Wall Street Cave In?
It looks very much as if we lose one of Wall Street’s better known firms in the next few days, if not tomorrow. Talks to bail out Lehman via a take over by Barclays Bank of the UK have broken down and now the only option seems bankruptcy. Here’s the latest from the New York Times: Lehman Heads Toward Brink as Barclays Ends Talks
It is astonishing how fast things are unravelling for some of these investment banks. The real estate binge that they all went on coupled with a disastrous faith in mathematical models built upon the foundation of neo-classical economic theory has been their downfall. It is this latter point I want to bring to your attention because it is arcane and hidden within the welter of bad news. Many of the so called derivative products the investment banks invented in the past decade to ‘manage’ risk were based upon financial theories that were, themselves, outgrowths of text book economic theory. Those theories are wrong. They live only in an abstract world where information is freely and widely available to all the players in the market. Indeed in a strict interpretation of text book economics there is no ned for risk management at all since all players know everything! Nonetheless models have been built on that rickety foundation and now we are seeing the damage that poor theorizing can do!!
Meanwhile: not only is Lehman going down, but now it looks as if Merrill Lynch is also on the block, with Bank of America making a take over offer today. Such a move in this environment is more than a strategic attempt to take advantage of the chaos enveloping Wall Street. It also smacks to me at least, of an attempt to forestall the collapse of another famous Wall Street firm.
Who knows when this credit crunch will end? But it looks as if the reputation of Wall Street will have taken a huge, if not fatal, blow. Lehman and Merrill Lynch are not light weights or fringe players the way Bear Stearns was. They are core players. By this time next week Wall Street could be a much diminished place. Think of what impact that may have on New York, let alone the national economy.
I have said before that I believe the economy is the central issue for this election. This weekend and its aftermath are an example of why we need a proper and adult debate about it. I hope John McCain calls off the sleaze and starts to get serious. Otherwise there is no choice but to question his courage, judgement and patriotism. In times like these the country deserves leadership and discussion. Let’s see if he has the qualities necessary.
