Lehman Brothers: A Wall Street icon goes bust.
After Monday’s dramatic tumble in the financial markets–led by dire announcements about Lehman Brothers (bound for bankruptcy court), Merrill Lynch (absorbed by Bank of America) and insurance giant AIG (desperately seeking bridge loans)–I got in touch with Doug Henwood for some help in sorting out these latest developments and what they augur for the US economy on Main Street.
In a 20-minute interview taped Tuesday afternoon, Henwood–the publisher of the invaluable Left Business Observer newsletter and perhaps our most plainspoken economics journalist–took the measure of “Gray Monday” and the arc of the US economy.
“So far, by historical standards, it’s not a very severe recession,” Henwood tells MnIndy. “The economy could, considering the blows it’s taken–the housing bust and the financial crises over the last year or two–it could be in a lot worse shape than it is. But I don’t think this is going to do it any good. “My thinking is that we’re in the midst of a very long-term period of stagnation and economic trouble. I don’t think we’re going to see the kind of big collapse that a lot of people are expecting, certainly not like the 1930s, but even like the kind of deep recessions we saw in the 1970s or early 1980s. I think we’re going to see a very long period of a grinding and very unpleasant economy [where] the unemployment rate creeps higher and wages and income creep lower. It’s going to be very, very difficult to generate any prosperity out of this for a considerable period of time.” A complete transcript of the interview follows below the audio player.
Listen: Doug Henwood talks about Wall Street and Main Street after Monday’s financial bloodletting (19:28)
Editor’s note: The player tool we were using here seems to have caused a glitch. We’ll restore the audio to this post later.
Minnesota Independent: After a day like yesterday, one of the things that’s most lacking is any sense of perspective. so i’d like to start by asking you a big-picture question: How is the US economic outlook different today from a week or a month ago?
Doug Henwood: Part of the reason we don’t have perspective in the heat of things is that we just don’t know, but my guess is that it’s marginally worse than it was. We’re in recession. I think that’s pretty incontrovertible, though it’s not officially declared yet.
So far, by historical standards, it’s not a very severe recession. Employment has contracted a little bit, but far less than in earlier recessions. The unemployment rate has crept higher, but also, again, less than in earlier recessions. The economy could, considering the blows it’s taken–the housing bust and the financial crises over the last year or two–it could be in a lot worse shape than it is. But I don’t think this is going to do it any good.
My thinking is that we’re in the midst of a very long-term period of stagnation and economic trouble. I don’t think we’re going to see the kind of big collapse that a lot of people are expecting, certainly not like the 1930s, but even like the kind of deep recessions we saw in the 1970s or early 1980s. I think we’re going to see a very long period of a grinding and very unpleasant economy [where] the unemployment rate creeps higher and wages and income creep lower. It’s going to be very, very difficult to generate any prosperity out of this for a considerable period of time.
MnIndy: Can you shed some light on the decision to let Lehman Brothers go bust but to pursue assistance for AIG?
Henwood: Who knows what these people are thinking? The other question is, why did Lehman Brothers go bust when they bailed out–well, they didn’t bail out, but they had the forced merger of Bear Stearns. The conspiracy theory version of events is that Goldman Sachs had it in for Lehman Brothers and was happy to see it go under–the Treasury secretary, [Henry] Paulson, and several other important people around all this were Goldman Sachs alums, and they were just happy to see it go down. I don’t know whether that’s true or not. People on Wall Street love conspiracy theories and gossip.
[There is] the possibility that they just wanted to teach Wall Street a lesson, that sometimes you can go bust. I think they got a little nervous after the Bear Stearns thing, the sense that Wall Street could get away with murder and get a get-out-of-jail-free pass. They didn’t want that to circulate too widely. So that may be why they let Lehman go down.
AIG is very, very, very big, the biggest insurance company in the country, and I think the consequences of it going under would be pretty dramatic. They may just be buying time for some sort of order rearrangement; who knows? But I think the fear is that to have Lehman go under, Merrill [Lynch] go into Bank of America in what could be something of a forced merger, and to lose AIG–all this in a couple of days would be just too much to handle. So they may just be buying some time [with AIG]. But I don’t think they really know what’s going on or what to do, either. They’re just improvising as they go along.
MnIndy: There’s been talk about what the Fed will do, later today and in the near term. What can the Fed do by way of containing this crisis that it hasn’t already done?
Henwood: It seems that just lowering interest rates is not enough. They’ve done a lot of that. Lowering interest rates works in more or less normal times. But credit markets are not normal markets in a lot of ways. And just lowering the price of it does not necessarily increase the demand for it. For example, if lenders get very, very scared and don’t want to lend money, they’re not going to lend. Or they’ll just buy government bonds with whatever cash they have, and avoid [doing] anything that looks even slightly risky.
