Monday, September 22, 2008

The day investment banking died 

In writing a presentation for a conference I'm speaking at today and tomorrow, I put this into the last slide: "Remember September 21 as the day the investment banking industry died." It hasn't disappeared, certainly not in the world, but creative financing will no longer be the realm of Goldman or Morgan Stanley. It will have to move to other, newer, more nimble innovators.

Justin Fox reports on Ethan Harris, who echoes where my current thinking on the economy and the result of this collapse will be:
The New York Times reported that members of Congress were stunned into silence by the dire picture painted by Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke of what would happen if they didn't create an agency to take bad debts off bank balance sheets. The picture? Financial breakdown, with banks ceasing to lend and the economy grinding to a halt.

That's clearly really bad. But what will the economy look like if Congress does approve a workable bailout plan, and the worst-case scenarios are averted?

Well, probably still pretty bad. "By the time we�re done here this is going to be equivalent to the big recessions of the past," says Harris. "Similar to the recessions of 1974 and 1982." That's a lot better than a rerun of the Great Depression. But it still means big-time job losses, and lots of painful retrenchment for consumers and business.

This is not, yet, a unanimously held opinion. There is even still some debate over whether this even is a recession. But I'm thinking that's going to fade away soon.
Suppose we take out $3 trillion of net worth across the country (that's little more than a SWAG, but I'll remind you of the 'S'.) Not everyone is going to be made whole by the bailouts, which is only transferring some of the losses incurred on Wall Street and elsewhere back to taxpayers. ("Why us?" you cry. Did you have a mortgage that was lower in interest rates thanks to Fannie and Freddie? Did you think that interest rate discount was a free good? Get back to me on that.) What's the net effect of a $3T loss on domestic consumption? Probably somewhere between $40-90 billion. That should be enough, with knock-on or multiplier effects, to take over $100 billion off GDP. Not a cataclysmic loss, but somewhere along the way you get -1% to -1.5% for quarterly GDP growth. I'll bet even money that we get the two consecutive quarters of negative GDP growth before mid-2009. Mr. Kudlow, you hear me?

The bailout is bad, except for every possible alternative. One of those alternatives is being explored right now with Senator Doddle, who is insisting on checking the insurance card of the gunshot victim in the emergency room before allowing so much as a blood pressure cup to be applied. Some on the right are also being cold water Yankees. Now is not the time for that, gentlemen. January is a lovely month for hearings. The thing to be sure of now is that financial markets are open enough that we don't have banks holding $90 billion in excess reserves out of fear of what happens next (it's an estimate, but even if it's half-right it's alarming.) That's the number I'm watching for the next month.

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