As more than a casual observer of the recent economic and business events of the last two weekends, it occurs to me that the age-old adage “Pigs get fat, hogs get slaughtered” applies here. It is truly regrettable that such venerable institutions as Bear Stearns, Merrill Lynch, and Lehman Brothers are no more. Thousands of jobs have been lost. Careers have been shattered. People have asked me, “What’s the next shoe to fall?”. My response is “Who knows? I never thought that it would come to this”.
Oh, how the once mighty have fallen! Three years ago, the afore-mentioned three were making money hand over fist. Trading in mortgage-backed securities, collateralized debt obligations, and structured investment vehicles were at an alltime high. Huge bonuses were being handed out to the folks who put these “investments” together. Real estate values were going to rise in perpetuity and these firms were going to be at the forefront of financing them. But along the way something strange happened. It turned out that the real estate phenomenon fueling the bubble was exactly that–a bubble. The real estate wasn’t really worth what it was appraised for. The borrowers couldn’t afford to repay the loans, and, horror of horrors, like a bad game of musical chairs, someone had to lose. It turns out there was more than one firm left holding the bag.
And then, just when the plot was beginning to thicken, those left holding the bag, in this case the MBSs, CDOs and SIVs, began looking for a scapegoat. The regulators were lax, they said. (Perhaps, but that’s not the main issue.) Mortgage brokers were aggressive and put people into loans they couldn’t afford and designed products that were flawed, like interest-only, negative amortization, and 100% LTV loans. (Perhaps, but that’s not the main issue.)
When all is said and done, Bear, Merrill and Lehman did not do sufficient due diligence on the securities they were buying, selling and marketing. They got caught up in the euphoria surrounding greed and checked their collective brains at the door. In contrast, Goldman Sachs did not participate and is surviving to tell about it. I suppose this proves Darwinian Theory–survival of the fittest.
As for today’s markets, this too shall pass. Solvent banks are thriving and will be the acquirors in the future. The real estate market will recover, although the lastest theories suggest it will be the second quarter of 2009. And sadly, in ten years all of this will be forgotten and exotic mortgages to marginally-qualified borrower will be all the rage and the cycle will continue…