[DEBATE] : Siegel in WSJ - The Resilience of American Finance
Riaz K Tayob
riaz.tayob at gmail.com
Tue Sep 16 11:47:32 BST 2008
More on the greatest pyramid finance scheme... ever...
The Resilience of American Finance
By JEREMY J. SIEGEL
The turmoil in the financial markets will reorganize the financial
landscape. But this does not mean the financial industry will shrink
dramatically. In fact the current crisis could well lead to an
increase in the demand for financial services, as the world grapples
with the need for new financial instruments, new risk management
techniques, and the increasing complexity of the financial world.
[The Resilience of American Finance] Getty Images
There is no doubt that some of the most hallowed names in the
industry, such as Bear Stearns, Merrill, Lehman and others will
disappear as separate entities. Their demise was caused by bad risk
management, and a failure to understand the high risks of an
overheated real-estate market, the root cause of our current problems.
We can argue about who was responsible for the overleveraging of the
financial industry and the poor to nonexistent credit standards that
prevailed in real estate. Certainly the regulatory agencies, including
the Federal Reserve, should have sounded a warning. But the lion's
share of the blame must go to the heads of the financial firms that
issued and held these flawed credit instruments and then, in many
cases, "doubled down" by buying more when their price was falling.
Overleveraging has been the cause of many past financial crises, and
will undoubtedly be the cause of those in the future. It was the cause
of the 1998 blowup of Long Term Capital Management, where the Fed also
intervened to prevent a crisis. Then two years later the tech and
Internet boom burst. If banks would have been allowed to buy on
leverage these stocks during the bubble, they would have been in even
more trouble than now.
But few were willing to admit that subprime real-estate loans could be
as risky as stocks. It was just too profitable to issue these
mortgages. So eyes were closed and the money kept pouring in.
Groupthink prevailed. To paraphrase John Maynard Keynes, it is much
easier for a man to fail conventionally than to stand against the
crowd and speak the truth.
There is no doubt in my mind that if we didn't have a proactive
Federal Reserve and deposit insurance, we would have been following
the same course as we did in the 1930s, when the bursting of the stock
bubble and fear of loan defaults led to thousands of bank failures and
ushered in the Great Depression.
That will not happen this time. The rapid provisions of liquidity by
the Fed will prevent any full scale downturn. In fact, I take it as a
mark of confidence in our financial system that the Fed did not feel
compelled to bail out Lehman Brothers as they did last March when they
folded Bear Stearns into J.P. Morgan. Certainly politics played a role
in this election year, as critics (and some Congressmen) criticized
the government for bailing out the big boys, while letting homeowners
twist in the wind.
Despite the recent turmoil, there is good evidence that the worst is
over, especially for the commercial banks with access to Federal
Reserve credit. Despite yesterday's severe sell-off, most are
significantly higher than their July 15 low, and some such as Wells
Fargo and UBS are up over 50%.
Nevertheless, the current crisis will change the financial landscape.
Certainly Bear, Merrill, Lehman and others will disappear as separate
corporate entitles. But other institutions, specifically the
commercial banks that absorb these firms, and who have direct access
to Federal Reserve credit, will become larger.
The demand for financial services will in no way disappear as the
automobile pushed out the horse and buggy a century ago. Although
unemployment on Wall Street will undoubtedly rise, many workers will
be reabsorbed elsewhere in the industry. The current financial crisis
calls out for new products and services as well as more, not less,
information about what is safe and profitable in the future environment.
It is easy to be pessimistic about the future of financial services in
the current climate. But objective facts indicate that the future
demand for these services will be high. Looking beyond past losses,
the demand for financial services, especially internationally, has
been strong. The growth of the developing countries, combined with the
aging in the developed countries, will lead to huge international
capital flows that will be facilitated by new and existing financial
It is shocking that firms that withstood the Great Depression are now
failing in what economists might not even call a recession. But their
failure was not caused by lack of demand for their services. It was
caused by management's unwillingness to understand and face the risks
of the investments they made. The names of the players will change,
but the future growth of the financial services industry is assured.
Mr. Siegel, a professor of finance at the University of Pennsylvania's
Wharton School, is the author of "Stocks for the Long Run," now in its
4th edition from McGraw-Hill.
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