What Went Wrong? – The Financial Meltdown and Why We Are Rethinking Everything By Gregory Hilton

The investment bank Lehman Brothers is just one of many firms which have failed in the current recession.

The investment bank Lehman Brothers is just one of many firms which have failed in the current recession.

What Went Wrong? – The Financial Meltdown and Why We Are Rethinking Everything By Gregory Hilton–
There are a number of villains associated with the current global economic crisis. Plenty of blame can be assigned to Fannie Mae, Freddie Mac, Congress, home buyers, lenders, investment banks and many others. However, it is also true that the vast majority of people involved in the meltdown had good intentions, and they never realized the consequences of their actions. The financial collapse which began in early September totally surprised them, and the arrival of a day of reckoning did not occur to them.
One of the biggest surprises came with the crash of the insurance giant AIG (American International Group) which so far has resulted in a taxpayer outlay of $152 billion, and it has exposed the firm to over $500 billion in liabilities. There has never been an American company to receive so much bailout money from the government.
The problems associated with the five major investment banks, AIG, and the burst housing bubble, have already resulted in massive changes to the American economy. The stock market has been cut in half, Congress has approved a $700 billion bailout plan, the new Obama administration will have its own $775 billion stimulus package, and over $1 trillion in new credit has been pumped into the economy from the Federal Reserve. All of this is designed to avoid a broad credit collapse but few analysts can speak with confidence about the future. Practically everyone has a sad story, and the personal wealth of Americans has declined by $9 trillion in the past year.
The article below is the third installment of a three part “Washington Post” investigation of AIG. The people at AIG and the Wall Street investment banks were truly our best and brightest professionals. They are hard working and dedicated with advanced degrees from Ivy League schools and golden resumes. One reason for not understanding the enormous risks they were creating was because all of their computer simulations indicated it was not possible. They produced what appeared to be brilliant quantitative analysis for managing complex derivatives, but all of it was fatally flawed.
AIG was considered one of the world’s safest companies and it was one of very few firms to have an AAA credit rating. Year after year AIG made a 15% profit, and they started the boom in credit default swaps. According to the “Post”, AIG clearly thought this expansion posed no risk.
In a similar manner, investment bankers confidently sold mortgage backed securities which also had triple A ratings from respected agencies such as Moody’s and Standard & Poor’s. The wizards of Wall Street did not think it was possible to over borrow, and with their staggering annual bonuses they were often referred to as “masters of the universe.”
As the “Washington Post” noted: “At the end, though, the AIG story is not about math and financial formulas. It is a parable about people who thought they could outwit competitors and market forces alike, and who behaved as though they were uniquely positioned to sidestep the disasters that had destroyed so many financial dreams before them.”
Since September the behavior of the average American has been changing. Already we are not buying new cars, and sales will fall from 17 million vehicles annually to 12.2 million. In 1982, the personal
U.S. savings rate was 11 percent, but by 2007 it had declined to zero. We have not been saving because of increased home values, and a positive side effect of this behavior was an extra $1 trillion/year in consumer spending. That  spending pattern has now largely vanished.
The bottom line is that this recession will make us rethink everything. Bill Clinton was correct in noting, “Wall Street as we knew it no longer exists,” and the conventional wisdom of the past went with it. Many of our top financial experts are still having a difficult time explaining how a subprime problem in
America developed into a global financial crisis.


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