Economic Outlook:The Great Divide: Wall Street vs. Main Street

By Richard Hylton
Thursday May 08, 2008 - 10:17:00 AM

A strange thing happened last week. Financial experts, government officials, CEOs, and the odd billionaire investor declared the financial crisis all but over. These are the same folks who only a month before were calling it the worst systemic financial crisis since the 1930s and predicting that even the basic functions of the global money machine were at risk. Now only weeks later we’re being told that the worst is over and stocks have begun rising again. Things move quickly in the new economy—but that quickly? After all, that other big crisis that started in 1929 lasted a bit longer than nine months. 

There is no single answer to what spawned this burst of irrational exuberance, but it is spreading fast. Wall Street hedge funds and investment houses like Goldman Sachs are now rushing to buy at discounted prices the very mortgage-backed securities that they were running from only weeks ago. Somehow, what was declared radioactive nuclear waste in March is once again a potential gold mine.  

To be sure, over the last few months there has been pain: About $312 billion in losses and asset markdowns have been racked up by banks and financial companies and the business of writing mortgages has shrunk almost out of existence. The nation’s biggest banks are sending emissaries around the Middle East trying to convince oil-rich Arab countries to invest billions in their strapped companies while Americans are paying $4 a gallon at the pump. ExxonMobil and the other oil giants are netting billions of dollars in profits every three months and the dollar continues its wild ride down. The stocks of the country’s biggest house-building companies have lost so much value—more than $49 billion since they peaked in January 2005—that they’ve been kicked out of the ranks of large value companies, and default rates on mortgage payments are soaring.  

Never mind all that. The worst is over, says Wall Street. But don’t be fooled, there’s a lot of pain left for the rest of us. And, some still believe, for a financial system that is always inventing a new way to put off paying the piper.  

“There’s going to be more pain,” said Warren Buffett, the world’s richest man and one who believes we are in a recession whether or not the government’s numbers show it. Earlier this week Buffett was castigating the regulators for letting Wall Street investors and banks run amok with debt and unbridled speculation. “Wall Street is going to go where the money is and not worry about consequences,” he said, which seems to be a lesson the regulators don’t want to learn. 

Don’t be surprised if next week the mood darkens again and another investment company announces that it is teetering on the edge of collapse. Who knows? The IMF expects losses in the financial system to reach $1 trillion, which suggests that the reports of the market’s recovery may be greatly exaggerated. 

There are some things that are quite clear though. First, for most Americans the crisis is very real and still in its early stages. Massive job losses are still in the offing for this year and the mortgage crisis that is threatening to push millions out of their homes has gotten worse as mortgage rates continue to climb. Meanwhile, the rising cost of food and energy is rapidly eroding the basic standard of living that many Americans take for granted. Things are likely to get worse for American families as the long-term outlook for the various national deficits worsen and the government has fewer dollars to spend on things like health care reform, schools, and Social Security. 

Second, the folks in Washington, D.C., and New York continue to make it clear that they think fiscal and monetary policies should above all serve the interests of big corporations and Wall Street investors. Never mind the growing divide between the concerns of the average American family and the interests of market speculators and the CEOs. Our government—and therefore our tax dollars—are focused on making sure the big boys come out on top. This is the “too-big-to-fail” doctrine that argues that Uncle Sam has to come to the rescue of speculators like Bear Stearns because the full consequences of their failed bets would do grave damage to all of us. (Strange, that sounds like an argument for vigorous regulation, doesn’t it?) 

And the third thing that is now quite clear: We can forget about real reform and rational regulation of our financial system until the next (bigger?) crisis comes along. Even former Federal Reserve chief Paul Volcker has declared that our system of regulation is in the era of the abacus, and the financial markets now exist in the age of the supercomputer. Most of the markets that can cripple our economy if they spin out of control are not regulated at all and even our banks are being given enough rope to hang not just themselves but all of us as well. As Buffett said earlier this week, “You’ve got a lot of leeway in running a bank to not tell the truth for quite a while.”  

That’s what passes for regulation these days, and Treasury Secretary Henry Paulson, Wall Street’s man in D.C. and the former head of Goldman Sachs, seems pretty determined to keep it that way. With the Fed willing to print as much money as is needed to protect our hedge-fund gamblers and no meaningful regulation in sight, the guys on the Street may be right: Let’s get this party started!