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The Great Shakeout

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Only two firms appeared to have come out from mortgage-bond hell effectively unscathed: JPMorgan and Goldman Sachs. The former, run by Jamie Dimon, wisely allocated its capital and shrewdly built deposits at Chase Bank. Those deposits give it more wherewithal than any of the other major firms including Citi, which has a bigger deposit base but looser risk controls. Goldman, managed brilliantly by Lloyd Blankfein, made an actual bet against mortgages that started out as a hedge against its own toxic portfolio but ended up being much more profitable than the losses its mortgage bonds sustained.

Still, there are reasons to believe that no one’s entirely safe. Right now, every single kind of merchandise the remaining Wall Street firms have to offer—the underwriting of corporate stocks and bonds, mergers and acquisitions, stock and bond trading, and so on—are all simultaneously in the toilet. Even Goldman, once seen as the blue chip of the blue chips, reported a so-so quarter, but a profitable one, and its stock promptly fell 40 points on the news (though it later recovered). When the best of the best gets clobbered, even though it’s making money, you have to wonder whether things can ever get back to the way they were. When the economy eventually rebounds worldwide, we could see bigger profits for the big financial-services firms simply because there are fewer competitors sharing a shrinking pie. The remaining outfits can survive, perhaps thrive. But it’s hard to imagine, without the huge profits that these kinds of now-disgraced complex mortgage-backed investments can bring, we are going to see a return to what now looks to have been Wall Street’s Golden Age.

“The hardest thing is to have your compensation cut. It’s like you’re a bad person.” … Bankers may not make as much money, but they get to keep their jobs …

For two-plus decades, New Yorkers have been living in a Wall Street–dominated world. Ushered in by Michael Milken and Henry Kravis, popularized by Oliver Stone and Tom Wolfe, and carried to its decadent extreme by hedge-funders with 32,000-square-foot Greenwich mansions and Gulfstreams at every airstrip, it was an era that dramatically changed New York. I don’t care what the stock market did late last week or what it does in the next few days. That age, the Master of the Universe Era, is over. Too many people were too badly burned by taking too much risk to repeat that trick again. That has practical implications for everything from private schools, Range Rover dealerships, and Sotheby’s auctions to SAT tutors, newsstand operators, and shoeshine guys. It will also have an impact on the Zeitgeist. Greed is good? Not anymore. I’m nobody’s innocent, but I think we’ll see a more chaste culture emerge from all of this, on Wall Street, and perhaps beyond. Caution will be the new daring. Safe will be the new sexy.

In terms of the broader economy, we’ve often been able to cordon off Wall Street meltdowns from Main Street. Anyone who lived through the crash of 1987 knows that it turned out to have virtually no economic impact. But this sell-off has more far-reaching roots. It’s jarred the confidence of consumers and lenders in a way that could lead to a severe downturn in consumer spending and a starving of capital for businesses. Any purchase that can be put off, from a home addition to a vacation, is likely to be put off, at least until the economic dust settles. Any project that needs financing, from building skyscrapers and bridges to opening a new restaurant or dry cleaner, could be stopped in its tracks. The $180 billion in liquidity the Fed injected into the system last week was helpful, but it wasn’t the key move. The real difference maker was the government’s decision to buy these toxic bonds for pennies on the dollar, taking them off everyone’s books. The feds could have kept handing these firms money, but if the bad paper kept losing its value, then that money would have gone down the drain too.

Still, a recovery from a storm this big is going to take time. I don’t see the current recession ending until the second half of 2009. Ironically, housing, which got us into this mess, could be one of the first sectors to recover, as cheap mortgage money and a dearth of new supply should lead to a bottom by June of next year.

New York is insulated somewhat—especially the housing market—by the flood of foreign money that’s been pouring into town because of the weak dollar. The city’s economy is also far more diversified than it once was, and many of the area’s big non-financial companies—IBM, Honeywell, United Technologies, and the like—are flush. And an awful lot of the Wall Street people who are now out of work made an awful lot of money before they got the boot.


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