U.S. FINANCIAL CRISES TROUGH THE EYES OF A FINANCIAL MANAGER

BOSANSKI

Mirsad KRIJESTORAC: Bear Stearns was one of the largest investment banks in the world and among the first to crumble in the current crisis. It has already been bought by JPMorgan Chase Bank. Nora believes that one of the reasons for calamity to reach the current proportion is that old-timers running those mammoth companies could not adjust to the new realities in the trading market. “I remember what the company philosophy was when I worked there,” Nora said. “The former Chairman of Bear Stearns, Alan “Ace” Greenberg, had a funny approach. He would give a new employee a box of paper clips and the employee was expected to use it and not get a new box, for as long as he or she worked there.”

Most the news coming from Wall Street these days sounds very bleak. Report after report speaks of financial meltdown. Yet some are trying to make money even now. Nora Zaki is a financial manager for a hedge fund that is hoping to gain in the long run.

“People who run my company would not react like the people on the floor,” Nora said. “We are not selling, so we didn’t incur any losses yet. Since we are in it for the long term, we are actually buying a lot; that’s all that we do these days.”

Nora is a calm family person. She lives in a nice four-bedroom house in the city of Boca Raton and works for the fund since 2002. Before that, she worked for Bear Stern Investment Bank as a stock broker and she now knows both sides of the crises.

Otherwise a quiet person, Nora becomes lively when the conversation goes around the business of buying and selling financial commodities.

“This kind of crisis is actually an opportunity”, she said. The economy is running on expectations, and because of uncertainties of these times the prices could go down significantly. Things could be bought really cheap.

“You can now buy Lehman bonds, for example, for 16 cent on a dollar,” Nora said. “A year from now they may be 80 cents on a dollar.”

These companies are out of business, but they still have valuable assets. Whoever is in the trading business for the long term could potentially benefit a lot. Yet it’s risky, explains Nora.

Many of the people who work on Wall Street calculate things in the long term, she said. Predicting the future however, is a tricky business. The traders try to do that based on the company’s history, performance and other factors, but they often make mistakes.

According to the Investment Company Research monthly survey of the U.S. funds industry, as of July of 2008 there are approximately 36 thousand mutual funds in America. There are much more funds then actual companies.

“That’s what is moving the market; those funds not individual investors,” Nora said.” So, people put there even their retirement money and all other savings.”

All of these funds have someone like Lora overseeing them and making sure numbers add up. But things are not always logical in the world of traders and investors, especially when things change as quickly as they are these days. Nora believes those fast changes are main part of the current problems.

“There are many different ways to have a rift,” Nora said. “Maybe you put all of your assets in the same type of industry, and you have everything there. If that industry goes down, that’s it; you are in trouble. You can’t cover it and the game is over.”

That happened to Lehman Brothers also, pointed out Nora. They had too many subprime commercial real estate mortgages in their basket and when those mortgages defaulted, the firm went down. Many people are still wondering though, how such a company got to that point.

“They became too big and they took a big risk,” Nora said. “For any kind of investing you have a risk vs. profit. If there is no risk there is no money to make, so you have to take the risk. But, you also have to manage it very carefully.”

As an example how things are complex, Nora described the wild ride with real estate that many people blame as the root cause for the current crises. Since there were only so many properties to sell, and everybody wished to make money out of it, many companies and investment funds decided to sell mortgages instead, Nora explained.

“Remember the mortgage products are different then some other products being traded,” said Nora. “Mortgages are not tangible commodities you can see. They can ultimately be bad debt that people don’t want.”

As the potential for making money of those mortgages grew, the rules relaxed more and more, eventually made everybody eligible for a loan.

“You know how it was here, they were lending money to anybody,” Nora said. “If you just had a name and social security number, you didn’t have any credit or you had a bad one, no problem. Anybody could get a mortgage.”

Nora’s former employer, Bear Stearns went into the same business and eventually collapsed.

“They had their own fund, and they just botched a billion dollars in real estate,” declared Nora simply. ”They had too much exposure to one thing and it did not work out. People took mortgages they could not pay back. They owed 6 percent the first year, second year was 10 percent and then they could not pay it anymore. So it came down to this.”

Bear Stearns was one of the largest investment banks in the world and among the first to crumble in the current crisis. It has already been bought by JPMorgan Chase Bank. Nora believes that one of the reasons for calamity to reach the current proportion is that old-timers running those mammoth companies could not adjust to the new realities in the trading market.

“I remember what the company philosophy was when I worked there,” Nora said. “The former Chairman of Bear Stearns, Alan “Ace” Greenberg, had a funny approach. He would give a new employee a box of paper clips and the employee was expected to use it and not get a new box, for as long as he or she worked there.”

Nora pointed that people like Ace did not have extensive formal education. They were just average guys who went to work when they were in their 20s as stock brokers who made their way up the ranks.

According to the company’s history available through their web site, former CEO of the bank, James Cayne, was hired by Alan Greenberg, Chairman of Bear Stearns Board, as a stockbroker sometime in the 60s. Another indicator of the company philosophy is that even the Chairman himself started working at Bear Stearns in 1949 as a clerk and rose to become the Chairman till the last day of the bank in 2008.

