Tuesday, September 16, 2008

The Resilience of American Finance: The Future Growth Of Financial Services Industry Is Assured

The turmoil in the financial markets will reorganize the financial landscape. But this does not mean the financial industry will shrink dramatically. In fact the current crisis could well lead to an increase in the demand for financial services, as the world grapples with the need for new financial instruments, new risk management techniques, and the increasing complexity of the financial world.

Despite the recent turmoil, there is good evidence that the worst is over, especially for the commercial banks with access to Federal Reserve credit. Despite yesterday's severe sell-off, most are significantly higher than their July 15 low, and some such as Wells Fargo and UBS are up over 50% (see chart above).

Nevertheless, the current crisis will change the financial landscape. Certainly Bear, Merrill, Lehman and others will disappear as separate corporate entitles. But other institutions, specifically the commercial banks that absorb these firms, and who have direct access to Federal Reserve credit, will become larger.

The demand for financial services will in no way disappear as the automobile pushed out the horse and buggy a century ago. Although unemployment on Wall Street will undoubtedly rise, many workers will be reabsorbed elsewhere in the industry. The current financial crisis calls out for new products and services as well as more, not less, information about what is safe and profitable in the future environment.

It is easy to be pessimistic about the future of financial services in the current climate. But objective facts indicate that the future demand for these services will be high. Looking beyond past losses, the demand for financial services, especially internationally, has been strong. The growth of the developing countries, combined with the aging in the developed countries, will lead to huge international capital flows that will be facilitated by new and existing financial intermediaries.

It is shocking that firms that withstood the Great Depression are now failing in what economists might not even call a recession. But their failure was not caused by lack of demand for their services. It was caused by management's unwillingness to understand and face the risks of the investments they made. The names of the players will change, but the future growth of the financial services industry is assured.

~Jeremy Siegel in
today's WSJ

MP: Capitalism is a "profit AND loss" system.


At 9/16/2008 9:31 AM, Blogger Dave Narby said...

I agree the future growth is assured.

The $64,000.00 question is when we can expect this future growth.

The 'credit crisis', which we were assured a couple years ago would be contained, has spread.

Bear Stearns craters and has to be rescued with the help of the Gov't.

Just a few weeks ago we were assured that Fannie and Freddie were well capitalized. Now they're "well nationalized".

Lehman Brothers is toes up.

Now AIG looks like it's next on the chopping block.

The remaining investment banks are being urged to find a buyer before they go the way of Lehman.

Roubini seems to be the only one that understands the problem, and that's only in general terms. But it looks like the banking industry slowly found a way to circumvent many rules so they could find higher risk/reward investments, rode them too long, and now the jig is up.

While I doubt we will ever have another crisis like The Great Depression due to controls, faster and more flexible markets, vastly increased productivity and efficiency, etc., this is likely to get worse before it gets better, with many bounces leading to new bottoms before it finally truly bottoms out.

So the pain likely won't be as big, and will take longer.

IMHOP This is not our century's Great Depression, but "The Great Unwind".

On the positive side, I expect the recovery to be pretty rapid. But it's going to be awhile.

At 9/16/2008 10:28 AM, Anonymous QT said...

Personally, I am relieved to see the Fed drawing a line in the sand and refusing to be the backstop for the finance sector. Up to this point, the FED has done a credible job maintaining liquidity.

The financial system has become excessively leveraged however, securitized instruments will not disappear from the earth. For example, companies will still sell their uncollected accounts after 90 days.

The problem with securitization of mortages was that the market disappeared overnight because investors could not tell which securities had sub-prime exposure. Many perfectly sound mortgages had to go back on the balance sheet and collaterol had to be set aside to guarantee them resulting in a liquidity crunch. The alternative was to write down billions of dollars in investments.

Hopefully, the Basel II international banking rules that raised capital requirements for conventional loans & mortgages but not for loans/mortgages held in the form of securities will be revised. For several years, economists including Alan Greenspan have been wondering why the global economy was awash in money and now, we understand why.

The capital requirements under Basel II have encouraged securitization and leverage in the financial system and made de-leveraging far more difficult.

"The Great Unwind" - sounds like a good title for a book. Certainly, this will make an interesting subject due to its inherent complexity.

At 9/16/2008 10:39 AM, Blogger the buggy professor said...

1) The resilience and predictable growth of American financial institutions?

Obviously, if the future means a period of a couple of decades, most likely. Even if the future means a decade or 6 years, quite possibly.

If it means the next year or so, there will be way too much uncertainty hanging over the financial system --- even as new regulations (fortunately multiply) --- to ensure that . . . let alone ensure that the financial institutions that have been over-leveraged for years now will quickly de-leverage, become financially sound, and show they're capable of effective ris-management.


2) One thing for sure: the era of financial deregulation --- which has shown itself capable of encouraging all sorts of new financial institutions (like independent mortgage brokers or conglomerate insurance groups that haven't the foggiest idea what they're committing themselves to in backing this financial firm or that) --- is fortunately being reversed.

In the last decade alone, the financial system has been going haywire. It has produced one dislocating surge of turmoil after another . . . at a time when huge profits for certain financial players were being reaped, witholut these financial institutions they were running doing what free-market financial institutions are supposed to do:

No, not make huge wealth for some top players (most of them lucky), but rather:

* Allocate capital efficiently

* And manage risk effectively.


