Tag Archives: lehman

Wall Street vs. Main Street? I’ll Take Main Street

It’s pretty easy to get caught up in the hype. There’s the wining, the dining, the company-sponsored boozing, the free meals, the car service home, and most alluring, the potential of making six-figures right out of college. Of course, there are also the 100+ hour weeks, the requisite face time, the Blackberry taking over your life, the tacit no-vacation clause, and the fact that your six figures all depends on your bonus (and thus, the volatile market).

Ah yes, the life of an investment banker on Wall Street is a charmed one indeed.

The opposite of investment banking.

Yet, even with the soul-sucking work and grueling hours, there are still thousands of recent college grads scratching and clawing for i-banking jobs every year. Some may want to put in their two years to land a cushy PE/corporate job. Others may want to prove to themselves that they can survive the torture. Still others may just want to hit on girls with the line, “I’m an investment banker”… which, oddly enough, seems to work just as well as “secret agent,” and much better than “consultant”.

But now, given the recent financial crisis, many of the remaining investment banks are cutting their recruiting budgets and giving out fewer full-time offers and coveted internships. Plus, with the plethora of ex-Lehmanites floating around in the pool of unemployed, getting that entry-level banking job will be much tougher than in previous years. Unless you’ve spent your summers running DCF models or honing your valuation skills, you may want to abandon your childhood dream of becoming an i-banker. So, here are some (mildy exaggerated) tidbits about the Street life that may help you cope:

  • Accounting for hours worked, an investment banker probably makes about the same hourly wage as the IT tech support guy in Mumbai. With an annual coup of $120,000 a year ($60K base salary + 100% bonus), 100-hr work weeks, for 52 weeks of the year = $23.08 average hourly rate.  And this is before taxes.
  • On a related note, Brooks Brothers suits start at $898, and you’ll still look cheap compared to your MD, your clients, and the club owner at Lace.
  • At most bulge-bracket firms, Big Brother will be keeping tabs on your email and web searches for signs of insider trading. Swearing is strictly prohibited through email messages (but strongly encouraged in everyday conversation). Most websites will be blocked as well, so not only will you never get to see your friends, but you won’t be able to keep up with their status updates on Facebook either.
  • If you are female, prepare to enter a world where men are vulgar and crude by default. If you are male, prepare to enter a world where there are no females.
  • Asking about work-life balance is akin to putting on a tutu and galloping through the office singing “Somewhere Over the Rainbow”. That is, it’s frowned upon.
  • You will likely spend the majority of your 15-hour days sitting in a chair, sitting in a black car, or sitting on the toilet from scarfing down your latest SeamlessWeb order. So, if you don’t gain at least 20 lbs in your first year on the job, then la cocaina must be working wonders.

Finally, one last reason why i-banking on Wall Street may not be the best move? Two words: job security.

Isn’t Main Street starting to look more attractive?

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Auto Industry Bailout: For or Against?

The case AGAINST:

Simple economics: If the Big Three automakers fail, it’s because someone else is doing it faster, better, and cheaper. And that won’t change with a measly $15 bn loan that can barely cover the companies’ monthly billion-dollar losses… As they say, you can’t teach an old dog new tricks. Any bailout will just be delaying the death.

carsTime to restructure: Just as it doesn’t make sense to grow oranges in Minnesota, it may not make sense to mass-produce cars in the US. GM, Ford, and Chrysler all have profitable overseas operations, but they’re getting squeezed here at home with higher costs, tighter regulations, and powerful unions. We’ll have to take the hit sometime, so why waste taxpayer money? It’s time to acknowledge that the economics just cannot support an auto industry in Detroit.

Bailing out a lack of innovation: Finally, Tom Friedman likens an auto industry bailout to funding typewriter companies on the eve of the birth of computers.

The case FOR:

lions_fanLost jobs: If there is no bailout and the Big Three automakers must reduce production, a conservative estimate is that we will lose 453,000 jobs next year; others have said it could be as bad as 2.5 million. What will all these people do next? Watch the Lions go 0-16?

