The End of the World as We Know It?

Maybe not that bad, but troubles in the financial markets are starting to cause some grave concerns with government officials. As if Fannie and Freddie weren't enough, over the weekend Merrill Lynch was bought (read: saved) by Bank of America, Lehman Brothers (all 158 years of it's history) chose to declare bankruptcy, and AIG (just the largest insurance company in the country) started pursuing large amounts of capital or it was threatening to go the way of Lehman (AIG's story is still developing).

Talking heads are using terms like "changing landscape of Wall Street" and the "end of Wall Street as we knew it". And they're probably correct. Now that Bear, Merrill and Lehman are effectively nothing more than memories now, and only two large investment banking firms are left standing (Goldman Sachs and Morgan Stanley), the face of Wall Street has indeed changed. There are plenty of things to argue about regarding the current crisis and these failed institutions. It's just a question of where to begin?

Should these firms have been bailed out?

Could this whole mess have been avoided? And who's to blame?

Where do we go from here? How do we avoid the same mistakes?

US Govt Bails Out Fannie and Freddie

Over the weekend, the U.S. Government stepped in and took over the two beleaguered GSEs (government sponsored enterprises) Fannie Mae and Freddie Mac. The move was not unexpected and was almost anticipated, but the rapidity with which the move was made caught some folks off guard. On Friday, September 5th, Fannie Mae stock was actually trading up before the close, and had been climbing over the last couple of weeks. To think that the folks buying the stock (or even short-covering) would make this decision in the face of a takeover makes little or no sense. Therefore, it seems this move caught atleast some folks unawares.

The Street had been clamoring for this move for the past six months, and maybe twelve, and they've finally been satisfied. Fannie's stock was down to $0.70 on the monday after the announcement and Freddie was similarly down, in anticipation of common shareholders being almost if not entirely wiped out. Now that the Street has it's desire, does this make sense and will it help the housing and mortgage markets improve? The idea is that with the government's explicit guarantee, debt issued by the GSEs and their mortgage-backed securities, should carry less perceived risk and therefore have lower yields. Sure enough, on the mortgage rate side, rates have come down, in some cases substantially. However, is this a trend or a momentary blip on the radar? Several analysts are indicating that the housing market still has more downside and until inventory subsides and prices stabilize, the bailout of the two GSEs will not have significant material impact. I say that this is the beginning of the capitulation and the market had to go through this period before any kind of recovery could occur.

Maybe of more significance is the status of the banking system and the health of those institutions that the economy will ultimately look to as credit facilities. The toxin that exists in the market place must be removed for the economy to make any kind of recovery. As long as concern and uncertainty about the health of the debt and assets of the two GSEs continued, the credit market was not going to recover but was going to continue to flounder, as too many credit market participants were holding their securities. Now that the government has stepped in, these securities should strengthen and with them the health of most of these credit providing entities.