The game Wall Street played relied on leveraging up the cash provided by shareholders to enormous levels and using all the debt to accumulate a giant portfolio of securities. As long as interest rates trend downward, the value of that portfolio swells, yielding gigantic returns on a slim equity base. And, with the exception of a few scary blips caused by the Asian currency crisis and the tech meltdown, that's what happened for most of Lehman's existence since it was spun off by American Express (AXP, Fortune 500) in 1994. Based on a huge surge in profits, the employees arrange to take compensation in amounts unheard of outside of sports and Hollywood. This model has an obvious, and fatal, flaw. Earnings on Wall Street no longer come chiefly from recurring businesses but rather from a combination of huge leverage and huge risk. When good luck turns, as it did in the credit crisis that began just over a year ago, the shareholder wealth supporting all that leverage gets wiped out. That's precisely what happened at Lehman. Its shares are trading today at around 20 cents, meaning that outside of the dividend that the firm slashed last week, Lehman managed to destroy wealth for shareholders. The employees, though, took out tens of billions in excess pay that's parked in mansions, yachts and stock portfolios. How did such a scenario come to pass? There are four key reasons: too much leverage … riskier products … big bets, short-term debts … exorbitant pay … Given all of this excess, there's no way this business model can last. The best bet is that Morgan Stanley will eventually be absorbed by a big bank that will reduce leverage, shrink pay scales, fund assets with deposits and impose strict risk controls. That's what JPMorgan CEO Jamie Dimon is doing with the old Bear Stearns and what Bank of America CEO Ken Lewis will no doubt do with Merrill. Goldman, on the other hand, has the financial strength to move in the other direction and buy a bank. Even so, the Wall Street follies will soon end. They were great while they lasted – though mainly for the hired hands. – Fortune
Dominant Social Theme: Wall Street was just too greedy and unstable for its own good.
Free-Market Analysis: Thanks to Fortune for this insightful analysis. We just don't buy it. For us, Wall Street was always something of a dream, a sometimes languid and sometimes frenetic slumber ongoing for a very long time – longer than we have been around – nearly a century.
Why was Wall Street just a dream? Allow us to explain … Before the beginning of the 20th century, Wall Street was primarily a place where you came to get a business funded by private investors and where investors came to buy bonds – either corporate or government. But after 1913, when the most powerful economy in the world adopted a central bank and graduated income tax, "dreamtime" spread about the land (and its nexus was Wall Street).
Prior to the 20th century, the United States market model was among the best and purest on earth. New England alone saw commercial startups throughout its various states, giving rise to the term Yankee Ingenuity. That small patch of hardscrabble earth, snow and rain spawned vast industries that circled the globe. Waterbury Connecticut was the brass capital of the world. And at the same time, in the same place, there was the "textile revolution."
And here are a few of the innovations that led to the "revolution" – almost all of which took place in and around America's northern New England region.
Samuel Slater & Mills: Samuel Slater has been called both the "Father of American Industry" and the "Founder of the American Industrial Revolution." Slater built several successful cotton mills in New England and established the town of Slatersville, Rhode Island.
Francis Cabot Lowell & Power Looms: Francis Cabot Lowell was an American businessman and the founder of the world's first textile mill. Together with inventor Paul Moody, Lowell created a more efficient power loom and a spinning apparatus. (Massachusetts)
Elias Howe & Sewing Machines: Before the invention of the sewing machine, most sewing was done by individuals in their homes, however, many people offered services as tailors or seamstresses in small shops where wages were very low. One inventor was struggling to put into metal an idea to lighten the toil of those who lived by the needle. (New England)
Ready-Made Clothing & Shoes: It was not until after the power-driven sewing machine was invented, that factory production of clothes and shoes on a large scale occurred. (New England)
Throughout New England the lack of regulation and of taxation and the ease with which capital could be raised created a virtual golden age of invention and industry. The New England textile mills became a kind of Holllywood-like industry, attracting thousands of girls to a "better life" – one with more glamour and sensation – than farm life. Consortia of local business people got together to raise funds with local banks from which factories were built and shares issued locally. Local fortunes were made and splendid houses, big churches and community halls were raised with the profits.
As for money? … Money was gold and silver coin, or paper bills based on gold and silver. While there were downturns, local farming and local industry carried the day. Why should there have been a recession or depression in areas where business was plentiful and many individuals grew their own food? This was New England, and increasingly the rest of the country prior to the Civil War, and especially prior to 1913 when both the Federal Reserve and graduated income tax became law.
The first thing the central bank of America did was meet with the English central bank and decide that the dollar was to be devalued so the pound could find its rightful place in the post-war economy. Accordingly, the Federal Reserve printed quantities of dollars, creating the great 1920s Wall Street boom.
The results were almost immediate. For the first time, in the 1920s, the idea that there was a place in New York called Wall Street took hold generally – and for non professionals. (Yes, there had been railroad speculation in the 1800s, but the average man, certainly the average farmer and office-worker, was likely not a heavy speculator at the time.)
The idea that you could buy "stock" in the right company became prevalent in the 1920s and for about a decade people did become rich. It was a time of flappers and jazz and bootleg scotch.
Then came the Great Cash and with it the the Great Depression. Subsequently the US government began to regulate this rogue place called Wall Street. Those who horded gold – once the legal tender of America – were informed sternly that they would have to turn it in. Franklin Delano Roosevelt became a hero to a great many Americans during this time as he tried to pack the US Supreme Court and issued one futile regulation after another to try to get the country "moving again." Of course, many were fooled by Roosevelt. And the historical media to this day gives him credit for "saving" America from the Great Depression, or at least making Americans feel better about that terrible epoch.