Repaying taxpayers: Letting the car companies fail would lead to less tax revenue from lower incomes and lost jobs–which may end up costing us more than an upfront loan funded by taxpayers. Plus, there’s always the chance that the car companies could take the loan and actually turn things around… meaning we’d get our money back eventually, even if it’s in yen.

Like our economy isn’t crappy enough already… let’s just make it worse. The death of the auto industry would have a ripple effect on the entire economy, just as we saw with letting Lehman fail (bailout of AIG, collapse of WaMu, hello-goodbye of $700 bn). If the Big Three go down, taxpayers may eventually have to jump in and bail out everyone on down in the supply chain, plus insurers, pension guarantors, etc. How long could it take to get out of this? Well, how long have the Lions been in the “re-building” phase? Years and years.

What do you think?

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Random Thoughts on… Moral Hazard

An argument for studying economics is that one will leave school with an extensive knowledge of concepts and theories that are applicable in the real world.  An argument against studying economics, however, is that these theories are typically limited to a world where we assume all participants make rational decisions.  Given that Kath and Kim is still on the air, universal rationality is doubtful.

One economic concept, however, has stuck with me after college.  Moral hazard occurs when “an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would,” thus “leaving another party to bear some responsibility for the consequences of those actions.”  For example, there is a moral hazard associated with life insurance.  After purchasing insurance, individuals may decide to take greater risks with their life.  twilightThey may be keener to go skydiving, try bungee jumping, or enter a crowd of teenage girls in line for Twilight.  After all, these individuals are now insured, so we can rationally understand (from the individual’s point of view) why they would be more likely to participate in dangerous activities.  However, from the point of view of the insurer, braving crowds of crazed middle schoolers pining after vampires is not recommended. 

We face moral hazards every day.  On an individual level, athletes anecdotally have had a drop-off in production following the signing of a guaranteed, long-term contract.  We act differently in a hotel room than when we’re in our own homes.  In my intro economics course, Larry Summers summed it up in a guest lecture: “You don’t wash a rented car.”   

In that same line of thinking, government bailouts may cause big companies to take more risks, with anticipation of being saved if they fail.  This can lead to even more trouble, as evidenced by the mortgage crisis (mortgage lenders that securitized their junky loans, backed by Fannie and Freddie, became more lax in lending).  Part of the Fed’s rationale for letting Lehman Brothers go under was because it feared creating a moral hazard if it had stepped in again, especially after its role in the Bear Stearns deal. 

impalaBut still, it’s hard to quantify the size of a moral hazard.  And there are times when the negative risks of the moral hazard outweigh the potential benefits of, say, a government bailout.  In the case of the auto industry, I’m not sure what would be best.  All I know is that I’ve been driving a rented car for the past ten months, and I’ve gotten it washed.  Twice.

 

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The Presidential Debate Redux, With Michael Scott

TOM BROKAW: Good evening from Belmont University in Nashville, Tennessee.  I am Tom Brokaw of NBC News.  Welcome to the second presidential debate of this campaign season, sponsored by the Commission on Presidential Debates, AIG, and Dick Fuld’s compensation package.  As you have noticed, this is the first ever debate to feature not only the two presidential candidates, but also a representative of middle America, Michael Scott of the Dunder Mifflin Paper Company.  Welcome, Senator Obama, Senator McCain, and Mr. Scott. (polite applause)

MICHAEL SCOTT: Tom, I would prefer that you address me as Senator Scott.

TOM BROKAW: (long pause)…Uh, okay, let’s get started.  The first question is to Senator Obama.  This from Oliver Clark.  Oliver asks: Through this economic crisis, most of the people that I know have had a difficult time.  How is this bailout package actually going to help these people out?

SENATOR OBAMA: Thanks Tom.  Oliver, first, let me tell you what’s in the rescue package for you. Right now, the credit markets are frozen up and what that means, as a practical matter, is that small businesses and some large businesses just can’t get loans.  If they can’t get a loan, that means that they can’t make payroll. If they can’t make payroll, then they may end up having to shut their doors and lay people off.  And if you imagine just one company trying to deal with that, now imagine a million companies all across the country.  So it could end up having an adverse effect on everybody, and that’s why we had to take action. But we shouldn’t have been there in the first place.

