Judgement Day comes for easy, cheap credit

Mississippi Business Journal, The, Sep 22, 2008 by Chandler, Clay

A series of events that started the early part of this year came to a head last week, and the results were borne out in the stock market and in the conference rooms of blue-blooded investment banks.

Lehman Brothers, a financial services firm that had been operating since the 1800s, filed . for bankruptcy. Bank of American bought another financial services giant, house Merrill Lynch. And insurer American International Group (AIG), is counting on an $85-billion loan from the federal government to avoid the same fate.

Last week's news comes on the heels of investment bank Bear Steams' collapse last March, which ultimately prompted the government to pump money into the bank to keep it from going under.

Chris McAlpin, with Financial Strategies Group in Ridgeland, says his clients usually have the same three questions when it comes to the stock market and the overall health of the economy: Why is this happening? How do you stop it? And how do you turn it around?

"The first one is pretty easy to answer," McAlpin said. "The other two aren't.

"It's the culmination of too many years of easy credit and cheap credit. In January, major investment banks started realizing that they were going to have major problems (associated with subprime lending). Then there was a fear that there would be nobody to lend money and that would have trickled down to the smaller banks."

McAlpin believes it was that fear that led the U.S. Treasury Department to conclude that it had to step in and assist Bear Steams in March. The investment bank was eventually bought by JP Morgan Chase at $10 per share. Prior to the sale, the 52-week high of Bear Steams stock was just under $134.

"The concern was that (a Bear Stearns collapse) would push what was going to be a recession into a depression," McAlpin said.

But Lehman Brothers was offered no such attempt at rescue. London-based investment firm Barcays was still considering parts or all of Lehman Brothers early last week.

"I think the decision in March (to bail out Bear Stearns) was a correct one," McAlpin said. "If Bear Stearns had imploded, you would have had a run on the bank and that would have started a run on the local banks."

But the timing of the Lehman Brothers collapse probably hurt the chances of government assistance, McAlpin said.

"The Treasury eventually had to draw a line in the sand and say that they were going to let the market punish you," McAlpin said. "So even with the Treasury telling Lehman Brothers, basically, 'tough luck,' there is still the perception that the government has bailed out three institutions that messed up," McAlpin said, referring to Bear Stearns and mortgage giants Fannie Mae and Freddie Mac. "But in reality, they've only bailed out one, because the government was always on the hook with the other two."

McAlpin said he spent most of last week fielding panicky calls from his clients, which tends to happen when the stock market plunges.

"I've been putting out fires, calming fears and educating," McAlpin said. "We tell our clients all the time that the market is cyclical. It's never going to stay really high or really low. There's always some sort of change on the horizon.

"This just happens to be a down cycle.

So I don't want people to be falsely nervous.

At the same time, when the market experienced the boom of 2004 and 2005, I warned my clients not to be falsely happy. I have to take that position when the facts support it.

"But when things are going like they are now, the market tends to get numb when bad news comes in waves like it has been."