Last month, I wrote that we could see a recovery in the construction materials industry by late 2009. But since then, the final of many shoes may have dropped from the centipede that was known as Wall Street. I wonder now if we will see a turn in 2009 at all.
Wall Street as we knew it is gone forever. While headlines shouted about the now infamous $700 billion bailout, the more interesting development may be the conversion or absorption of five of Wall Street's big investment banks into commercial banks. Goldman Sachs and Morgan Stanley have become commercial banks, joining the other three big investment banks/brokerage houses that were acquired by commercial banks this past fall. This raises intriguing issues.
There was a powerful motive for converting investment banks into commercial banks. Commercial bank managers aren't hogtied by onerous balance sheet accounting rules that required fire sale pricing of securities that were virtually unmarketable during a panicky scramble for liquidity. This confirms what many experts have been saying about the foolishness of letting arbitrary bookkeeping rules dominate economics. Investment banks that strictly adhered to those rules or face possible litigation found patience a vice and a “buy and hold” approach impossible.
What is a bailout?
My uncertainty comes from this change. Scholars from the Cato Institute, a non-profit public policy research foundation, remind us that Wall Street was always a metaphor. But so are terms like “bailout” and “toxic debt.” For example, the nationalization of Fannie Mae and Freddie Mac was a bailout for creditors, not for stockholders or executives. The federally forced shotgun marriage between J.P. Morgan and Bear Stearns certainly was no bailout for Bear Stearns. And the 11.3% federal loan to AIG, contingent on the expropriation of 80% of shareholder value, was no bailout either.
And the controversial bailout to buy mortgage-backed securities is also a terrible misnomer. The average American believes the beneficiaries of the government's efforts are the tattered remains of a Wall Street financial scheme. While the effect of the bailout results in shifting the risk to taxpayers, actual losses could not reach anywhere near $700 billion unless the securities were literally worthless, an unrealistic scenario implying the value of the underlying real estate would have to fall to zero.
Another metaphor is “toxic debt.” Debt is not equally toxic for the Treasury Department, compared to investment banks. The federal government does not have to account for its debt on a balance sheet of assets and credits.
But there's another cause for uncertainty: America's economy is deleveraging. Commercial banks are, by their very nature, more conservative. Credit card limits will be dramatically diminished, and consumers will soon need a sizable down payment to buy a car or a home.
Despite the financial carnage we have experienced in the last year, there are interesting trends that I find hard to square with the headlines. We had been a nation built on debt. Bank loans continued to expand almost every month. Commercial and industrial loans exceeded $1.5 trillion in August, up from less than $1.2 trillion a year ago. Real estate loans exceeded $3.6 trillion, up from less than $3.4 trillion. Consumer loans were $845 billion, up from $737 billion.
But now, credit standards will become tougher, which is surely a good thing. And in time, interest rates for creditworthy borrowers will remain low compared to speculative efforts.
Our parents' generation did just fine against this backdrop of leverage. A less risk-tolerant environment can't be anything but good for the future of the ready-mixed concrete industry.