SENATOR McCAIN: I’d like to jump in here.  My friends, Oliver’s question is a good one.  You know, the match that lit this fire was Fannie Mae and Freddie Mac. I’ll bet you, people like Allen and Mr. Scott here probably never even heard of them before this crisis.

MICHAEL SCOTT: (perplexed)Who’s Allen?

SENATOR McCAIN: See?  So, Fannie and Freddie were the match that started this forest fire.  Some of us stood up against it. There were others who took a hike.

TOM BROKAW: Thank you Senator McCain.  Mr. Scott, do you have anything to add?

MICHAEL SCOTT: Tom, again I would prefer it if you addressed me as Senator.  And yes, yes I do have something to add.  You know, I run a paper business out in Scranton, Pennsylvania.  While Fannie and Freddie are out there lighting fires, guess who, or more importantly, what–is getting burned?  That’s right: paper.  And you know what will happen if these forest fires don’t get extinguished?  No more paper. (McCain nodding somberly) Now, I’ve taken a hike before, don’t get me wrong.  There are many beautiful trails outside of Scranton.  But if we keep having these fires, what’s going to happen to these trees that overlook the trails?  Whoa, big fire, (simulates fire with hands) Smokey the Bear can’t save us, ahhh–there goes the paper!  There go the trees!  There go the trails!  Now I’m out of both a job and an enjoyable weekend hobby.

TOM BROKAW: …Right.  OK, next question.  Senator McCain, in all candor, do you think the economy is going to get worse before it gets better?

SENATOR McCAIN: My friends, we can fix our economy. Americans’ workers are the best in the world. They’re the fundamental aspect of America’s economy.  They’re the most innovative. They’re the best–they’re most–have best–we’re the best exporters. We’re the best importers. They’re most effective. They are the best workers in the world.

TOM BROKAW: (confused) OK… Senator Obama?

SENATOR OBAMA: Part of the problem here is that for many of you, wages and incomes have flat-lined. For many of you, it is getting harder

MICHAEL SCOTT: That’s what she said!

SENATOR OBAMA: (looking pissed) Excuse me?

MICHAEL SCOTT: Sorry, that’s just a thing I do, I–you know, OK, so seriously–the economy.  I mean, I live a pretty good life.  I don’t own 8 cars or anything, but I do own my own condo, I run my own branch of Dunder Mifflin, AND (pointing to stomach) I am a soon-to-be father.

TOM BROKAW: Congratulations, but we really need to get on–

MICHAEL SCOTT: (continuing) Now, do I want to raise my child in a country where America is #2?  Where we’re sitting at home, looking up as Madagascar laps us in the recyclable paper business?  No, no–that is not what I want for my child.

TOM BROKAW: Thank you Mr. Scott.

MICHAEL SCOTT: (wagging finger) Tom???

TOM BROKAW: (reluctantly)…Senator Scott.  Let’s move on.  Next question, Senator Obama: There are some real questions about whether everything can be done at once.  Health care, energy, and entitlement reform–give us your list of priorities.

SENATOR OBAMA: Terrific question, Tom.  We’re going to have to prioritize, just like a family has to prioritize. Now–

SENATOR McCAIN: (interrupting) Hey look, we’re not–we’re not–we’re not rifle shots here.  We are Americans. And I think you can do all three at once.

MICHAEL SCOTT: (whispering) That’s what…

TOM BROKAW: That’s enough.  We’re moving on.  Our last question is from a hippie in New Hampshire.  She asks: As president, how will you know what you don’t know and what will you do when you figure out that which you don’t know?  Senator Obama, I’ll start with you.

SENATOR OBAMA: Tom, one of the things that we know about the presidency is that it’s never the challenges that you expect. Here’s what I do know: I know that if the economy continues to struggle, Mr. Scott over here is going to have a tough time keeping up with the mortgage payments on the condo he’s got.  His firm may soon be facing the real possibility of having to let some people go.

We can’t expect that if we do the same things that we’ve been doing over the last eight years, that somehow we are going to have a different outcome.  We need fundamental change. That’s what’s at stake in this election.

