Monday, September 15th, 2008...1:14 am

It’s The Stupid Economy

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I returned back to reality Sunday night after a fun and mindless weekend celebrating the Great Weino’s great wedding. I checked in with my dad to get the weekend update (on both my family and the world) and the first thing I learned from him is that it’s official: Wall Street has failed. (Actually it was the second thing. First, he told me the inning by inning performance of the Met’s relief corps this weekend. Talk about failure!)

Back in March, right after Bear Sterns collapsed, I became keenly alert of Wall Street. I didn’t like what I saw and I didn’t buy what the financial news experts had to say. It just didn’t add up. Seemingly out of nowhere one of the most prestigious banks was gone. It wasn’t even a reaction to a sensational development. I wrote a strongly-worded blog post in which I argued that Wall Street had been greedy and now it was about to pay the price. Here is one excerpt

I’m going to short the Dow, short Lehman Brothers and look into shorting every other bank that doesn’t have a commercial bank or extensive cash reserves. If you want to know where the speculators are betting check out the activity on put options. I’ll also start to look at other credit companies (cars, credit cards, etc.) and see if there are other disasters waiting to happen. Maybe, I’ll take it to the next step and figure out which industries are prone to disaster as soon as their credit lines dry up.

The very next day Lehman stock price shot up on news that the Fed was creating a discont window of cash reserves that would allow financial banks to have access to liquidity. I didn’t invest at all. My blog post was written off the cuff after one week of interest and it’s much easier to write a blog post than to plop my savings account down on a short-sell hunch.

So tonight when I learned that Lehman is done, Merill Lynch is being swallowed up by Bank of America and that AIG has more bad debt than Charles Barkley (and all of this on top of the collapse of FannieMae and FreddieMac a few weeks ago) I can’t say I’m all that surprised. But, I’m not writing this blog post to pat myself on the back. I want to discuss what I think will happen next.

Please remember that I have very limited experience in finance. I haven’t taken an economics class since high school and on a daily basis I probably follow the markets as closely as I do NASCAR (I kind of think Biffle is a dark horse to take the chase. That dude can drive.). In my last blog post, I might have got a bit carried away trying to be too punchy so I’ll be more direct here.

I was saddened and scarred to learn about today’s events. It basically is a signal that conditions are so bad that there is absolutely no way for the most prestigious financial institutions in the world to save themselves. Yes, the Lehman collapse was somewhat expected but Merrill putting together a merger within hours means that they were also fearing the worst and probably beat the street by just a few days as it would have been the next target to collapse. AIG restructuring 40 billion in debt means that the insurance industry is as broken as the financial industry.

Lehman had so much bad debt sitting on their books and it was impossible to move. Just because Lehman goes belly up, or Merill merges, doesn’t mean that debt disappears. I’m not exactly sure what happens but it seems that between all of the major banks there is hundreds of billions of dollars of bad debt? Is nobody paying their mortgages any more? Or has wall street created such finely engineered derivatives of derivatives that the slightest economic tremors and change in market conditions will blow up the entire market?

I know some very bright people who work at Lehman. I’m sure they are bummed but they are smart and young and will land on their feet. There are thousands of other employees who will probably lose their jobs and have already lost their valuable stock. As sad as it is, this is only the very tip of the iceberg. I’m more concerned with the macro effect of this bank failure as it permeates through the global economy.

There are rumors that Washington Mutual will soon fail. There is talk that hundreds, or even thousands, of regional banks will fail. Now people are wondering if Goldmen Sachs or JP Morgan will need to merge in order to have the backing to stay afloat in the longterm. I expect all these things to happen. The negative momentum of this market is too great to overcome and rumors become self-fulfilling prophecies. Just because things are bad doesn’t mean we are near the bottom. That would be like me declaring my ankle (which I sprained this weekend) will soon get better because it’s more black and blue than it has ever been before.

I get nervous every time I hear that the government or the Fed bends the rules to help stabilize the markets. We are a capitalist economy, Laissez-faire, right. Every student who has ever taken a finance or economics class knows that term. Laissez-faire has a hugely positive connotation. So when the Fed creates new policies to support the economy, alarm bells start ringing in my head. The ONLY reason why the Fed would be doing this kind of unprecedented stuff is to prevent total collapse. If their hand is forced to do things to prevent catastrophe, I can only imagine that these maneuvers will have horrible long term effects to the economy. Otherwise, why wouldn’t the Fed already have these policies in place? In addition, while the Fed is set up to steer our capatilist economy in the right direction they is no guarentee that it will work.