Only if financial institutions do that, will Adam Smith's hidden hand work: individual self-seeking leads to overall economic and social betterment.


3) No one can say where the new regulatory boundary will be drawn --- not now anyway; nor be sure what kind of new institutions will emerge for financial oversight. Only it will be far more intrusive and require far more transparency, accountability, and effective risk-management over the entire business-cycle than has been the case for a decade now.

All coinciding, please note --- free-market enthusiasts --- with a huge run-up of American federal deficits that have transformed the Clinton budget surpluses into massive budget deficits.

And no, only about $800 billion of the $3 trillion increase since 2001 has been due to official defense spending.


4) As for the WSJ link Mark provided us, it seems to me that two or three important paragraphs were omitted in Mark's selection. They are more in line with the analysis, I believe, I just offered --- however fast and top-skimming it happens to be>

"Overleveraging has been the cause of many past financial crises, and will undoubtedly be the cause of those in the future. It was the cause of the 1998 blowup of Long Term Capital Management, where the Fed also intervened to prevent a crisis. Then two years later the tech and Internet boom burst. If banks would have been allowed to buy on leverage these stocks during the bubble, they would have been in even more trouble than now.

But few were willing to admit that subprime real-estate loans could be as risky as stocks. It was just too profitable to issue these mortgages. So eyes were closed and the money kept pouring in. Groupthink prevailed. To paraphrase John Maynard Keynes, it is much easier for a man to fail conventionally than to stand against the crowd and speak the truth.

There is no doubt in my mind that if we didn't have a proactive Federal Reserve and deposit insurance, we would have been following the same course as we did in the 1930s, when the bursting of the stock bubble and fear of loan defaults led to thousands of bank failures and ushered in the Great Depression.

That will not happen this time. The rapid provisions of liquidity by the Fed will prevent any full scale downturn. In fact, I take it as a mark of confidence in our financial system that the Fed did not feel compelled to bail out Lehman Brothers as they did last March when they folded Bear Stearns into J.P. Morgan. Certainly politics played a role in this election year, as critics (and some Congressmen) criticized the government for bailing out the big boys, while letting homeowners twist in the wind...."


5) One other thing for sure: thanks to our Federal Reserve head, Ben Bernanke', deep empirical research into how the entire US financial system went loco in the 1930s, we actually have an economist at the head of our major financial institutions --- along with a pretty good Secretary of Treasury right now --- who doesn't just react to huge economic challenges by an automatic gut-level set of inferences deduced from a few simple-minded theoretical premises . . . whether they are of the Chicago-school sort, the Austrian marvels at George Mason (who think that the Chicago school types are fuzzy headed even talking about market failures: if a buck is to be had, failures can't possibly last for more than . . . well, maybe a few years or until we're all dead), or the Harvard/MIT neo-Keynesians.

Note though. At least Larry Summers (a Democrat) and Martin Feldstein (a Republican), both at Harvard, agree on the need for far more action by our government to stave off a huge collapse of our financial system and --- if oil continues to wind down --- quite possibly a deflation of domestic prices (already mildly under way for months or longer) that emerged with hurricane force in the Great Depression era). And unlike libertarian enthusiasts, they have both had extensive experience in government at high-levels, and especially Summers.

The upshot?

If we’re lucky, our new activist regulatory agencies and the US Federal Reserve and Treasury will do what US advisers warned Japan’s government to do throughout the 1990s: sanitize the rotten financial institutions there, especially the banks, if you want to restore decent and sound economic growth . . . the latter something that has not occurred in Japan for 17 years now.


Michael Gordon, AKA, the buggy professor

At 9/16/2008 11:51 AM, Blogger K T Cat said...

In 1873, there was a financial panic because there was a railroad bubble. Around 2000, it was the dot com bubble. This time it was the real estate bubble. There have been lots and lots of bubbles and crashes throughout the years.

Bubbles and crashes are a natural outcome of human economic activity. Too bad we've been frittering our money away on unnecessary things and now have a $9.7T debt. Some of that $9.7T would come in handy right now, don't you think?

At 9/16/2008 1:00 PM, Blogger bobble said...

LOL, i see a chart of wells fargo.

why not post a chart of washington mutual?

or citigroup?

one can only contemplate how many banks would be closing right now without federal deposit insurance.

lucky for you free market folks, the federal government is there right now or your "resiliant american finance" would be a freeeeking train wreck.

as it is, it's sort of a slow motion trainwreck.

as dubya so eloquently put it "wall street got drunk"

At 9/16/2008 7:56 PM, Blogger bobble said...

oh btw,

how about a chart of
AIG the largest insurance company in the world. they just failed . . .

and the
russian stock market just crashed, down 20% overnite . . .

At 9/16/2008 8:20 PM, Anonymous Anonymous said...

They did a real nice job of cooking the books and stuffing worthless securities off on the government last Q but hey if you want to take the heading number as gospel knock yourself out frat boy. Oh and by the way now the government owns and insurance company to go along with their mortgage business.

At 9/16/2008 10:22 PM, Anonymous Anonymous said...

About time to short Wells Fargo again there is a lot of meat on that bone.

At 9/16/2008 11:30 PM, Anonymous QT said...

What the hell could you short, jr.?

Tell me another fairy tale

At 9/17/2008 7:56 AM, Blogger K T Cat said...

The Russian stock market crashed? Jumping Jupiter! I wonder if there's still time to cash in my Russian stocks and invest in Zimbabwe?


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