MICHAEL SCOTT: (looking fearful) Will there still be enough money for a Christmas party?

SENATOR McCAIN: My friends, there are challenges around the world that are new and different and there will be different–we will be talking about countries sometime in the future that we hardly know where they are on the map, some Americans. (Michael Scott nods emphatically)

When times are tough, we need a steady hand at the tiller and the great honor of my life was to always put my country first. And–and–you know who is going to raise our taxes and take away Christmas?  That one.  (points at Senator Obama)

MICHAEL SCOTT: (running from stage) Noooooooooooooo!!

TOM BROKAW: And that concludes tonight’s debate from here in Nashville.  We want to thank Belmont University, the Commission, and the traffic light operator for tonight’s debate.  There is one more opportunity for the talking heads to give their stump speeches: next Wednesday, October 15, with host Ryan Seacrest and musical guest Akon.  Good night everyone.

(NOTE: All text in black is what was actually said, taken from the CNN transcript of Tuesday night’s debate.)

 

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Lessons Learned from Buying Lehman at $61

In the past few days, another investment bank has fallen, another huge government bailout has been announced, and WaMu customers are making like it’s 1929 and rushing to take money out of their Whoo Hoo! checking accounts. Year to date, the S&P 500 has fallen by over 20%, unemployment is at a five-year high of 6.1%, and it doesn’t seem like the end is in sight.

So, how did this all happen? What has caused Morgan Stanley to court Wachovia, and WaMu to pimp itself out to the Koreans? We’ve heard the terms “housing bubble” and “subprime crisis” and “credit crunch” ad nauseum over the past few months… but what does it all mean? The following is my attempt to explain the recent travails of the economy, and why I probably never should have bought Lehman at $61:

A couple years ago, you bought a house and took out a $300,000 mortgage on it. The bank that issues this mortgage takes it and pools it along with other customers’ mortgages. Then they sell this product, called a mortgage-backed security, to Lehman Brothers. Lehman likes buying mortgage-backed securities, since it can get a decent return for a perceived low amount of risk, as historically, people rarely default on their mortgages. All the other big investment banks/brokerage houses are doing it too, and so there’s a strong secondary market out there for these securities. This is a seemingly win-win situation for all: a profitable venture for Lehman, and a way for the banks to lend more money and increase home ownership.

Enter subprime.

The banks and mortgage lenders are doing well; they can sell off their pooled mortgages to the traders at Lehman, or to Fannie Mae and Freddie Mac. Much of the risk that the customer will default, then, can be transferred. Thus, the mortgage lenders start getting more lax in their lending terms. More and more subprime mortgages are issued, which involves lending to high-risk borrowers like your deadbeat cousin Charlie. The lending terms are structured so that it looks good at the time of signing (encouraging more Charlies to borrow), but after a certain initial grace period, borrowers are hit with much higher rates.

Meanwhile, the MIT grads at Lehman are concocting new complex derivatives in order to make money. Remember that a mortgage-backed security is already a pool of mortgages. Now, the guys on the Street are trading pools of these pools. And pools of pools of pools. Your $300,000 mortgage is all part of this. Thankfully, you, as a credit-worthy, responsible citizen, have been diligently making payments. But Charlie, who is using his home as a laboratory for crystal meth, is not. Of course, mortgages had already been pooled to mitigate the risk of individual borrowers defaulting. BUT, if a whole bunch of people start using meth instead of paying off their mortgages, then we’re in trouble not just for that one security, but for all of its new derivatives as well.

Then, to make matters worse, the housing bubble bursts.

Prior to 2005, housing prices had been on the rise, with higher sales and consequently, more homes being built. At some point though, supply far exceeded demand, and housing prices began a steady decline. Let’s say the house you bought was worth $300,000 at the time of your purchase. Now, the price of your home is at $200,000, a decline of 33%, right around the rate that housing prices in Southern California have declined. Because the price of his house has fallen too, your cousin Charlie can no longer afford his monthly payments (which have also skyrocketed after his low-rate grace period expired). He, along with thousands of other subprime borrowers, defaults. His meth lab goes into foreclosure. You’re still scraping by, but your monthly payments are going up because the price of your home has dropped so dramatically.

