By Invitation: Buy lots of mattresses

Wall Street woes

By V Anantha Nageswaran

In the last few months, financial markets had got used to the idea of the authorities conjuring up some solutions to problems in the US financial industry over the weekend and announcing it on Monday morning (Asian time) in time for the Asian stocks to open higher. This routine worked initially but when problems did not go away, the impact became rather muted.

Unfortunately for Lehman Brothers such a weekend solution did not arrive. Late on Sunday evening in the US it announced that it was going to declare bankruptcy. Wanting to avoid that fate, Merrill Lynch sold itself to Bank of America. Some called it tectonic shifts on Wall Street. Alan Greenspan, former chairman of the Federal Reserve said that America was facing once-in-a-century financial crisis. He should know better because he played no small role in creating it.

For those who sleepwalked through the last one year the flashback is this: American financial intermediaries lent too much to too many to buy too many homes that they did not need; they lent money to builders to build too many of them and then proceeded to package those loans into further products and sold it to many in Europe and other parts of the world. European banks did the same as well. When those who borrowed found it difficult to pay mortgage instalments, the juggernaut stopped rolling and started going into reverse. Mayhem followed.

Home prices fell and mortgage arrears piled up; loans did not get collected; homes had to be foreclosed; inventory of unsold homes rose and financial products (‘innovations’) made out of such loans unraveled. Two of the high profile casualties of this mayhem have been today’s Lehman Brothers and Merrill Lynch.

In the meantime, American International Group (AIG), an insurance company, is perilously close to extinction as is Washington Mutual and scores of others. It is silly to think one could explain how American financial pride could have been so irretrievably dented. But I shall try.

Years of accumulated bad incentive and reward practices, false and pretentious homage to risk, regulators’ wink-and-nod at such practices, low interest rates and academics’ cheerleading right and high sounding words like transparency and innovation leading to hubris on Wall Street could be counted as core causative factors. Finally, the point tipped.

Given America’s pre-eminent role in global financial and economic affairs, it has and will have global repercussions. Severe global recession bordering on depression or global depression itself cannot be dismissed simply because we find the possibility loathsome and scary. Most optimistic forecasts on economic and financial variables arise out of the fear of facing the unpleasant. That is another problem of the industry.

In spite of such high drama, financial industry problems in America are a sideshow. The real crisis is the potential collapse in global aggregate demand if American consumers decided wisely to rebuild their battered balancesheets. The average American household hardly saves any out of disposable income. Asset markets did their job. Now that asset markets have pulled the shutters down, Americans have to search for their kitty box, locate it and start using it.

The world is going to be unhappy. They have gotten used to selling goods to Americans and to lend money to them so that they would buy those goods. Now, they face the prospect of their market disappearing and being saddled with hopelessly worthless IOUs denominated in American dollars whose value has now become indeterminate at best and negligible, at worst.

In the meantime, with few exceptions (India and Brazil), they had forgotten how it is to grow their economies of their own accord. India got most things right on financial and capital markets and interest rates but some one forgot to teach its government the basics of bookkeeping and budgeting. This is probably the first time that an economist and a lawyer would bequeath a fiscal mess to the next government.

What and where is the end and how? I wish I can see that and say that. No, I do not know. Being prepared for the worst—two years (if we are lucky) of low or no growth in the world and another 20% to 30% decline in asset prices—is a good way to start.

Buy lot of mattresses to store savings under. It is better if the cash is in multiple currencies. Precious metals would help too because they are neutral currencies.

This is going to cost the United States dear in more ways than one. I would leave it to the owner of this blog and people like him to figure out those costs.

Will America emerge out of this stronger? Again, I find this question too speculative for me to answer. Believers of American dynamism and demographics answer in the affirmative and sceptics point to historical demise of empires caused by hubris and overreach. The United States qualifies on both counts now. But, one small problem: there is no alternative to the United States now. Al Qaeda is not the alternative. Vacuums are dangerous.

If you are a believer, it is a good time to start praying. Non-believers can get ready for combat.

These are Dr Anantha Nageswaran’s personal views.

12 thoughts on “By Invitation: Buy lots of mattresses”

  1. The power brokers on Wall Street and the Fed and Treasury must be confident that the damage from the Lehman bankruptcy can be contained. I.E. Wall Street will survive.

    Otherwise Lehman would have been bailed out.

  2. New product launch – Inflatable Bedding. Pillows stuffed with gold certificates and a multi-layered mattress filled with various currencies and short-term notes. My grandmother would approve!


  3. Alan Greenspan, former chairman of the Federal Reserve said that America was facing once-in-a-century financial crisis. He should know better because he played no small role in creating it.

    Greenspan doesn’t cause booms or busts. Isn’t it (transferred) hubris to think so? He does play a small role in all these market events – I’ll allow that; after all he presided over the Fed.

