Over the past year a long string of news stories has given a blow–by–blow account of the crumbling power structures of Wall Street. Countrywide Financial, was forced to sell itself after building up a portfolio of almost one and a half trillion dollars in loans. After being badly damaged by the mortgage crisis, Bear Stearns was bought by JP Morgan Chase for a bargain basement price. Bank of America acquired Merrill Lynch in a last ditch effort to avoid filing bankruptcy. Lehman Brothers was not so fortunate, becoming the largest bankruptcy in U.S. history.
We’ve also seen the largest destruction of shareholder value in American history with the collapse of AIG: $180 billion gone in a matter of days. By comparison, Enron, the largest failure when it filed for bankruptcy in 2001, wiped out $60 billion—a mere third of AIG’s loss. More recently, Washington Mutual accounts for the largest bank failure in US history. The Wall Street investment bank no longer exists, as Goldman Sachs and Morgan Stanley have become standard bank holding corporations, submitting to greater regulatory scrutiny in an attempt to strengthen their balance sheets with deposits from traditional banking customers.
While some politicians were making impassioned statements about slow growth and the weakening manufacturing industry over the past 5 to 6 years, there were many sectors of the US economy that were growing like wildfire. Now that the entire system has been burned, it is clear that much of this growth was fueled by nothing more than greed and complicated arithmetic. Even those who criticized the state of the economy failed to take note of the disaster that was lurking in some of our nation’s most respected financial institutions.
The situation deteriorated to the point where the Chairman of the Federal Reserve, Ben Bernanke, and the Secretary of the Treasury, Henry Paulson, pleaded with Congress to enact legislation allowing the US Government to spend hundreds of billions of dollars on buying depressed assets from struggling financial corporations.
What is a depressed asset? An asset is anything that has some economic value and can generally be bought, sold or traded for some other asset—cash, a house, a car, a share of stock, or in the case of these banks, collateralized debt obligations and mortgage–backed securities. In a market–based economy, the value of any asset at a point in time is the amount that a buyer is willing to pay for it. An asset becomes depressed when its value drops below the inherent worth of the asset or below a level where the owner can sell it without incurring massive financial harm.
The meltdown in the housing market and a growing foreclosure rate have created a giant crisis of confidence in any asset backed by mortgages or real estate, and as a result they have plummeted in value. Banks, investment houses and insurance companies rely on the value of their assets to guarantee that they can raise capital and obtain the credit they need to continue to function. When those assets are depressed, a bank cannot sell enough of them at a price that allows them to continue operating. The flow of cash and liquidity slows to a crawl and the bank’s customers may be unable to make withdrawals or access their funds.
With the ownership of these depressed assets spread throughout the financial system, the liquidity slowdown can cause a complete gridlock that will affect not only Wall Street firms, but banks, businesses and families throughout the country and even around the world. This is similar to the financial crisis that affected the Japanese economy for almost 14 years from 1991 to 2004. In that situation, the crisis also started with a real estate bubble bursting that created a ripple effect through the financial system and a massive increase in bad debt. After the situation reached an apex, it took years and several rounds of massive government intervention to resolve the crisis and restore stability to the economy. Bernanke and Paulson have described their proposal as an attempt to apply a comprehensive recovery effort early and avoid a similarly prolonged economic stagnation. Even still, they are unsure if it will be successful, or too little, too late.
A tarnished global reputation
Whatever the outcome of the government’s plan, the run–up to the current events and the staggering mistakes of America’s revered financial giants has left the rest of the world shaking their head in disbelief and searching for opportunities to increase the prominence of their individual economies. These countries feel that the United States has long had an economic superiority complex and run roughshod over other nations. Now, what was the crown jewel of free market economies is in turmoil after a series of missteps. Other developed nations are frantically taking their own measures to try to limit the global repercussions. And some are seizing the moment to try to claim a more prominent and powerful position on the world stage.
On September 25th, the German Minister of Finance, Peer Steinbrueck, spoke to Germany’s lower house of Parliament. He told them, “One thing seems very likely to me. The United States will lose its superpower status in the world financial system. The world financial system will become more multi–polar.” He also criticized the “Anglo–saxon capitalist drive towards large profits and massive bonuses for bankers.” Steinbrueck later discussed the role of the dollar as the world premiere reserve currency, saying that in the future, it would just be one of several major currencies alongside the Euro, the Yen and the Yuan.
French President Nicolas Sarkozy has also discussed the need for an overhaul of American–style capitalism. Sarkozy called for world leaders to meet together and create a plan to overhaul the global financial system. “It is the duty of the heads of state and government of the countries most directly concerned to meet before the end of the year to examine together lessons of the most serious financial crisis the world has experienced since that of the 1930s.”
Bloomberg reports that countries like Brazil, Venezuela, Bolivia, and Argentina, who have often felt the weight of America’s economic influence, are also taking the opportunity to lash out at the United States. The report quotes Cristina Fernandez de Kirchner, President of Argentina, as saying “No one can talk about the ‘caipirinha crisis’ or the ‘tequila crisis’ or the ‘rice crisis’ or whatever name that always denoted the crisis was coming from emerging markets. We should perhaps call it the ‘jazz crisis,’ where the effects emanate from the center of the biggest economy.”
Even if the United States is able to stabilize the financial system and secure the flow of liquidity, a full recovery may be slow arriving. Doubts about the resiliency of the American economy have continued to spread and grow, and some analysts fear that many individuals and corporations will cut spending and investments to a level that could halt growth or even cause a contraction. A crisis of this magnitude has created a sense of panic in many investors that will be hard to overcome.
This financial crisis has undermined and embarrassed the US financial empire, revealing the faulty principles on which it has been built. The implications will continue to ripple around the world for years to come as the sun sets on American economic supremacy.