While all this is happening, Lehman and other banks with large portfolios of mortgage-backed securities are taking the losses incurred from all the Charlies defaulting. They also face the suddenly very real risk that you may default too. Already saddled with these losses, the prices of all mortgage-backed securities (and its derivatives) drop across the board. No one wants to buy, and so the value of these assets just continue to plummet. Firms are forced to issue billions of dollars in write-offs. Lehman’s stock price falls and it tries to raise capital–not only because it needs more cash as collateral for its lenders (like your mortgage payments going up when your house price falls), but also to assuage outside perception that it’s going under. But there aren’t too many institutions out there that are in a position to lend money, and not many that want to do it–especially to a firm whose net worth is unknown because of all its mortgage exposure. Banks everywhere enact tougher lending standards to individuals and businesses, making it universally difficult to get cash… thus leading to a “credit crunch”.

So in the end, with a portfolio full of assets that have no market, hedge funds aggressively shorting its stock, and no one willing to lend it money, Lehman files for bankruptcy. Charlie is living on the streets, you’re struggling to pay your mortgage, and more turmoil (involving more derivatives, including AIG’s credit default swaps) is roiling the market… Not a very happy ending.

Obviously this is a simplified version of what happened in the overall economy; in reality, the chronology of what happened is not as linear, and the situation at Lehman was far more complicated than anything I could explain. Many of our venerable publications will do a far better job of sorting through the mess than I have, but hopefully this can serve as a primer. After all, this story is probably not over yet.

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Lipstick, Politics, and the Economy

There are many political issues that preoccupy us on a daily basis. Some care deeply about issues like climate change and environmentalism. Others are concerned about healthcare costs and the future of Social Security. On John McCain’s website, McCain describes his stance on 19 vital issues, including the second amendment, the space program, and the “sanctity of life”. Not to be outdone, Barack Obama lists 23 issues on his site, although blindness caused by small text does not seem to be one of his major concerns. However, while recent news headlines have revolved around another investment bank possibly going under, the takeover of Fannie and Freddie, and our highest unemployment rate in 5 years, the candidates have been arguing over… lipstick.

After spending four years studying economics in college, I would like to think that the economy is more newsworthy than another story about Sarah Palin. But even while we hear about it all the time, the economy is often difficult to understand, and even more difficult to explain. The complexity of today’s economy can lead smart people to different conclusions with regards to policy… thereby confusing the rest of us even more.

For simplicity’s sake, I would argue that the difference between Republicans and Democrats is that Republicans focus on the macro aspect of the economy, while Democrats focus on the individual. From a macro perspective, we judge the economy based on indicators like the stock market, consumer confidence, the unemployment rate, and GDP growth, to name a few. As individuals, however, our perception of the economy is colored by our own experience: Do we have a job? Can we afford to buy things? Do we have money in the bank? Conservatives promote free-market ideals, lower taxes, and less government–sometimes at the expense of unskilled laborers and people who have fallen into misfortune. Liberals, on the other hand, advocate for an active government to temper the market’s unpredictable and unequal consequences on its citizens–sometimes at the expense of productivity and efficiency.

Then, determining good economic policy may ultimately depend on one’s beliefs and values.

My personal opinion is that while conservative economic policy may lead to greater productivity and wealth, I do not believe that increasing wealth is the only source of fulfillment for most people. The Darwinian inclination of the market can create an unhealthy focus on accumulating wealth as the benchmark for success or happiness, and can lead us to lose compassion for anyone less fortunate. We also know that a rising tide does not lift all boats, as inequality in America is just getting worse. I would rather live modestly in a community where I feel safe, than lavishly in a place where I’m constantly looking behind my shoulder.

An interesting take from RFK on our measure of the economy:

Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product – if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities…. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile.Robert F. Kennedy, Kansas, 1968

Of course, the reason why most economists are conservative is because it’s difficult to measure the joy of children’s play and the behavioral reaction to growing inequality. For a conservative perspective and more technical tidbits and interesting facts about the economy: http://gregmankiw.blogspot.com/

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