One major negative effect of the Fed’s actions is that the rest of the world economy will look at the USA banking system as being weak. The US no longer is the most important economy as we are now part of a global economy with some very formidable competitors. When I hear about countries that print currency and experience inflation (ex. Uganda, Yugoslavia) I think it’s an unstable banana republic. Those stories about people bringing suitcases full of cash to buy a loaf of bread sound apocalyptic (unless you are trying to make it rain at a strip club). I would expect that other parts of the world will look at the US tomorrow and feel the same way. There’s lots of Middle Eastern oil money, Chinese dollars and European wealth infused in our economy. What happens when these people get skittish and begin to call in their loans? I don’t know.

The DOW is on track to open down over 300 points tomorrow. I’m sure that by the time you are reading this it will have already taken a major hit. At some point, the traders will dive back into the market trying to hunt for bargains. My guess is that these guys will get burned again. I’ve had a few people in finance tell me how “psycho” the market has been acting and they are sweating it out. But to me it seems like the market is acting rationally. It’s going down. That’s because the economy is bad and companies aren’t making as much money as they once did. Perhaps the concern is that the markets aren’t acting as they usually do. That makes sense too. The events that are effecting the markets aren’t normal.

Tomorrow marks the start of BAD. Besides horrendous debt, the failure of the banking environment will mean that credit will become difficult to obtain. This will further slow the economy and metastasize to every industry. AIG might just mark the beginning of the Insurance industry collapse. My industry is Media. Everybody in media seems to be in denial that this soft economy will ravage the advertising marketing and growth of media. How could it not? How bad will it be?

As long as conditions are bad the economy will get worse. The four major diseases are

1) Housing Crisis – Home prices are plummeting, mortgages are defaulting, the market is illiquid
2) Energy Prices - The world is dependent on Oil and Natural gas and consume it at almost any cost. The higher the energy prices the more money is being sucked out of the US economy. Prices have come down recently but the volatility is startling.
3) Banking/Credit Collapse – The US economy relies upon the major Investment and financial banks for liquidity, to create markets and to engineer the economy. The banking system is broken. The Fed has stepped up but they can’t replace the banks.
4) The Dollar – It is weak. Other countries want no part of a dollar that is weakening. When our dollar becomes weaker our position in the global economy becomes weaker.

For each of these obstacles I expect lots more bad news before I hear any good news. This means that things will get much worse before they get better. When I hear about banks or the Fed banding together to create emergency safety valves I don’t consider that good news. Those are desperation moves and not the kind of stuff that will right the ship.

It will take awhile, surely a few years and perhaps even longer, but someone will start to come up with solutions to solve each if these fundamental issues. The finance world seems to have an amazing ability to be regenerative and reinvest itself. The very smart people who lost this round will come back stronger and more diligent and will figure out how to “win” next time. Except next time it won’t just be Americans competing amongst each other but it will be the world competing against each other. My hope is that innovation becomes a catalyst and that things like reliable alternative energy and new financial policy will lead the way.

I’m worried for our immediate future. I’m also acutely interested because there will be chances to sniff out amazing opportunities. Markets will change, the banking system will change and our economy will change. To me change=new opportunities. But there might be lots of punches in the face before we’ll be able uncover some of those opportunities.

P.S. Gold is stupid. The fact that gold goes up when there is turmoil in the world is stupid. If the entire global economy collapsed I’m not sure what I would do with my bricks of gold. Probably smash my head in with it once I realize all my worth is tied up in this stupid, shiny pointless biblical commodity. Currency is no longer based on Gold. Nothing has been based on gold in the last 100 years. It’s a symbol. People like it because it’s shiny. Urban Dwellers find it useful because it’s a good substitute for teeth. Whatever you do, please don’t buy gold. It reminds me of the story of the Emperor With New Clothes. One day the market for Gold will collapse. I promise.

P.P.S. Can I please hear McCain or Obama talk candidly about this economy. What they think will happen, how they believe the role of President can help, and what their plan will be to ensure that American maintains it position at the forefront of the world economy. This may well become the defining issues of the presidential race (unless Bridget aborts of course!).