*wall street crumbles*

Black Sunday
an editorial by Jared Barlow

Sunday saw two of the largest investment banks on Wall Street go down and yesterday the turmoil in the markets continued. Sunday will probably go down in history and folks on Wall Street will say for decades "do you remember where you were the weekend of Sept 13-14th when Lehman and Merrill went down". Lehman Brothers, one of the the oldest broker/dealers on Wall Street, died over the weekend and filed for bankruptcy Monday morning...not entirely surprising, it has been rumored they were next to go since Bear Stearns died last March when it went to JP Morgan in a firesale. On Sunday Merrill Lynch, the world's largest brokerage, announced it was selling out to Bank of America. Pre-empting a firesale (or worse) Merrill smartly found a buyer before it got any closer to its death bed. 3 of the 5 large independent investment banks are now gone (Goldman Sachs and Morgan Stanley remain). AIG, the world's largest insurer, is now on the ropes (stock down another 60%+ yesterday and 90%+ year-to-date)..the end for AIG could be any day (or hour) unless they get some capital quickly. After that my guess is that the next to go (or at least face a world of hurt) are WaMu and Wachovia; both have massive exposure to the mortgage market and need to raise capital or face insolvency. The government already back-stopped (with tax payer dollars) Bear's sale to JP Morgan (government assumed up to $30 billion in losses) and also took over Fannie Mae and Freddie Mac, the two massive mortgage companies that became insolvent a few weeks ago. All this at a massive expense to the US taxpayer, but the Fed determined the collateral damage of not doing so would be worse. The Fed had to draw the line against a bail-out of Lehman and AIG to teach the market there remains a "moral hazard" and that the US taxpayer will not be a "catch all" for the bad decisions and risks taken by companies. 18 months ago few could have thought that Bear, Lehman, Merrill, Fannie and Freddie - huge pillars of the American financial system - could all go down the way they have. The fear continues to be that there will be a continued ripple effect of pain throughout the financial industry and of course on to the broader economy. I walked by the Lehman building here in NY yesterday, people did not look happy there. Wall Street is being brought to its knees right now as almost never before. All the old guys on Wall Street - the guys with 30+ years of experience - are saying they've never seen such extraordinary events as are taking place now. Some quotes from big wigs on what has transpired:

"[The credit crisis] is in the process of outstripping anything I've seen, and it still is not resolved and it still has a way to go...Indeed, it will continue to be a corrosive force until the price of homes in the United States stabilizes. I can't believe we could have a once-in-a-century type of financial crisis without a significant impact on the real economy globally, and I think that indeed is what is in the process of occurring." Allan Greenspan, former Fed Chairman (also said the bottoming out of housing prices would not likely occur until some time in 2009)

"This is the biggest reshaping of the financial industry since the Great Depression" (Wall Street Journal)

"The tectonic places beneath the world financial system are shifting, and there is going to be a new financial world order that will be born of this." Peter Kenney, Knight Capital Group


How did all this happen? In short...an era of super cheap debt (2001-2007) for companies and consumers fueled over spending and a credit "bubble" that is massive and painful when popped. The culprits? Wall street firms themselves, banks generally, the government (Fed), and spend-thrift consumers. All have played a role. The Fed has kept interest rates super low the last few years to stimulate the economy and didn't adequately regulate the mortgage industry. This fueled significant growth (and speculation) but also resulted in a huge over-extension of credit to companies, banks, investment firms and consumers. Companies and consumers have taken on much more debt then they could ever handle adequately. In the run-up in home prices consumers started thinking of their homes as ATMs, taking loans against their equity and increasing their debt over-hang until they had no equity left. When prices correct, your debt-load is high, and your equity is gone you're in a world of hurt, whether you're a homeowner in Vegas or you're a Fortune 500 company that is leveraged to the hilt.

Global shift in wealth (away from the US and toward foreign economies): The crisis in the US financial system combined with the run-up in global commodity prices (oil, gas, minerals, etc.) has resulted in a massive wealth shift. America is literally mortgaging itself right now...and it is doing so largely to foreign investors (not necessarily a bad thing, without them we'd be in much worse shape). Just as our financial system is hemorrhaging... Middle Eastern and Asian countries and investors (as well as Russia) have been reaping HUGE profits in commodities as prices have risen and as these "emerging markets" have enjoyed generally strong economic expansion (although oil/gas prices fortunately coming down in recent weeks). 10-20 years from now I think we'll look back and see 2007-2009 as a turning point, a time when the US was seriously weakened on the world stage, when the layout of the US financial system was forever changed and when powerful world actors (economically and politically) emerged in Asia and the Middle East.

Silver Lining (barely perceptible at present, but present none-the-less): There is a lot of doom and gloom now and certainly more pain still to come, but long term the market will get through this. The US is resilient and will rise from this (albeit slowly) and should not be written off. For those with capital to deploy there are going to some of the best buying opportunities in a generation. Get your eTrade and Schwab accounts ready (can't say I have any stock picks for you just yet...). In my line of business (private equity secondaries) we're currently raising lots of money to tackle buying opportunities. Some will make a fortune coming out of this if they play it right.

But what does all this mean to us? Understand the magical effect of leverage (debt). It can help you; it can kill you. It has made investors billions and wiped it out just as fast. Debt is not a bad word...understood and used appropriately debt is extraordinarily useful and crucial to a functioning financial system. Used inappropriately debt can be a prison that does not let you get free. Be cautious and conservative in its use in your daily life; understand how it works and make it work for you. Live within your means. Re-read the several articles from President Hinckley and others the last few years when we were warned/reminded of these principles. I was reading 1st Nephi on the plane the other day...a classic phrase kept jumping out at me: “Inasmuch as ye shall keep my commandments ye shall prosper in the land” (1 Nephi 4:14). This simple statement is probably repeated more times in the Book of Mormon than almost any other...to the extent it risks becoming numbing and we gloss over it. The promises made to the inhabitants this land still apply, but only if we are doing what we need to be doing and are following the Lord. Important stuff for us all to remember.

Regards,

Jared