The Echoes Of Crisis

There has never been a week like this!" "There is no playbook!" "The worst financial crisis since the Great Depression!" These phrases and others of equal hyperbole were repeated any number of times on Wall Street these past weeks. No doubt the drama has been spectacular. In the space of ten days, the U.S. government took over two mortgage-bond behemoths, Fannie Mae and Freddie Mac, and assumed de facto control of one of the world's largest insurance companies, AIG. Two of the oldest and most renowned investment banks, Lehman Brothers and Merrill Lynch, came to an end; Merrill was acquired by Bank of America for about $50 billion; and Lehman was forced into bankruptcy, with some of its more-valuable assets and employees picked up for pennies by Britain's Barclays Bank. Morgan Stanley and Goldman Sachs saw their stocks plummet and then boomerang back up. Global stock indices lost and then gained trillions in value, and central banks injected hundreds of billions to prevent the global economic system from freezing. To cap it off, the U.S. government announced a far-reaching plan to assume responsibility for the bad mortgages that triggered all this in the first place.

When someone shouts "Fire" in a crowded theater, the person who stands up and asks for calm usually get knocked down. That doesn't make him wrong. The suggestion that the current crisis may not be quite so critical isn't finding much traction these days, but that doesn't make it false.

The meltdown of Wall Street and the resulting government intervention are real and will reshape the industry. But it's much less apparent what the ramifications are beyond the financial industry. The link between Main Street and Wall Street has always been mysterious. There have been Wall Street crises that barely touched the broader economy (think the Panic of 1907 and the implosion of Long Term Capital Management in 1998), and there have been Main Street downturns that have only marginally hurt Wall Street (the 1981-82 recession). Many people say that today's crisis on Wall Street will have dire effects on the "real" economy, but for now, at least, those assertions are just that. The U.S. economy, at least as measured by GDP, has shown surprising growth through the first six months of the year, up 3.3 percent in the second quarter alone. Consumer spending has flattened but not collapsed under the weight of higher gas and food prices and tighter credit. Stocks are down, but in the last presidential election year of 2004, the only real gains in the market happened between late October and the end of the year. On Main Street, there may not be much to celebrate, but it's a far cry from what's happening on Wall Street.

And it's not even happening everywhere on Wall Street. Trillion-dollar asset-management companies such as Fidelity and Vanguard, for instance, are doing fine, though the decline in stock prices is a negative for them. Companies that make money processing transactions, ranging from massive banks like State Street and Bank of New York, haven't imploded. Credit-card companies like Capital One, and Visa (which had one of the most successful initial public offerings in years earlier this summer) have not seen the consumer defaults that the dire rhetoric would suggest. In free-fall are investment banks and anyone involved in mortgages and their many derivatives, but parts of Wall Street are business as normal, though you'd never know that judging from the mood. After all, Bank of America—flush with consumer deposits from Main Street—actually had $50 billion to buy Merrill Lynch.

Even the absolute size of the problems isn't as dire as depicted. Lehman Brothers just before it went bankrupt had a market value of $2.9 billion and about 25,000 employees. Most of its value is now wiped out, though 10,000 of those workers will find new jobs at Barclays. But even at its height, it was far smaller than hundreds of companies that get less press. Take a company called Polycom, which makes teleconferencing equipment; you've probably seen their triangle-shaped units in some office or another. It had a market value of about $2.4 billion. If Polycom were, hypothetically, to go bankrupt tomorrow, would people be tearing their hair out about the end of teleconferencing? Doubtful.

Of course, unlike the Polycoms of the world, investment banks and insurers like AIG have trillions of dollars in outstanding assets, obligations, and contracts. But that doesn't mean trillions of dollars in losses. Only a portion of their business is tied up with mortgages and derivatives, and while some of those might be worthless, most aren't. We know that because even in a terrible, dysfunctional market, they have been purchased.