    Let’s not panic and advocate cash in mattresses and all that. On September 1, 2000, the S&P 500 closed at a high of 1520.77 (dotcom boom). It fell to the low of 1085.78 on September 7, 2001 (dotcom bust). Then, the planes fell on the World Trade Center, and by October, 2002, the index was in the 700 range (terror bust). Then, the housing boom – index up in the 1500s in 2007, and then the bust – the index at 1192 today. [data source: http://finance.banks.com/intersearch?Account=banks&Page=HISTORICAL&Ticker=%24SPX) Among all these booms and busts, which ones were the making of Greenspan?

    My two bits on the macro. The housing boom was the result of a glut of savings, resulting from a massive wealth transfer to the OPEC countries. During the period 2002 – present, crude oil prices have risen from $27 a barren to $147, before falling to $92 today (data source: http://inflationdata.com/inflation/Inflation_Rate/Historical_Oil_Prices_Table.asp). The OPEC was incapable of absorbing its windfall profits into productive investments. So, where did it all go?

    Back into the hands of the the investment bankers -Bears Stearns, Citi , Lehman … I have too much cash in my hand, what do I do with this? I have been bitten, investing in vaporware and virtual reality; I am twice shy. Ah ha, real estate – that’s investment brick and mortar – literally- right? We can’t go wrong with secured loans, can we?

    And, the home buyers, assessors, mortgage brokers, lenders – no one thought there are other curves than straight lines that may fit price trends. Actually most of these fellows have trouble in understanding y = mx+c; logistic functions will simply blow their minds out! Of course, there’s always a sucker at the end of the line – me, the taxpayer!

    About the financial innovations such as mortgage backed securities and hedge funds, well, never forget to factor in the counter-factual. It could have been a lot worse without these.

    Will the U.S. weather this crisis out? I am quite confident it will, if only Sens. Obama and McCain were to confine their regulatory saber-rattling to the election podiums, and stop it at the door steps of the White House.

    Sorry about the long comment, Nitin. Couldn’t resist the temptation to fall back into my good old armchair 🙂

  4. Thought the potential mattress shoppers amongst you might be interested in a couple of interesting data points: Lehman Brothers employed only 12,000 people in the United States, which translates to measly 0.0087% of the US employment, and only 0.15% of financial services employment.

  5. Dr. Nageswaran – well written piece. Wall street is going bust but to declare a bust of the entire US financial system on the basis of this is too cynical a leap of faith. It is more than a cynical leap of faith to declare the dollar dead just yet. As you yourself point out, there are no credible alternatives.

    btw, in case you did not notice, commodity prices (including precious metals) are well below their recent peaks.

  6. Cash under the mattress is a 1930s solution applied to today’s problem. Issuers of currency are not constrained by gold standard. Governments will try and spend their way out of the problem. This combination could make those currencies hidden under the mattress practically worthless ( One day may be the mattress would be worth more than the notes that are hidden in them)
    PMs on the other hand may be able to hold value. As always the best investment is investing in enhancing productive capacities of things/services that will be needed even in times of recession/depression

  7. <>
    Beleive me, that really doesnt mean much. Becos these very same power brokers were quite convinced little more than a year ago that securitization, CDS and other exotic instruments were the best things to have happened to the world. See what they hv led us into!
    While we shd not give way to panic, there is no real reason to be sanguine either. Because, this time aorund, things look much worse than the last one in 2001. Consider the folowing:
    1. The ability of the US govt to bail out is seriously comprmised becos of their own weak fiscal position. OTOH, Clinton left with a surplus budget, if im not wrong. The households are in no better position either, with savings actually in the negative (can you beleive that!). And how is the external sector faring? Well, current account deficit are record levels – in other words, the US economy is borrowing from the rest of the world to feed its current consumption. Only the corportae sector seems to be in reasonably good shape (if you exclude the fin svcs sector, that is)
    2. The degree of leverage during the current asset bubble is much much higher than last time, thanks to the proliferation of complex instruments like CDS, MBS, securitization and the rest. The impact as the process reverses, ie delverages, would be that much more painful.
    3. The financial sector has become one of the most important sectors of the US economy. I remember reading that about 44% of corporate profits are derived from financial sector in the US! And this time around, the financial sector is the centre of the storm.

  8. Sai – “See what they hv led us into!”

    It was nearly two decades of low interest rates, which led us into the current crisis, in my opinion.
    So, if you must blame somebody, I suggest placing Alan “maestro” Greenspan at number one, and Bill Clinton at close second.

    p.s. are you sure that 44% of corporate profits are derived from the financial sector?

  9. What bothers me that instead of taking advantage of the financial turmoil in US to make Mumbai an attractive alternative, may be a small one, for the global financial industry, FM and RBI are just sitting around. It’s still not too late. Unfortunately the new RBI chief seems to be saying opening up of financial industry will have to wait….

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