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Hitting the Wall: Who's to Blame for the Panic Over Wall Street?

September 25, 2008 By:
Fred D. Snitzer, JE Feature
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Ben Bernanke
When the current credit crisis finally ends, and the panic has subsided and perspective can be gained, scholars will spend their entire careers studying this unprecedented seizure of the financial markets.

Thousands of doctoral degrees will be awarded, and reams and reams of paper will be printed, all in the service of figuring out just exactly what happened, just as thousands of scholars have been studying the Depression for the past 80 years.

There will be many questions to study: Was the panic justified? With unemployment at 6 percent and GDP growth still positive, why did it feel like another Depression was coming? Did human nature turn a bad, but manageable, situation into a disaster?

Did individuals and institutions alike behave as if they were on the Titanic, and end up tipping over a damaged, but still healthy, ship?

Scholars will also ask: Was the Federal Reserve to blame for easy money? How critical were the accounting rules that forced banks to value securities as worthless because no one wanted them during the panic, even if the underlying collateral on many of the securities -- though perhaps marked down 20 percent -- was not truly worthless?

Was there too little regulation or too much -- or some of both -- depending on the issue?

There will be hundreds of questions, enough to award our children and our children's children many advanced degrees.

Unfortunately, now is not the time for quiet reflection and scholarly detachment, and policy makers don't have that luxury as they are forced by the immense pressure of daily events to take action and stem the panic.

Ben Bernanke ("gentle Ben," as he is called), the scholar of the Depression, was forced to act -- and act quickly.

Brokerage Lived Up to Its Name

If the shockingly swift demise of Bear Stearns represented a run on a bank, then last week we may have seen a run on the entire financial system. Realizing that their piecemeal approach to saving financial institutions might not be working (death for Lehman, a lifeline for AIG), Bernanke and Henry Paulson, secretary of the treasury, decided that the only way to truly stop the panic was to take the toxic mortgages off the balance sheets of our major financial institutions.

They also agreed to insure money market funds. You may not have realized it, but when you deposited that money into your money market account, you were funding the daily operations of American business; you were making a short-term loan to places like IBM, GE and Lehman Brothers -- RIP -- so they could pay their employees and their suppliers.

So, when we American investors, caught up in the panic, sucked $180 billion out of those money market funds and put them in short-term treasury bonds, or stuck them under our mattresses, we were choking the flow of capital to businesses at exactly the time they needed it most.

Bernanke and Paulson were faced with a grim choice: step in and stop the panic -- but only by injecting the federal government into private industry and raising the charge of moral hazard -- or let events take their course and stand idly by while the entire foundation of the financial markets crumbled.

Rather than demonize Bernanke and Paulson -- mortal men thrust into a situation that should make all of us reconsider whether our jobs are really that stressful -- we should be praying for them, for their ability to make the right decisions here, as they will affect all of our lives for years to come.

And, tempting though it is, we probably should give our presidential candidates a break, too. They know as much about a credit default swap as you and I, but the "gotcha" press and the pressure of the moment forces them to say something so as to appear, well, presidential, when the only truthful thing out of their mouths should be: "I don't know what is happening, and I'm not sure what to do."

We learn in Econ 101 about how the modern-day economy is run on credit. A bank takes deposits, keeps a fraction of those deposits for safety, and lends out the rest to another bank. That bank, in turn, takes that money and, like the first bank, keeps a fraction of it and lends out the rest.

Voilà -- money is created! This money circulates throughout the economy; businesses make investments; consumers buy things; productivity increases, and wealth is created. Pretty cool.

Now, imagine the reverse. Businesses make bad investments (i.e., Lehman buys bad mortgages); consumers stop buying things and hoard money; banks mark down the value of the loans they made and -- scared out of their minds -- stop making loans to other banks, as well as to businesses and individuals. Wealth is destroyed.

Ugly, ugly stuff.

Our problems are real: Bad loans were made; financial engineering lost sight of common sense, and human beings behaved liked human beings -- that is, they behaved like idiots.

But the panic makes a bad situation worse. The government's hand was forced. We should be thankful that, at least for now, we have a government whose credibility we assume is still strong enough to help calm us down, as well as our financial system.

Fred D. Snitzer is chief operating officer in the investment-management firm of Prudent Management Associates, specializing in high-net-worth and tax-deferred asset management. For information, go to: www.prudentmanagement.com.

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