In the wake of the stock market crash Monday, and all the questions about Lehman Brothers and AIG last weekend, the RN&R sprung into action: What the hell does any of this stuff mean? Who to call? Elliott Parker, an economist at the University of Nevada, Reno since 1992. He’s also chair-elect of the faculty senate. His website is www.business.unr.edu/faculty/parker.
Can you tell me exactly what we’re looking at? What happened with Lehman and AIG?
What I know: A lot of these firms are big investment banks, and they are not well-regulated in terms of where they put their money. Commercial banks are not where the problem is. Commercial banks are generally regulated. There are rules about who they can lend their money to and how they can put their investments. What Lehman Brothers did and a lot of these other companies did is they invested heavily in real estate. Just like—
You and me.
—just like you and me in terms of buying. They saw it as a way to make high returns and thought, like many of us, that it was a relatively stable investment. The problem is—if it’s you and me, we owe the bank, say $200,000, but Lehman manages about $300 billion worth of assets for its clients, and it has another $700 billion as far as I can tell. More or less, it’s a $1 trillion company. Its net revenues are something like … oh, I don’t know … something like $20 billion, and it makes about $4 billion profit a year, at least for 2007. And it turns out they were starting to admit how bad their balance sheet looked. A lot of the investments that they had made in real estate were paying off very badly, and they owed more money than they had in investments, just like a lot of other people.
So they got upside down in their receipts and their payments?
At least their assets and liabilities. So they got basically upside down, too. Many of these investment banks, I don’t know if Lehman was one of the bigger ones that did it, but many of these investment banks were involved in the restructuring of debt. That is, they take other people’s mortgage debt and repackage it in securities. One of the things they do is they chop it up. For example, you look at the subprime mortgages. A lot of that subprime [lending] is what started this because there is an awful lot of investment firms that would take what they considered the safe portion of subprime mortgages, and chop it up into one kind of bond, and then they’d have another riskier kind of bond, and people were buying these bonds without knowing, really, what the risks were. When the subprime mortgages started going south and not being repaid, all of a sudden, assets people thought were relatively safe assets turned out to be worthless.
Now Dow Jones lost some 500 points—
That’s right, about 4 percent; same with NASDAQ, about 4 percent of market value.
What’s that mean to you and me and the calendar editor?
Those of us who own stocks, you learn to ride the waves. You have bad days, and you have good days, but you have to look at the longer track picture. This is a particularly bad day, and it’s hard to recover from this. The danger is if it sets off more panic. People say, “Oh, my god, I’m investing in companies that I think are relatively safe, and now I discover they’re not safe anymore.” Everybody pretty much thought Lehman and Merrill Lynch were pretty well managed. Your equity was safe with them. So if it sets off a panic, it could be the start of a few bad days. In terms of what it means … you have to look at the long term. If this causes more banks to get nervous and more banks to decline, then it could really push us over the edge into recession. And this could be a nasty next year or two.