The Chickens Come Home to Roost

09/16/2008 12:00 am EST

Focus: MARKETS

Howard Gold

Founder & President, GoldenEgg Investing

What are we to make of the extraordinary events of the last few days?

Shock waves from the bankruptcy filings of the venerable Lehman Brothers, a firm that predated Abraham Lincoln's presidency, and the stunning takeover of the nation's largest brokerage, Merrill Lynch, by Bank of America hit the markets Monday, driving US stocks down by over 500 points, their biggest one-day loss since 2001.

Now investors are awaiting the fate of insurance giant AIG, whose losses on subprime mortgages may require it to raise as much as $70 billion to stay afloat. This is the latest in a long series of financial cliffhangers, and it won't be the last.

As people try to make sense of it all amid fears about their own financial futures, what nobody's saying but which I think many of us believe is that the free market has exerted its form of rough justice on a Wall Street culture that's rotten to the core and has gotten away with it for years.

These firms-and far too many of the people who work in them-are getting exactly what they deserve for years of recklessly enriching themselves at the expense of their clients and for ruining the lives of thousands of innocent people who are now losing their homes and livelihoods.

Before you accuse me of being callous and vindictive, let me say that I have a lot of sympathy for the executive assistants, average working people, and mid-level employees who spent their entire lives at firms like Lehman, tried their best to help clients and hoped to attain some level of financial security for themselves and their families. I hope somebody has the decency to give them something for all their years of hard work.

Many others will be hurt by this financial storm-limo drivers, hot dog vendors, small business owners, restaurateurs, and others whose livelihoods were tied to serving the employees of these firms. For the financial industry and the Northeast, this is clearly going to be the worst bust since the 1970s-or maybe even the Great Depression.

But many of the "professionals" who work on Wall Street-brokers, traders, investment bankers, the overpaid MBAs from Wharton and Columbia (full disclosure: I'm a Columbia MBA myself)-have profited handsomely from a bonus system that rewarded short-term profits but didn't punish long-term losses.

It has been a game of heads I win, tails the shareholders lose, and even this year, as the crisis intensified and their firms' capital disappeared, they extracted near-record bonuses from shareholders' pockets. The CEOs who leveraged their companies to the hilt and ran them into the ground deserve a special place in the Hall of Shame.

And it didn't start just yesterday. Remember the dot.com era, when individual clients of the big Wall Street firms were led like sheep to slaughter so analysts and bankers could carve up fat investment-banking fees?

The departed and disgraced Eliot Spitzer was able to extract a $1.4-billion settlement from the Wall Street giants, but Merrill Lynch, one of the biggest offenders, had to pay out the equivalent of a year's worth of copy paper and postage stamps. (I'm not making this up-you can see it on page 17 of Merrill's 2002 annual report.)

The big firms restructured their operations to separate research from investment banking, but quietly played hardball in industry-sponsored arbitration courts to thwart clients who pressed claims for money they lost on overhyped dot-com stocks. And Wall Street got away with it.

There is plenty of blame to go around in the subprime mortgage crisis and the credit crunch that followed: unscrupulous mortgage brokers; shady real estate agents; dishonest borrowers looking to make a quick buck flipping houses; rating agencies that signed off on dubious paper, and government regulators from the SEC to the Federal Reserve who let it all happen under their noses.

But the Wall Street money machine's insatiable demand for more, more, more mortgages to package and sell to investors was the driving force behind it all.

And that's not it by a long shot, as Wall Street firms foisted tainted financial products on clients big and small.  Wealthy clients (or "high-net-worth" individuals, as the industry calls them) were steered into in-house hedge funds at Bear Stearns, Citigroup, and Goldman Sachs, some of which failed while others racked up big losses.

For the hoi-polloi there were auction-rate securities, money market-like instruments whose rates reset with every auction. Unsuspecting investors were told they were safe and suffered when the credit markets seized up, creating tens of billions of dollars of losses that these firms are being forced to repay.

And then there's the case of UBS, the Swiss banking giant that has gotten into US financial markets in a big way. UBS, which has had to write down more than $40 billion so far from subprime-related losses, is cooperating with the US government in a criminal investigation of its alleged efforts to help almost 20,000 wealthy US clients evade billions of dollars in federal income taxes by using secret overseas bank accounts.

With a budget deficit that may hit $500 billion, don't you think we could use some of that money?

To anyone with eyes to see, the pattern is clear. When the Spitzer investigation of Merrill and Wall Street first broke, I wrote the following in Barron's Online (subscription required) in 2002: "There's only one word I can use to describe this: corruption."  

Who wouldn't say that it's far worse now? And the stakes are much, much higher. Here's what Senator John McCain told Matt Lauer Tuesday on the Today show: "The excess, the greed, and corruption of Wall Street have caused us to have a situation that is going to affect every American," he said. (Senator Barack Obama has made similar statements, while fixing blame primarily on the Bush Administration.)

The wheels of justice are turning as criminal investigations proceed in the mortgage mess. Congress undoubtedly will kick in with high-profile hearings next year. Maybe there will be a 9/11 Commission, as Sen. McCain proposes, that will analyze the crisis and recommend regulatory changes.

But for now at least, the markets have stripped some of the ill-gotten gains from the people most responsible for this catastrophe.

Let's just hope they don't take the rest of us with them. 

Howard R. Gold is executive editor of MoneyShow.com. The opinions expressed here are his own and do not necessarily reflect the views of Inters how or MoneyShow.com.

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