No quick recovery after near-meltdown

A year after Lehman collapse

WASHINGTON, D.C.: A year ago, the financial system appeared to be on the brink of a meltdown and the future of American-style capitalism in doubt.

Dominoes were falling and the collapse of venerable investment bank Lehman Brothers on September 15 sent shock waves around the globe. Global stock markets went into a tailspin that would not hit bottom for another six months.

The government declined to rescue the Wall Street firm but stepped in with massive aid for financial giants including mortgage finance groups Fannie Mae and Freddie Mac, insurance titan AIG, Citigroup and others.

Regulators also secured a deal that saw Bank of America scoop up troubled brokerage Merrill Lynch.

On September 21, Goldman Sachs and Morgan Stanley converted their status to become regulated commercial banks, marking the end of the last two major independent Wall Street investment banks.

A year later, the system is seeing a fragile recovery but many questions remain about the near-death experience.

“What strikes me is how close we came to a financial market meltdown, which would have led to a really steep economic meltdown,” said Joel Naroff of Naroff Economic Advisors.

“And when we look back, we have to ask why was this ever allowed to happen.”

Analysts say there was no trigger for the unprecedented collapse that made September 2008 a tumultuous month.

Problems in the credit markets began brewing in August 2007 and major financial players were on shaky ground since the March 2008 rescue of Bear Stearns, in which the Federal Reserve engineered and backed the sale of the troubled Wall Street broker to JPMorgan Chase for a song.

“You had an old 19th century-style panic,” said Cary Leahey, senior economist at Decision Economics. “There was no single catalyst” for the upheaval.

“For 15 months, Wall Street was saying we are in recession. It took Main Street that much time to realize the problem. But one thing happened after Labor Day [in early September], effectively every firm and every consumer in the United States came back from vacation and said they were not going to spend a dime on anything.”

Economists say big investment banks and other players outside the scope of regulators had taken on massive risks, borrowing heavily to bet on securities tied to sub prime real estate loans.

When the US housing market collapsed, this sent the walls crashing down, freezing up credit and economic activity in the worst crisis since the 1930s.

The US administration and Federal Reserve swung into action to contain the crisis.

Congress passed the $700-billion Troubled Asset Relief Program in an effort to purge the system of toxic assets.

The central bank led by Great Depression scholar Ben Bernanke would cut rates to near zero and offer over one trillion dollars of credit on easy terms in an effort to jumpstart economic activity.

As the crisis deepened and stock markets sank further, po­licy­makers grasped for so­lutions. Some $180 billion were pumped in to save AIG, and rescues were engineered for major lenders Wachovia and Washington Mutual.

“The outlook after the failure of Lehman was very, very dire; it would understate it to say there was widespread pessimism,” said Hugh Johnson, chairman and chief investment officer at Johnson Illington Advisors.

“There was a belief that the financial crisis could not be solved and would lead to a second Great Depression.”

But Leahey said the aggressive policies to jolt the economy out of recession appear to have worked, albeit with a lag of several months.

“After letting Lehman go, policymakers did not make any mistakes,” said Leahey.

“Things could have been a lot worst if the Fed had not intervened or allowed AIG to fail.”

The new regulatory focus may curb the excesses that led to the boom and bust, say analysts.

“Hopefully what will happen is that the Federal Reserve and other regulators will have the authority to poke their heads into any systemically important operation,” Leahey said.

At the same time, the new climate of risk aversion could prove harmful to the economy in the long run.

The current focus on regulation and risk mitigation “has enormous implications for the availability of risk capital in the US and the primacy of the US financial system,” said Naroff.

“Risk capital is absolutely critical for good growth in an economy and it has to be out there.” — AFP