What really did get America moving again was the Second World War which destroyed most of Europe and much of the industrial base of China and Japan. America was the "last man standing." As it ended up producing nearly 50 percent of the world's good and services after the war, those who led the country – a new breed of national money men – could pretty much could do as they wanted.
Wall Street sizzled. The American model of regulatory capitalism became accepted the world over – though of course it was seen as something else, much more laissez faire than it was. The 40s gave way to the 50s and a great push by Merrill Lynch (RIP!) to inform American investors that the stock market was a safe place for their fiat-money savings. The 1960s were kind to Wall Street. Money poured into "blue chip" stocks and speculative entities as well. The Nifty Fifty brought great gains before collapsing in the late 1960s as the second wave of serious fiat-money defaults overwhelmed the American economy.
Wall Street stumbled through the 1970s. All sorts of "unpleasant" things happened. Regulatory capitalism nearly unwound. Gold soared to nearly US$850 an ounce and silver hit more than US$50 an ounce. But by the 1980s, the money men were firmly in control again and dreamtime resumed. Western central banks printed money and mutual funds began to swell. Limited partnerships became popular and private investing in hedge funds began to rise. The 1986 stock market crash put an end to the party for a time, but once again, in the 1990s, Wall Street gathered strength.
Oh, those ‘90s! In the 1990s, the money magazines told everyone how to build portable pensions using mutual funds and 401Ks. Hedge funds were discovered and investment bankers (especially those who worked with "technology") became some of the sexiest people on earth. Yet (somehow!) it all came crashing down around the turn of the century when the Nasdaq lost 50 percent of its value.
This time Wall Street was resilient. The 2000s were not to be like the 1970s. No, Wall Street and the Fed doubled down. Alan Greenspan kept interest rates low and ignited a firestorm of of easy credit. Houses were bought and "flipped" for profit. People took out mortgages two, three even four times. Police officers and firemen could retire at 40 with full benefits, both pension and health care. School teachers made six figures. 401K pensions swelled. And Wall Street and hedge fund mavens grew fat. Everyone who could pick "stocks" did so. Retirements were flush. Bank accounts were full. It was hard to find a loser.
And Then Dreamtime Ended…
In our humble opinion, it was something of a cheat. One hundred year's worth. The money men behind the Federal Reserve, behind Wall Street, behind Roosevelt and the Great Depression and all the other financial triumphs and failures of the 20th century had one goal in mind: financial internationalism. To get to that goal, they created a central bank at the heart of the most powerful free-market country in the world – in order to inflate its economy and speed up an orderly and sometimes disorderly transition to a global financial environment.
Looked at this way (admittedly an unusual point of view) the many events that have shaken Western economies in the past century are merely the effluvia, the ephemera of this larger goal. Portable pension plans? Grand retirement accounts. Fabulous stock picking. Hedge fund masters – all the unintended though expectable outcome of the single transcendent goal, to move the creation and control of capital out of the hands of the "little people" and into the hands of a monetary elite that believes in its privilege and power.
OK … perhaps this is an unduly negative view of the situation. But in New England all the mills are rotten now, and falling down. There are fewer carpenters and bricklayers. More people work for the government, federal, state or local. Try to use gold and silver in New England, or anywhere in the US, to buy something. People won't get it. They will understand it if you tell them about a "hot stock" of course. That kind of "opportunity" has been made clear to them. But now, in the wake of these collapses, they will be somewhat hesitant to even discuss the matter.
It is as if they are only just waking up from a … dreamtime. What they held sacrosanct is no more. The portable pensions, the stocks, the mutual funds and other investments – even the thousands and thousands of theories on how to "invest" and the magazines that trumpeted them – they remain for the moment, but confidence is shaken. Some of the certainty has leaked away.
No, the Fortune article has it wrong. It is treating this latest crisis as if it is an organic outgrowth of a rational business model. But Wall Street was never a business model. It was an invention of monetary stimulation, a convenient way to centralize assets and remove the spending power of the people's specie (gold and silver coin). The Wall Street model is dead, indeed. But in our opinion it never really lived. It was merely a means to an end. It was a show, a parade, a gilded curtain designed to hide the reality of the man in the booth, the "Great Oz."
What comes next? Tighter credit, much tighter, and rising rates. Defaults and foreclosures. Pensions plans will totter. The West's "social compact" with its citizens will be called into question. Significantly, there may be further removal of capital access from the average person. Raising capital was easy when your local bank would provide it, more difficult when Wall Street's boutiques need to pony up. But try to raise capital for a small town project from Bank of America. Try to build a textile mill or brass factory. Try it.
The Wall Street model is dead. But banks are not dead. High finance is not dead. The people behind Wall Street are not dead. Fortunately, real money is not dead, either. Please understand: More than ever, the world runs on gold and silver. The central banks hold it and the monetary elite has it. Those who will prosper in the 21st century will hold at least some gold and silver, and perhaps other forms of gold and silver as well, including mining stocks, which have leverage in a bull market for commodities. Gold and silver can't be controlled (not in the long term), can't be legislated away, or banned. People will always hold gold and silver. They will always trade it and use it for buying and selling.
Gold and silver are the opposite of ‘dreamtime." But you won't read much about them in the mainstream press. The 21st century will be the era of dominant global banks, and banks are not fond of honest money, which interferes with fiat. Those who still refuse to see the fundamental reality of what the West is becoming are in for a long, waking nightmare – before dreamtime comes again.