Nightmare on Wall Street

These words appeared at the bottom of the screen for the entire morning segment on the stock market in the opening few minutes of The Today Show on Monday morning, September 15. This was the message conveyed to millions of housewives 80 minutes before the New York Stock Exchange was scheduled to open. The words were entirely appropriate. By the end of the day, the Dow was down by over 500, and the S&P 500 was down by over 50.

At long last, the media are scared. I watched CNBC in the afternoon. I tuned in to see the looks on their perma-bull faces. They were visibly scared. I don’t blame them.

Anyone who has read what I have been writing since last November knew this was coming. On November 5, 2007, I told subscribers to my Website to short the stock market: the Standard & Poor’s 500. The index was at 1500, down from 1550 a month earlier. It is now under 1200. It lost over 50 points in one day. Those subscribers who took my advice have done very well, and I think they are going to do a lot better as the markets continue to fall.

But the experts did not know. The Today Show brought on the usual in-house experts from CNBC. These experts were Money Honey (Maria Bartiromo) and Mad Money (Jim Cramer). Both of them assured viewers that this is all temporary, that there is no major problem, that it will soon be a buying opportunity, the stock market will recover, yada yada yada.

This is what they have been saying, month after month, all year, as the nightmare on Wall Street has unfolded. This has been a nightmare ever since last October. Down, down, down have gone the stock indexes, but especially the financial stocks.


Lehman Brothers Holdings has gone bankrupt. Here is a firm that was founded in 1850. It survived the Civil War and the Great Depression. It did not survive the current breakdown.

Anyone who thinks this crisis is some minor affair is not paying attention.

On Sunday night, September 14, the attempted bailout by ten major financial firms and banks fell apart when Barclays Bank said “no deal” to the request by Treasury Secretary Paulson that they each pony up $7 billion to bail out Lehman. That decision certainly showed wisdom on the part of Barclays.

Less wisdom was shown by Bank of America, which agreed to buy Merrill Lynch. On Monday morning, Standard & Poor’s, the credit rating agency, downgraded Bank of America’s bond rating to AA—, down from AA. This means that Bank of America will have to pay higher interest to creditors. S&P announced that there may be another downgrading. Why did S&P do this? Because of doubts about Merrill.

Merrill was one of the ten firms called together over the weekend by Secretary Paulson. As to how Merrill was going to pony up the $7 billion on Monday morning, when it did not even survive as a separate firm on Monday morning, will be one of those questions that curious historians of 2008’s nightmare on Wall Street may want to chat about.

What the weekend showed is that the Treasury Secretary has declining influence. He spent the whole weekend trying to get a deal put together to save Lehman, and it fell apart at the last minute.

On The Today Show, there were scenes of Lehman employees walking out the door, carrying boxes of possessions or pulling boxes behind them on what appeared to be luggage carts.

Lehman is in the hole $613 billion. It has assets of $639 billion. It will have to sell these assets to pay creditors. This will put downward pressure on the prices of these assets. Some of them are illiquid.

What do I mean by liquidity? This:

You can sell rapidly.You can sell without a discount.You can sell without advertising costs.You can sell with low transaction fees.

The problem is this: the investing world does not know how many of Lehman’s assets are illiquid. When Lehman sells in order to pay creditors, this will put downward pressure on all the markets, but especially the illiquid markets.

When it does, the dominoes will continue to fall. There will be more bankruptcies, as Money Honey said on The Today Show.

In March, Bear Stearns was saved only by the weekend pressure of the Federal Reserve System on J.P. Morgan, which bought the shares at pennies on the dollar.

On Sunday, September 7, the Federal government, in the person of Secretary Paulson, announced that the Federal government was taking over the mortgage market in the United States. Over the past year, Fannie Mae and Freddie Mac have packaged 75% of all mortgage loans in the United States. The so-called “conservatorship” is in fact nationalization.

Congress did not protest on Monday, September 8. The public did not protest. This was a unilateral announcement by a lame-duck Treasury Secretary, and everybody in authority accepted it.

We have lost the free market in mortgages in the United States, and nobody blinked.

It’s falling apart. The entire capital structure is being hit, just as Austrian economic theory said it would.


One of The Today Show reporters said that Lehman’s employees were disappointed because they had been told by senior management everything was all right.

Of course that is what senior management said. All senior managements lie in a crisis. Everyone knows senior managements lie — except their employees. This is the Enron factor. Senior managements lie about imminent bankruptcy in the same way that politicians lie about virtually everything. If they did not lie about the imminent bankruptcy of their firms, shareholders would immediately sell the stock, which would immediately bankrupt the firms. Senior managers hope for the best. They hope for a miracle. They hope against hope.

Here were highly sophisticated employees who had spent a year watching the financial markets disintegrate, and these old hands sat in their offices, selling people investments that were doomed to go down, on the assumption that nobody was lying to them at the top. Talk about naïve!

There are people who take seriously the recommendations of brokers whose jobs are so close to oblivion that they are unlikely to have a career in the industry in a month or two. Yet the poor saps listen to these people, take their advice, and lose money.

Why would anybody believe a stock broker today? Merrill Lynch, which was bullish on America, no longer exists as an independent organization today. It took a bailout by Bank of America to keep the organization alive. Presumably, you know better if you have been reading my warnings for over a year. Presumably, you are completely out of the stock market. If you are wise, you shorted the market no later than last November. But if you are still in the stock market, then you are in it because you have been listening to the mainstream media.

