Wall Street’s 2008 Bonanza: An Economic Engine’s Permanent Damage
In 2008, when Wall Street all but went belly up in the midst of the economic breakdown, the ‘faith’ of U.S. economic engine rested on an economic ‘savior.’ The Federal Reserve aka, The Fed, aka “big gov” did its part in pretending to be the economic ‘almight’ himself, thereby diverting an almost certain disaster. To most market economist this came as a complete shock since “big gov” may have been the one entity that was responsible for Wall Street's deleterious transformation. With this said, it shouldn’t come as a complete surprise anymore: the edifices that make up New York City’s Wall Street has fallen victim to “big gov’s” kamikaze ideology. The “maniacal forces” that created the thrust of Wall Street’s sub-engine wasn’t the workings of Adam Smith’s theory of the invisible hand; the only hand that has “its hands” on anything has been “big gov’s big hands” and boy let me tell you, they were huge. In reference to Wall Street, the Fed has pretty much set a reverse economic paradigm in this country—i.e., America appears to be slowly “D-emerging,” while countries like, Brazil, Russia, India and China seems to be rapidly “E-merging.” Humorously ironic—isn’t’ it?
Levity aside, the situation we had in the Wall Street collapse of 2008 wasn’t a joke: widespread collapse of the U.S. financial system became imminent—as the government used everything in its arsenal to prevent an all out economic engine stall. In a little more than a week in mid-September, the nation’s banking landscape had been radically transformed:
Lehman had collapsed, and Bank of America had bought Merrill, leaving only two big investment banks—Morgan Stanley and Paulson’s Goldman Sachs. Then, on September 21, the Sunday following Lehman’s bankruptcy, the Fed turned these last two investment banks into holding companies, a power granted by Congress that the Fed had used sparingly in the past (Wessel).
The bail out of these major investment firms was, in essence, a bail-out of Wall Street—because without investment banks, the concept of a stock exchange doesn’t exist. One of Wall Street most important functions of capital formation is enacted through investment banks. When companies like Morgan Stanley and Goldman Sachs started going out of business, Wall Street, as an institution of capital formation, ceased to exist. When corporations, governments (local and state) need capital, it’s the investment banks that provide the capital: highways, hospitals, new factories, etc. Its companies like Goldman Sach that provides the billions that get these projects funded.
Serving as a kind of metaphor for a free market enterprise system in motion, a stock exchange is quintessential to the success of any small, medium or large economic engine. In essence, you get to see, in motion, the forces of free market economics unravel before your very eyes. What’s a stock exchange? A stock exchange is just a place which facilitates trading—that is to say, stock brokers and “stock traders,” trade stocks and other securities. Stock exchanges also function as major hubs for many other financial instruments: securities traded on a stock exchange include stocks, bonds, unit trust and derivatives.
Under a normal free market enterprise system, stock exchanges serves as an entity that allow individuals to ponder two very important questions: 1) Do I want to save my money; Or 2) Do I want to take some risk and invest it? In reference to the success of the U.S. stock market, the latter of these two choices held true: anytime individuals invest monies within the economy, the inherit risk involved begets an economy based around “winners and losers.” If I’m an individual investor in an economy with financial markets like the stock exchange, where can I go to take a little risk? Well, you can go to a financial market. Financial markets are where investors come together to pool their funds. Pooling of funds? Pooling of the funds benefits an economy by taking funds that would have sat dormant in a savings account and now are available to be used for consuming or producing goods and services. These goods and services represent one thing in financial markets: financial assets.
What financial assets allow individuals to do is make certain claims on the assets of the corporations that issue them. Here’s where it gets interesting, these same financial assets come in the form of debt or equity— meanwhile, whenever you buy debt you become a creditor (or lender of monies); for which the investor in return gets a contract or bond; this serves as proof of the borrower’s obligation to repay said monies. The reason why it’s worth mentioning is that in the natural order of things, bonds holder get paid first. Again, this is a question of risk, and under said agreement of these contracts would be mandated to pay you back your money if something like bankruptcy were to happen to the corporation.
The risk starts to get a bit more acute as you move away from debt instruments and into what’s called equity. Equity represents part ownership in a business and is a direct result of purchasing a stock in a corporation. When you purchase stocks, you purchase a number of shares; thereby becoming a shareholder. If I’m an auspicious entrepreneur and I want to raise capital to finance my business, one way of accomplishing this is by creating and selling financial asset. This, in an eggshell, is the basic premise of a stock exchange. Because of a stock exchange importance to an advanced economic engine, it’s worth noting—as an advanced economic society—how we’ve deviated from the mean of Wall Street’s ability to function as the ultimate venue of financial asset interactions.
Just how far have we deviated? Well, what the latest engine breakdown has shown is the fact that we’ve strayed off coarse enough to cause our once great stock market to nearly reach the kamikaze point of no return. And if drastic measures weren’t taken, we would’ve already experience an engine stall. When I say drastic measures, I don’t refer to something that was necessarily wanted but enthusiastically needed: Wall Street entered a period of “illogical ebullience” when it allowed simple concepts of financial economics to convolute into an esoteric world known only to credit default derivatives and hedge fund gurus.
What ever happen to real hard financial assets like stocks, bonds, commercial paper and mortgages? These paper thin credit default derivatives and hedge funds were about as real as the people who created them. Credit default derivatives, hedge funds—whatever you want to call them— were novel innovations, no doubt, but what a lot people don’t want to talk about is that novel innovation in financial economics always come at the expense of the macro-economy.