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Economy & Business

Commentary: After 2008, America will never be the same

This article first appeared in the St. Louis Beacon, Feb. 10, 2009 - It is difficult to overstate the seismic changes that occurred in the United States and globally during 2008. The events of this past year shook the financial, political and social foundations of American life. While much remains to play out, several observations can safely be made now.

In 2008, an entire group of financial institutions, including what the American public knew as "Wall Street," vanished. Greed has never been in short supply on Wall Street. However, greed in the massive institutional form it took at its recent peak, combined with excessive borrowing or leverage, rocked the domestic and world economy.

Leverage

At the time of the financial meltdown, Wall Street firms, including big banks that had entered the investment banking scene through deregulation, averaged 30 to 1 leverage ratios. This means that for every dollar of real capital or cash held by these financial institutions, an average of $30 of borrowing or leverage was in place.

The poisonous side of leverage either destroyed or altered forever such firms as Goldman Sachs, Bear Stearns, Morgan Stanley, Lehman Brothers, Merrill Lynch, CitiBank, Wachovia and huge quasi governmental financial institutions such as Fannie Mae and Freddy Mac.

To understand why the meltdown occurred, look back to 2001. Late that year, to protect the economy from the destructive effects of 9/11, monetary authorities in the U.S. pushed short-term interest rates to historically low levels over an extended period of time.

Seizing upon this environment, Wall Street firms deployed their capital to buy, resell and hold huge quantities of collateralized debt obligations or CDOs. Their cost of borrowing was very low and the yield on the CDOs was substantially higher. This favorable interest rate spread produced billions of dollars in profit, which was heightened by the excessive use of leverage. These gargantuan profits, in turn, fueled large increases in the stock prices of the Wall Street firms, making its executives very wealthy.

Such extraordinary profits were totally out of proportion to the fundamentals of finance and the creation of real value. It was absurd to believe that the American economy could actually produce the huge quantities of mortgages and other debt instruments needed to satisfy the voracious appetite of the CDO securitization machine.

In reality, the entire financial structure was a mirage, perpetuated by greed and fraud. The pools of CDOs filled with mortgages that were fraudulent in that they were "secured" by borrowers who couldn't pay, living in houses whose market prices were artificially inflated. Wall Street investment bankers, main street mortgage brokers and willing American consumers conspired to create this monster.

Wall Street CEOs knew, or should have known, that the outrageous profits and the leverage required to create them were enormous red flags that needed to be investigated closely. Instead, out of greed for profits and soaring stock prices of their companies, these executives turned a blind eye.

Collapse

When the bubble created by this activity, i.e., escalating housing prices, finally collapsed, so did the house of cards on Wall Street. Unsuitable borrowers defaulted, and housing prices plummeted. In turn, pooled CDOs full of subprime mortgages declined in value. The lower CDO valuations, which had supported the leverage on Wall Street, forced Wall Street firms to scramble for new capital, i.e. real cash capital, to repay debt. The collapse happened so quickly and on such a large scale that, even with unprecedented federal intervention, the century-old industry known as Wall Street disappeared.

As of January 2009, the U.S. federal government essentially controls a large part of the American banking industry. American citizens, through the federal Treasury, are de facto owners of large commercial banks that have "survived," including Bank of America, CitiCorp, Morgan Stanley and Goldman Sachs, and to a slightly lesser extent, J.P. Morgan and Wells Fargo. This nationalization process of U.S. financial institutions will continue throughout 2009.

At the same time as these extraordinary financial events took place in 2008, America experienced epic political and social transformation. In terms of its impact on American life, 2008 compares to 1968, 1932 and to some extent, 1865 and 1776. The human, financial and psychological impact of the wars in Afghanistan and Iraq, sparked by 9/11, culminated in the chaos of 2008. This is similar to the American experience with Vietnam, World War II and, of course, the Civil War and the Revolutionary War. Each of these precarious times produced domestic upheaval and the birth of new leadership.

Hope 

In 2008, Barack Obama became the first African-American elected to the presidency. America chose Obama knowing that he faced the burden of leading the nation at a time as challenging as almost any in American history. President Obama's most important duty will be to restore a sense of unity and confidence to the American people. His race, as improbable as it may seem, will be a great resource in bringing unity to America and in improving the attitude of the rest of the world toward America. If he can instill a spirit of trust and optimism about the future, he will have accomplished a great deal. The policies, decisions and leadership ability of the new president may well define the nation for a generation.

Prior to 2008, materialism had become the religion of America. Entitlement at every level of society was ascendant. The pursuit of money and all things material had become the societal badge of honor and the measuring stick for success.

Values such as service to others, savings, hard work, family unity and a belief in a spirituality and self-sacrifice had waned. In the post Cold War global environment, America stood alone as a superpower. The absolute power and wealth of America became a flash point for the rest of the world, particularly Islam.

The crisis of 2008 and its financial reckoning will cause Americans to reevaluate its intense materialism in favor of prudence, the simpler things in life and gratitude for the freedom and relative prosperity Americans do enjoy. One hopes this healthy change will commence under an Obama presidency.

A native St. Louisan, Joe Schlafly has worked downtown for more than 30 years both as a lawyer and an investment banker.

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