Confessions of an Investment Advisor

About a year ago, Lehman Brothers filed for bankruptcy, one of the largest since the Depression with worldwide assets of US $691 Billion. Prior to the Lehman collapse, Bear Stearns was bailed out by the US taxpayers with an explicit loss guarantee of up to 30 Billion dollars. The firm was merged with JP. Morgan. Fannie Mae and Freddie Mac were put into bankruptcy or conservatorship of the US federal government in July 2008. Given the pattern of bailouts, market participants began to rightly assume that the US Federal Reserve and the Treasury would rescue all firms that were too big to fail.
As an Investment advisor at a major investment dealer, I was starting to feel quite disturbed with the culture of bailouts. I distinctly remember one of the major financial magazines put a map of the United States and had a cover that read `Bailout Nation’. It seemed to me that the government was rewarding failure and creating a moral hazard by bailing out firms that engaged in excessive risk taking and destroyed shareholder value. It would be like the government rescuing your next door neighbour who lived beyond their means and went bankrupt. Subsequently, the government stepped in and used taxpayer dollars to forgive their debts. How would an honest individual feel if they were always dotting their I’s, crossing the T’s and staying within budget and yet their neighbour is given free money? I would argue that this would encourage a laissez faire lifestyle and a culture that rewards self-indulgence.
As a big proponent of capitalism and survival of the fittest, I always thought that the government should let firms fail and survive based on meritocracy. So when the US government decided to let Lehman fail i.e. file for bankruptcy, I was pleased. The US government had taken a bold step to let the firm fail. Little did I know that the failure of Lehman, the subsequent forced marriage of Merrill Lynch and Bank of America, and the bailout of AIG, would spiral out of control and lead to a global economic meltdown that would push smaller nations, states and municipal governments in major financial turmoil.
The market disruption that started with a subprime mortgage crisis in the US, picked up tremendous momentum post-Lehman, and brought the fastest global economic contraction since the Great Depression.
Conclusions
Time heals all wounds. The global economy is linked; it cannot decouple. The US remains the largest economy in the world. 70% of the US GDP is a result of consumer spending. Since the Lehman collapse, US corporations have laid-off workers at a record pace and we are headed for over 10% unemployment over the next six months. Both, the consumer and the private corporations, reined in their spending habits to the bare essentials. Government spending through fiscal stimulus programmes around the world, are aiding the economy from falling into the Great Depression II. The fiscal stimulus and record low interest rates are meant to create demand, until such time that the private sector and the consumer resume normal spending habits.