So the problem is really, now, the availability of credit, not its price–not the interest rate. We’ve seen this in the mortgage market, where it’s very difficult for people to get mortgages unless they have really sterling credit histories. And I think we’re going to see this spreading beyond the mortgage market. The risk for the real economy in coming weeks and months is, what happens to commercial and industrial credit, the C&I lending that banks do–that is, lending to businesses just to finance day-to-day business operations, financing inventory, paying for supplies until the money comes in.
That kind of bread-and-butter business lending is what keeps the economy going. Without it, the economy would grind to a halt. I think there’s going to be less and less willingness on the part of banks to make those sorts of loans. We saw something like it in the early ’90s, when there was a credit crunch and a long period of economic stagnation, and I suspect we’re living through something like that again. It may go on longer and run deeper than in the early ’90s, though.
The Federal Reserve does a regular survey of lending officers at banks, asking whether they’re tightening or loosening standards, whether they’re making loans or not making loans. Those tend to have a long lead time, so the answers to those questions tend to predict what’s going to happen to the credit market six or twelve months out. Those surveys are showing that bankers are growing more and more unwilling to make loans to businesses, and certainly to consumers. That shutdown of lending is going to be a weight around the economy’s neck for what could be years to come.
MnIndy: There’s talk among the financial writers at the New York Times and Wall Street Journal today about a “contagion” of panic and, essentially, a run on major investment banks. Does yesterday represent a new threshold of anxiety for Wall Street, or no?
Henwood: Yeah, I think–Wall Street operates on a real herd mentality. A lot of what goes on in the world of finance is just one guy imitating the other. They operate like a crowd, and crowds do not operate rationally. During the housing bubble, for example, the crowd was very optimistic, and the crowd made loans to people who shouldn’t have gotten loans. People bought risky securities they shouldn’t have bought. Everyone thought it was okay.
Now we’re seeing the mirror image of that. It’s just going crazy in the other direction. There are rumors circulating about insolvencies all over the place. Everybody’s afraid of everyone else. Banks aren’t lending each other money. So even if the Federal Reserve cuts interest rates, if the banks don’t want to lend each other money, the interest rate is just a purely theoretical thing.
The only thing I think the Fed is going to do is keep pumping in money and making reassuring sounds, and hope that things just don’t get out of hand. There’s always a risk that things will get out of hand. In the past, all these bailouts have managed to contain the problem and keep it from spinning out of control. But this time it’s not working as well as in the past. We’re seeing one thing after another. We’ve had so many false endings to this financial crisis that began more than a year ago. It’s kind of like a bad horror movie.
MnIndy: Is there a shock factor among investors stemming from the refusal to bail out Lehman Brothers, or did Wall Street understand that this line would be drawn at some point?
Henwood: I think they probably suspected it, but they were probably also shocked when it actually happened. They had gotten so used to getting bailed out that I think there’s shock when it doesn’t happen.
It’s interesting who doesn’t get bailed out. Bear Stearns didn’t really get bailed out. They got liquidated and rolled into JP Morgan. Bear Stearns was not a very popular company among a lot of people on Wall Street. They refused to participate in the bailout of Long-Term Capital Management, that hedge fund that went bust back in 1998. There’s some sense that maybe Wall Street and the Federal Reserve wanted to get revenge on Bear Stearns. If we go back to the early ’90s, the same thing happened to Drexel Burnham Lambert, the junk-bond home of Michael Milken. A lot of people didn’t like them. They weren’t very popular on Wall Street or in corporate America, and so they were allowed to go under as well.
Lehman was not that unpopular, so I was a little surprised that it was not bailed out. It’s a venerable old name, although it’s undergone many changes over the years, but there is a bit of a shock they were allowed to go under so dramatically. On the other hand, the Fed and the Treasury tried very hard to find a buyer to take Lehman Brothers, but no one wanted it. There are still some valuable parts of the business they’ll be selling off in the coming months, but no one really wanted to get into it. There was too much concern over what toxic waste was hidden in its balance sheet.
MnIndy: You and I talked about the economy six or eight months ago, and I’ve always remembered something you said in that interview: that one of the critical points over time was whether this was a recessionary, cyclical downturn, or the harbinger of all sorts of structural economic problems coming home to roost. How does the economy look to you in that regard now?
Henwood: I think it’s revealing some serious structural problems. It’s not behaving like a normal business cycle. If we go back into the expansion period–officially, the expansion ran from late 2001 onward–the economy stayed in expansion until, I think, the end of last year.
The National Bureau of Economic Research, which is the official arbiter of these things, hasn’t declared a recession yet, but I think they probably will. Those six years or so were the weakest expansion we’ve had since the end of WWII. Employment was very weak, GDP growth was very weak, wages went nowhere. It was just not a good time for most people. The contrast to the late ’90s, for example, is pretty stark. Then, the employment growth was strong, the unemployment rate got under 4 percent. There were wages increases absolutely across the income distribution, at every level, high to low. Black, white, Hispanic, men, women–everyone saw very nice income gains in the last few years of the 1990s.
