Financial prudence: Disasters, bailouts and their true beneficiaries

My friend and I share a common problem nowadays: we need cash. Crisp notes up front would suffice, but so would a check or even direct deposit, provided our bank accounts and the banks that maintain them are still active. So in short, we share the dilemma that almost all Wall Street firms and their managers share: we made a bet, went big on it and got sucker-punched in the jaw by probability. Should you be feeling sorry for us or for Wall Street? In the recent sub-prime Tsunami, the difference can cost you billions. Literally.

Our bet was ‘ballsy’, and involved a quantum leap from an average undergraduate education to a PhD program; read as blasphemy in the corporate underworld of internships, career searches, networking, job placement and the eventual MBA. Our rationale: pull out another 6-7 years of migraine-inducing education in order to guarantee a modest income stream and truck loads of ‘prestige’. Our mistake: using the word ‘guarantee’ in our mission statement. Several years and one department letterhead later, that error in vocabulary has cost us significant work experience, vocational skills and a chance of a decent income stream. Our lesson: financial prudence and the necessity of covering more bases than hitting home-runs. We now plan each footstep with intense thought and deliberation given our expired medical insurance, and are currently busy considering ‘other avenues’ and reading up on the ‘other skills’ we require for them. That spells the end of our story.

Scene change, and we arrive in Wall Street several years prior to the current debacle. The firms are playing ‘financial roulette’, and having fun at it. In formal jargon it’s the synchronized issue and purchase of securities, loans, commercial paper and derivatives by firms in an effort to raise capital. In English, they all gather around their roulette tables and start putting down bets. Missed a spot at your favorite table? No problem, just put your chips behind a player and feel the ups and downs of the game itself. And if those places fill up too, go ahead and put your chips behind someone who is playing behind someone. The wheel spun round and round, and the numbers kept on rolling by: 21 32 5 3 6 2 6. Smiles, cheers and the occasional frowns abounded, but few noticed that the lone number zero was also painted in the fabric. After all, in market trading, unlike real-world roulette wheels, the big movers can influence the very odds they are betting on by buying and selling in bulk. So in essence, the firms rode the wave of fortune they were spinning for themselves, but soon enough ‘ along came a spider’ and sat down beside them. On number zero to be precise. Zero!

Who, other than Paul Krugman and Warren Buffet and a few rare level-headed people could have thought that the sub-prime market was going to buckle under? Who could have noticed that odds, regardless of how small and insignificant they seem to us, are still on the table and waiting to swallow casually placed chips? The bets placed on a disaster not taking place went bust, and so did the money loaned to the markets from where the disaster emerged. So did our brothers at Wall Street follow the strategy of self-reflection and fiscal examination that my friend and I are currently engaged in? No, they had a better strategy: throw a tantrum, sending the media into a dizzy spin and drowning out the voices of home-owners genuinely hit by the foreclosures.

The tantrum worked. And it’s still working. Billions of dollars are being pumped into ailing firms that are either too diseased to be touched by their healthier rivals or simply unable to stand on their crooked feet any longer. Insurance giants and investment whales that are worth less than their logos can bask in the all merciful glory of a bailout, whose only remote counterpart in academia would be weeping in a Professor’s office until your C – on a qualifier is adjusted to an A, no strings attached. To press on with the analogy, if the transfer of a failing student from a third tier academic program into a top-rated school strikes us as absurd, why should the notion of a failed bank being bought at an inflated, pre-disaster share price through taxpayer money sound permissible? Even a casual observer would note that many of the buyouts were necessitated owing to the constant hesitancy of engaging in a fire-sale of firm assets, which would have been the only rational outcome in a fair market.

 

What could have been a re-defining moment in Wall Street history in terms of effective regulation and fiscal retooling has become the ultimate precedent for bad bets. So don’t feel sorry for me and my friend, as we have been scarred sufficiently to learn from our mistakes and start anew. Feel sorry for Wall Street , or for the sake of correctness those investors and hard- working citizens who place their money at the disposal of these betting behemoths. For those who had the ear plugs of a bailout stuffed into their ears while the alarms rang.

It’s a classic case of ‘moral hazard’, or the hazard of relying on the strength of another person’s morals when you have no better information to predict and correct their behavior. Given the Biblical proportions of the current bailout plan, there is little reason for Wall Street sharks to chase less risky bait in the coming years. And hence the vicious spiral of bad bet, bailout, bad bet, bailout, bad bets and more bailouts continues on. Did you notice anything while rolling through the last sentence? Where exactly is all this money coming from? The Government, which actually raises it through taxation, which happens to be an obligation you honor through a deduction in your paycheck. So in essence, the current Wall Street crash ends up resembling a wealth transfer from the lowest rungs of the economic ladder to those who sit at the summit of the national wealth pyramid. And the more tantrums thrown, the more rescue packages constructed, the more wealth transfers generated and the weaker that weighty sensation in your right back pocket. Oh, and by the way, you also lose your home . So if you need a roof above your head and haven’t had dinner give us a call and we can at least ‘guarantee’ you a twinkie. Isn’t there an odd sense of security in that? Amen.