remains very strong and that the firm has done a lot to directly address its "problem assets" from housing-related investments they made.

What does this mean for me if I have accounts with Merrill Lynch or Bank of America?

The deal won't close until the first quarter of 2009, so there won't be any immediate changes for clients of either company.

Ken Lewis, the chairman and CEO of Bank of America, said the Merrill Lynch acquisition was a "strategic opportunity of a lifetime" for its retail and corporate banking businesses. Bank of America said that the purchase of Merrill will create the largest brokerage in the world, with $2.5 trillion in assets.

A spokesman for Bank of America said that it plans to use Merrill Lynch's name for wealth management activities and that further decisions about the use of the Merrill brand won't occur until the transaction closes.

Currently, about half of Bank of America's business is in consumer and small-business banking, including deposits, credit cards and home loans. About 30 percent is devoted to corporate and investment banking, 15 percent focused on wealth management and the remaining 5 percent in miscellaneous business lines. A spokesman said the Merrill acquisition will enable Bank of America to increase its corporate and investment banking and wealth management businesses.

Will a bigger Bank of America translate into savings for consumers?

It's too early to tell. But it will depend on whether efficiencies from the combination trickle down to consumers.

John Thain, CEO of Merrill Lynch, said the sale of the storied firm with a bull as its logo wasn't "the outcome I would have expected when I took this job," but he said that the purchase presented a good opportunity for Merrill's shareholders and employees — including its flock of 16,000 brokers.

Lewis said Bank of America plans to keep the Merrill organization intact, but he didn't rule out layoffs once the two companies merge. The joint company, he said, would be "a much stronger entity and will survive most anything as a result of the combination."

What's happening with AIG, and are other companies in trouble?

Insurance giant American International Group Inc., one of 30 stocks listed on the Dow Jones industrial average, insures bonds tied to the mortgage market. When mortgage defaults go up it has to cover these bonds. It's facing a large ratings downgrade that would be devastating to its bottom line, and its stock price has fallen dramatically in recent days.

AIG gained permission from New York state to use $20 billion in assets held by its subsidiaries as collateral to borrow cash to help it stay afloat. New York Gov. David Paterson asked the state's insurance regulators to permit AIG to make this loan to itself while also calling on state regulators to push for a separate federal loan to the embattled company. AIG has asked the Federal Reserve for emergency funding.

All of the firms on Wall Street have ties to one another. That creates ripple effects throughout the markets. One firm's demise can drag down others. Other financial services companies are likely to face problems in the coming months as a result of investments they made in housing-related bonds.

Is the housing downturn the primary cause of the financial turmoil?

Secretary of Treasury Henry Paulson said on Monday that he remains confident in the "soundness and resilience" of our financial system, but he reiterated his assertion that the housing correction is "at the root of the problem." Turmoil in the financial markets will continue, he said, until there is "more stability in housing prices."

In terms of timing, he said it's likely that the worst part of the housing correction may be behind us within a "number of months as opposed to years."

Economist Dean Baker, co-director of the Center for Economic and Policy Research, agrees that the housing crisis has kept the financial markets in disarray. Housing prices, he says, continue to fall at a quick pace: "When you get rapid decline in house prices you are going to see very high rates of defaults and foreclosures."

Neither Bear Stearns, Lehman Brothers, Merrill Lynch nor any of the other Wall Street firms were "banking on this sort of downturn," he explains.

What's more, consumers are having trouble making payments on everything from consumer loans and car loans to credit cards.

"There's a lot of evidence that with virtually every type of loan the default rate is rising," says Baker.

From NPR reports and The Associated Press

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