The opposite was true this time. It was really just the very, very top of the income distribution that did well in this expansion. I’m not talking about the upper middle class; it was really just the top 1 percent. The further you go up the ladder–to the top tenth of 1 percent, or top hundredth of 1 percent–the further you go up, the better they did.
It was a very unusual situation. Certainly we’ve seen the rich getting richer for the last 25 or 30 years. But in the last five or six, we’re just off the charts in that regard. That suggested to me that something was wrong already–that the expansion just was not a normal one. The only thing that kept things going at all was the housing bubble. People felt richer, they spent more money because of it, they borrowed money against the value of their housing to sustain their consumption levels even though the labor market was kind of stinky.
Once that housing stimulus was taken away, the underlying fundamental weakness of the economy became very visible. We can make a list of what’s wrong with it: Income polarization is part of it. People don’t have the incomes to sustain a mass-consumption economy, so they’ve been borrowing a lot. That’s been going on for a long time, but it was especially egregious after the end of the late ’90s expansion.
The very sharp weakening of our manufacturing sector over the last 10 years [is another factor]. We have a narrower and narrower economy that’s based on retail and financial services, bars and restaurants, and housing. That’s not really a secure foundation for a productive economy over the longer term. We need to do something about that. That’s the real fundamental problem. It’s possible that retooling the economy to deal with climate change, better forms of energy and transportation, could generate a boom. But our political system and the consciousness of our capitalist class are not there yet.
MnIndy: There’s a lot of heated political rhetoric now about the extent to which the Bush regime and Republican economic policies are responsible for the woes we’re experiencing now. What do you think about that? Is this a Bush legacy?
Henwood: I think that’s a half-truth. Certainly the Republicans have done some worse things. The Clinton economic policy was not so great either, though. Bob Rubin was in the forefront of financial deregulation. The Clinton administration was very aggressive in financial deregulation. One thing they did do differently, however, was that in Clinton’s first term, he raised taxes on very rich people–the top 1 percent or 2 percent of the population. That balanced the budget, allowed interest rates to fall, and did help generate the boom of the 1990s.
That was really one thing you could point to that the Clinton administration did that was good. One thing they did that was bad was to encourage home ownership in a very irresponsible way by encouraging people to make low- or no-down payment house purchases. It really laid the groundwork for the housing bubble that got us into trouble more recently.
The Republicans and Democrats both have been very, very fond of financial deregulation. While the Democrats did a couple of good things and the Republicans did NO good things, I think both parties are very, very guilty of doing some bad things.
MnIndy: As you try to sort out the signs and portents regarding this particular financial crisis, and the health of the larger economy, what sorts of indicators do you watch most closely?
Henwood: One is the arcane one I was talking about earlier, which is what’s happening with commercial and industrial lending–whether banks are continuing to lend money to businesses for day-to-day activity. That’s a very important one, and one where financial troubles can get transmitted to the real economy. Sometimes the financial sector is just off on its own, dancing to its own tune, but that’s one way in which the financial sector has a very strong influence on the real sector.
Another thing is just to look at what’s happening with the job market. Every Thursday morning, the Labor Department releases figures on first-time claimants for unemployment insurance, when people lose their jobs. That’s been elevated recently, and if it rises more from here, it would be a sign that the job market is deteriorating.
The monthly jobs report that comes out on the first Friday of every month is in many ways the best economic indicator we have. It’s very timely; it comes out just a few days after the end of the month. And it’s a report on what matters to most people–what’s happening with employment, wages, hours, the mix of jobs, who’s getting them, who’s not getting them, what’s happening with unemployment.
Another thing to watch is what’s happening with retail spending. The government reports on that monthly, and there are private services that report weekly. You want to see if people are holding back. Certainly a lot of people are just broke and can’t spend money. But the people who aren’t broke, are they hoarding the money or spending it? What are they spending it on?
The pattern in retail sales lately has been people spending money mostly on essentials, and not spending money on impulse purchases or luxury goods. If that trend continues and gets worse, it would be a sign not only of distress, but also of anxiety that could become self-fulfilling if people stop spending and hoard their money. That would throw us into deeper recession than we’re in already.
But it’s also the case that Americans have been living way beyond our means. Over the last several decades, really, but it got very bad in the last 10 years. It used to be that people saved about 8 percent of their after-tax income. That’s gone down to 0. People who have money aren’t saving it; people who don’t have it are borrowing heavily. And that’s got to change. People have to save money and not borrow so much.
To do that, people are going to have to consume less. That’s going to mean a very wrenching change for the economy, but for the culture and the society at large. Overspending is practically part of the American way of life, and to cut back on that could lead to some very dramatic changes.