Market Update
Dwight Johnston
Vice President, Economic & Market Research
9.0 Earthquake in the Financial Sector!
In one short month, the financial landscape has completely changed. The Bear Stearns rescue, the problems with bond insurers, and various huge writedown shocks proved just to be some warning tremors for what came in September. Fannie and Freddie are now government owned, the world’s largest insurer AIG had to be rescued by an $85 billion government loan, Lehman Bros. failed, WAMU failed with the shattered pieces falling to JP Morgan Chase, Merrill jumped into the arms of Bank of America, Goldman Sachs and Morgan Stanley morphed from the last two independent investment dealer to banks, Wachovia surrendered to Citibank first then Wells Fargo, and the biggest bailout program in history was introduced to rescue the entire financial system. If a Hollywood had made a movie with this as a plot, it would have been seen as unbelievable. No Oscars. Unfortunately, it’s a true story.
The Paulson plan was a rush job. The financial crisis sneaked up on Paulson. He and Bernanke never came to grips with what was really happening. When the money market mutual fund industry started to unravel, Paulson finally realized something more than the haphazard “fixes” was needed. He had no plan but realized he had to offer something. There are a number of better options, but the urgency of the situation eliminated any ability for Congress to consider alternatives.
The good news is that the $700 billion rescue should help the ultimate unwinding of excess leverage in the financial system. It’s not a good plan, but even this bad plan has a shot at solving the problem. It certainly will make everyone (and the stock market) feel better for a while. The bad news is that this won’t happen overnight, and the economy will deteriorate further. The latest 159,000 job decline in Nonfarm Payrolls was just the latest in a series of discouraging economic reports. As we’ve been saying time and time again since the breakdown last year, we were heading into a credit crunch that would take a toll on the economy. We’re probably in the early stages of a slowdown, not near the end. The good news is that perhaps we can look forward to a hard landing next year that will establish the base for a recovery.
The change in the financial landscape will present credit unions with many challenges and opportunities. Most credit unions will see new competitors come into the market and old ones go away. While the government takeover of Fannie and Freddie does seem to be leading to lower mortgage rates, dealing with the ever-changing rules in mortgage lending is making it difficult for all lenders to offer consistent mortgage options. The increase in FDIC insurance will help you keep large deposits, but it will help your weaker competitors as well. The list of changes goes on and on.
While we are unlikely to see a month like September again, we aren’t done. There are still major problems in the credit markets, especially in restoring confidence between major institutions. We are also likely to see major changes in the $700 billion rescue plan in the coming months. Some elements of the plan are likely to fail, and the plan will need an overhaul. After a period of calm, financial concerns will surface anew. The financial system simply cannot be fixed with one poorly thought out plan, despite the big price tag. The good news is that the pace of deleveraging the financial system is quickening. This means we are not likely to follow the Japanese model of the 1990s that spread out the process over more than a decade. There will be more pain ahead, but the end will be in sight sooner rather than later.
You can follow Dwight’s insightful commentary each business day on Member Center or www.wescorp.org. You can e-mail him here.