“So they kind of knew how things work on the floor, but over time things changed,” Nora said.

The company went from a brokerage firm to a big investment player. People used to buy stocks and bonds only, but then it started to get more complicated as derivatives were being traded. The things you can’t really see.

“So those old-time guys started to feel the punch,” Nora said. “They didn’t really understand when they had somebody with a PhD from an Ivy League school playing with the firm’s money. That trader maybe understood what he was doing, but the person overseeing him, the person in charge of the money, did not.”

Times changed, people changed, what was being traded on the floor also changed.

“Things were moving too fast,” Nora said. “From what it was just a few years ago, when in order for you to buy something you had to have 20 percent down, to have a good credit, all of a sudden that changed. Zero percent down, with no equity, and you could buy anything.”

Since they did not understand new times, the CEOs would pay attention to the things such as paper clips instead.

“Yeah paper clips,” Nora said. “Or even the story of how was Jimmy Cayne hired.”

Cayne, the former CEO of the bank, was good at playing bridge. The Chairman Greenberg liked how Cayne played and he hired him for that reason only. Cayne was a school dropout, but he was good at the game and he kept winning. Greenberg believed he could do the same thing on the stock market floor.

“Jimmy ended up being a great stock broker because he knew all the strategies of risk taking and stuff,” Nora said and added, “but then those guys started to find themselves in a different world. What they were trading in the 70s and 80s, changed.”

The Wall Street Journal reported that Cayne, who remained the CEO of the company from 1993 until it was bought by Chase in 2008, was even absent from New York for a bridge tournament when Bear Stearns’ hedge funds collapsed in July 2007. This event was one of the causes of the subsequent global financial credit crisis. Yet Cayne’s love for bridge was not shaken by that. In March 2008, as Bear Stearns was on the verge of bankruptcy, the same newspaper reported that Cayne played bridge at another tournament; this time in Detroit.

While he was playing bridge, managers were supposed to oversee the process and make sure the things were in order. But they had different goals, Lora said.

“You have to realize all those people who work in this process don’t get paid based on the quality of performance,” Nora explained. “Even the managers are paid based on performance of the stocks, not their own performance. So when everybody gets paid based on sales percentages, the system is there to stimulate sales only, not accountability.”

Because of this process the credit demand increased, pointed out Lora. And when the credit history of borrowers is bad, the interest rates could go higher up, making loan originators earn more. Everyone involved in this process made money selling new mortgage products. The managers of companies were only concerned with the value of the shares. All the people under him or her had to come up with some brilliant idea of how and what to sell in order to raise the value of the shares. And they did, Nora said, without looking at the foundation of the products.

“They only cared about one thing, how to sell as much as possible and why not?” Nora asked and further explained. “Don’t forget, when the bank lends you the loan, they sell your mortgage to someone else.”

Eventually all those mortgages were bought by giant companies such as Freddie Mac and Fannie May almost by the process of automatization because this is why those companies were created in the first place.

Fannie Mae was founded at the time of other great financial disaster that engulfed the country in 1930s. It was created as a government agency in 1938 as part of Franklin Delano Roosevelt’s New Deal to provide liquidity to the mortgage market and to wrestle the market out of the hands of big monopolies. For the next thirty years however, Fannie Mae made the full circle and held a virtual domination on the secondary mortgage market in the United States.

People involved in the business, mortgage originators and managers were aware of the process of automatization and they knowingly passed the bills higher up as they made profits.

“The problem is that financial market is like a web, and if one part is taken away the other part collapses too,” Nora said.

The cash that circulates is everybody’s money and if that cash dries up, the country is in a deep problem since the banks will not have enough liquidity to fulfill their obligations to ordinary people, Lora pointed out. Then the Government has to step in and that creates another set of predicaments.

All these problems that are now affecting those big Wall Street firms will take time to cause widespread difficulties, but no doubt eventually they will. The confidence in the financial institutions is gone, people will not invest anymore, the money would not be circulating and that’s the problem, Nora explained.

We know that economy depends on positive prospects, but we also know that people live with uncertainty and with very little liquidity in most of the world. Only in the U.S. was it different because for some reason people were counting on the good times forever. Most of the world lives in insecurity for so long, yet the life still goes on. It appears that things in America are just starting to look same as in the rest of the world. Some skeptics wonder whether the current projections of many officials that the world economy will stop due to the Wall Street problems have any merit.

“It is psychological,” Nora points out. “Here was the American mentality, you buy your home, you pay it off, put as much as you can in your 401K, a bit of retirement money here and there and that’s it. Now that is not so certain anymore.”

As a confirmation for this, Associated Press reported that Americans’ retirement plans have lost as much as $2 trillion in the past 15 months — about 20 percent of their value. Furthermore, a staggering number of 760,000 jobs have disappeared so far this year and predictions are that unemployment rate will continue to grow. As the newest reports about further drop in consumer spending keep coming, Federal Reserve Chairman, Ben Bernanke, warned the nation of more economic pain ahead.

Considering all these news, maybe it is true and doomsday is approaching after all? Is it time to buy, or at least, lease the newest model of Noah’s Ark? There is only one problem though; no one is offering loans anymore!