The Wall Street Journal Guide to the End of Wall Street as We Know It
By Dave Kansas
Paperback, 224 pages
List price: $15.99
In the past year, both the U.S. and global financial systems have changed so radically that few, if any, could have predicted it. Large banks have failed, Wall Street's investment banks have essentially become extinct and borrowing has become exceedingly difficult for both companies and individuals. In order to try to save the financial system and boost the flagging economy, the government has extended more than $7 trillion — about half the total annual U.S. economic output — in various guarantees and loans.
In December, the National Bureau of Economic Research declared that the U.S. economy had officially fallen into recession at the end of 2007. Since then, tens of thousands of home foreclosures, millions of lost jobs and withered investment and retirement portfolios have added to a grim picture. It is an economic firestorm with little precedent, and its solutions will take some time to work out. Over the course of the chaos, not only have banks and companies "too big to fail" collapsed, but, in the case of Iceland, an entire nation is grappling with insolvency. Worldwide bank runs, once considered a throwback to financial panics past, grabbed headlines, and Main Street individuals feared for the safety of their cash deposits built up over a lifetime of work.
At the same time, stock markets around the globe fell sharply, surprising and angering many people who had counted on their portfolios for retirement and college payments for their children. The sharp drop in share prices forced recent retirees back to work, and those close to retiring began considering years more of work to put their broken nest eggs back together again. We're experiencing a moment when nothing and no one feels safe. In the wake of the $50-billion Bernard Madoff scandal, charities and even the very rich found themselves facing huge losses.
People are understandably frustrated and angry. Billions of dollars go to bail out banks, while families try to figure out how to make ends meet in straitened times. Fears of more lost jobs ripple through the country. It is a time of high anxiety with moments of panic arguably not seen in this nation since the Great Depression, even if the present circumstances don't exactly mirror the calamity of that age. Despite the horrible economic environment, vast shantytowns have not sprung up around major cities, and the unemployment rate, though higher than in the recent past, is still miles from the 25% seen in the 1930s.
How did this happen? In simple terms, everyone — banks, companies and individuals — borrowed far too much money and invested that money unwisely. Individuals bought more real estate than they could afford. Banks invested in mortgage-related debt that crumpled in value. Some banks borrowed as much as $35 for every $1 they invested, meaning that when things went bad, they went bad in a hurry.
All financial crises throughout time have boiled down to greed and overconfidence. From the Dutch tulip madness in the 1600s to the insanity surrounding outrageously valued Internet stocks in the more recent past, greed has driven irrational behavior, which always ends with the true value of pumped-up prices coming to light. In this case, greed drove unreasonable real estate purchases. Greed led banks to lend more money than they could reasonably expect to recoup. Greed inspired people throughout the financial system to do illogical things in the hope of ultimately getting rich.
Overconfidence meant that caution — on the part of investors, borrowers and lenders of all stripes — evaporated. Overconfidence meant that risk-management standards at even the most venerable financial institutions fell by the wayside. Overconfidence meant that too few planned for anything to go wrong. The combination of greed and overconfidence led to a financial hurricane that swept all of us before it.
Though the recent events have left people gobsmacked, the truth is, we've experienced financial panics before, though rarely of the scope and magnitude of the one we're living through today. Those of us who lived through the 1970s remember a period of high inflation and lackluster economic growth. Malaise during that period reached such a level that many wondered if the economy would ever recover. Of course, the economy recovered spectacularly in the 1980s after a tough recession in the early part of that decade.
As a financial journalist, I've witnessed other financial panics. The Asian financial crisis of 1997. The Russian crisis of 1998. The bursting of the Internet and technology stock bubble in 2000-2001. But all of these lacked the comprehensive nature of the financial crisis of 2007-2008. The notion that the "center might not hold" — that the entire system of liberal capitalism might fail — almost never became a topic of discussion during these earlier crises. But this time, the crisis took on these kinds of existential terms.
I've written about the financial markets in both good times and bad. As a reporter at The Wall Street Journal in 1995, I wrote about the Dow Jones Industrial Average bursting through 5,000. That sure feels like a long time ago. As editor in chief of TheStreet.com, I had a ringside seat to the crazy run-up of Internet stocks in the late 1990s. And during the early part of this century, I oversaw coverage of Wall Street for The Wall Street Journal during a time of rising markets.
It was during that last stint that the seeds of our present problems were sown. My colleagues and I wrote frequently about the overabundance of "easy money." It seemed that any hedge fund could borrow buckets of money from overeager banks with few restrictions. Individuals with modest means could take out a mortgage to buy a house well beyond their wildest dreams or, tragically, their basic means. Savvy Wall Street wizards created exotic investment instruments to take advantage of the oceans of debt flowing into the system. From the outside, it looked like a crazy merry-go-round that could keep going as long as the music never stopped.
But, of course, the music did stop. And all that debt turned out to have driven investment choices that ultimately made little sense. Enormous losses swamped banks, individuals and the entire system. Even as you read this, the great sorting out is continuing. Sometimes, such periods can take a long time. The Dow Jones Industrial Average didn't reach its 1929 peak again until 1954. Other times, recovery from a nightmare can come quite quickly. The 1987 stock market crash — when the Dow Jones industrials fell 22% in a single October day — hardly made a dent in the economy. And the Dow recovered its losses in less than a year.
What can we expect in the coming years? First we need to know better what has happened. From experienced bankers to neophyte homeowners, the travails of the past two years remain somewhat of a mystery. This book will explain the origins and events of the financial crisis. It will then give you guidance on how best to cope with its aftermath. It is a combination of history and strategic insight for these new times.
From The Wall Street Journal Guide to the End of Wall Street as We Know It: What You Need to Know About the Greatest Financial Crisis of Our Time — and How to Survive It by Dave Kansas. Copyright 2009 Dave Kansas. Reprinted by permission of HarperCollins.