Wachovia CEO Robert Steel has an answer: “People got very comfortable with risk.”
Over the past six to eight years, the CEO said during an interview with Cramer Monday, consumers took on more risk in their portfolios and mortgages companies used more leverage in hopes of making huge returns on their investments. And why not? Up until last summer there was plenty of money to be made but virtually no penalty for stretching yourself thin.
Of course, then the residential housing sector began to implode. Homeowners were using their equity like an ATM, and potential buyers were mortgaging more than they could afford. The downfall came when house prices began to depreciate rapidly, leaving people will property less valuable than what they’d bought. Then the foreclosures started.
All the previously mentioned financials – Merrill , Lehman , AIG – were exposed to these bad loans, and the market quickly turned on them. Steel attributed the causes to a three-part domino effect: bad credit issues, then trouble finding liquidity to make up for the losses, and, finally, problems hitting the real economy. That’s why even the big boys, the supposed professionals in the market, were hurt so badly.
“That domino effect has basically exacerbated the situation,” Steel said, “so that it’s a bit tough to get out of the way.”
Steel called it a “sad, hard day” for all the executives who worked so hard to keep these companies in business.
Still, as bad as things have gotten, the CEO doesn’t think the events so far have been catastrophic.
“We’re working through this,” he said, “and we’re making progress.”
Steel sees transparency is one of the keys to moving forward. That way investors know what they own or what they’re buying when they deal with a struggling financial company. (Both Lehman and AIG were virtually opaque with their balance sheets. Merrill, however, was very open about its own. Note the different outcomes.) That openness then leads to the confidence needed, another key, for these assets to be sold at real prices. Then the system requires capital to help companies get through these hard times.
And there’s plenty of capital left to be had, Steel said, whether it’s from high-level money market funds, sovereign wealth funds or savings. These potential investors just want to make sure financial companies are done with their business strategy of low liquidity and high leverage.
Given how difficult the past year has been, Steel’s surprised at just how well the economy’s held up. He admitted, though, that “more headwinds are surfacing,” namely unemployment. But so far Washington has responded well, Steel said, noting that the Federal Reserve and Chairman Ben Bernanke have made cash available to firms that need it. Still, the road ahead is unclear.
“I think the Fed’s got to be challenged as to how to move next,” Steel said.
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