Now, finally, the mainstream media are frightened. This fear will spread to the general public.

Think of the 24,000 ex-workers at ex-Lehman. They work in New York City. They are in debt up to their ears. They are now unemployed. They will probably lose their homes, if they own their homes. They will not find a job in financial services.

The entire financial sector in New York City is in contraction mode. In 2007, 140,000 jobs were lost in the nation’s financial sector in the first ten months. Over 40,000 of these were in New York City. In a report last November, we read the following.

Broker-dealers have been active in reducing their workforces. Morgan Stanley (900), Bear Stearns (310), Lehman Brothers (1,200), and Credit Suisse (320) announced cuts in residential mortgages, banking and leveraged finance. Those institutions with significant losses, particularly UBS (1,500), Citigroup (15,000), and Bank of America (3,000), are trimming their workforces even further and issuing warnings that more layoffs may be ahead. On October 26, Reuters reported that Merrill Lynch is expected to issue pink slips after a third-quarter net loss fueled by mortgage and leverage loan losses.

Yet on Friday afternoon, September 12, there were 24,000 workers at Lehman who were still on the job, still hoping for the best. They believed senior management. These people were slow learners.

In late March, just after the Bear Stearns fiasco, London’s Guardian reported on the estimate that 20,000 jobs on Wall Street would disappear over the next two years.

In short, the experts in the financial industry were blind to the magnitude of what was about to happen. They could not see that the financial sector was about to get smashed.

People hope for the best. They hate to face unpleasant reality. They stay on the job when it is clear that the job is terminal. This is human nature. This is why people who own stocks and mutual funds still hold them, and still take Jim Cramer seriously.


The Federal Reserve is in panic mode. On Sunday, it announced another lowering of its standards for making loans. It used the usual bankers’ jargon. The following means “the markets are falling apart. The collateral on loans is declining in value. We are taking steps to loan money on sows’ ears at silk purse interest rates.”

“In close collaboration with the Treasury and the Securities and Exchange Commission, we have been in ongoing discussions with market participants, including through the weekend, to identify potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses,” said Federal Reserve Board Chairman Ben S. Bernanke. “The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets.”

I like this phrase: “potential market vulnerabilities.” It means “capital market collapse.”

“We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world,” Chairman Bernanke said.

This means: “Things are unraveling so fast that the government’s entire regulatory structure is trying to figure out what is happening. So far, nobody has a clue. But we’re working on it.”

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

Translation: “We are willing to loan freshly created money to buy just about anything the cat brings in.”

These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.


AIG is the largest insurance company in America. Most Wall Street companies are connected to AIG in one way or another.

AIG has the signs of a company in its terminal stage.

Jim Cramer made one point that I agree with entirely. He said that the real threat to the economy now is AIG. This giant insurance company needed an infusion of capital something in the range of $40 billion. That’s what Cramer said.

Before the market closed, AIG needed $75 billion.

If it goes under, who is large enough to bail it out? If the Treasury Secretary could not put together a deal to save Lehman, how could he reasonably expect to put together a deal to save anything as big as AIG?

Cramer mentioned the possibility that the Federal Reserve would have to intervene. He was not alone. By late afternoon, when the Dow Jones Industrial Average had fallen over 400 points, CNBC interviewed two experts. One looked grim. He spoke of the need to preserve confidence in trying times like now. The other one agreed, but said the FED may not intervene.

When the stock market opened on September 15, AIG’s share price was down 41%, at $7. Last October, it was at $70. In early August, it was at $30. It was under $6 by the afternoon.

This is a collapse. When a stock falls 90%, a financial company is as good as finished. Potential clients will not become clients. Old clients will flee.

By the end of the day, the Federal government had asked the last two surviving investment banks, J. P. Morgan and Goldman Sachs, to intervene and put together a $75 billion package to bail out AIG.

Money Honey by 3:30 p.m. announced that AIG had lost $19 billion in capital in less than one trading day. The market value of the stock was $14 billion. In less than one day, it lost over half its value. The share price declined from $12 to under $6.

The guy she was interviewing, Win Smith, said AIG is too important to fail. “AIG has to survive.” When some harried looking guy on camera who looks bleak says that an outfit “really has to survive,” it’s as good as gone. He said, “It must go forward.” Don’t bank on it. Who is Mr. Smith? He is the former chairman of Merrill Lynch International. He said everything is fine at Merrill. The merger with Bank of America is great.

His former employer is gone. This is great, he says. Up is down. Black is white. There is good news ahead.

The government is grasping at straws. There will be no bailout for private firms without government guarantees against losses. AIG is a huge pile of liabilities. Who wants them?

The experts did not see this coming. But they want us to believe them when they tell us that the worst is behind us, so don’t sell your shares, don’t panic, yada yada yada.

An insurance company holds lots of long-term debt. This means bonds and mortgages. Lots and lots of mortgages. These are liquid in normal times, but in a panic sell-off, they are not.

What happens if AIG declares bankruptcy and is forced to unload its portfolio rapidly? Who will buy the toxic waste that has led to the company’s precarious position?


The experts are scared. I could see it as they faced the cameras. They are seeing a meltdown. Two icons of the industry died over the weekend. A third is about to die.

Then there is Washington Mutual. It is close to the end. Its stock went under $2 yesterday. It is almost a penny stock: below $1. The 8th largest bank in the nation! It’s going to get much, much worse.

Stay tuned.

September 17, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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