Monday, September 29, 2008
The Tsunami on Wall Street: West Coast to be hit
|While the federal Band-Aid is being applied to Wall Street’s financial mess, it will take a lot more structural surgery, regulatory medicine and healing time before it can begin to support normal growth of the economy. The credit boom of the last decade and a half supported not only the real estate boom but also the generous expansion of state and local economies. On the West Coast, and California, Nevada and Arizona in particular, it led to remarkable expansion in home ownership. While the average home ownership rate in the three states increased by 4.6 percent from 1986 to 1996, it rose by 10.6 percent in the next decade, 1996 to 2006. A large portion of this was fueled by easy credit.
But that is not the whole story. Plentiful liquidity also facilitated business growth financed by venture capital, private equity and hedge funds. Many of these funds made their money on Wall Street, and funded new and small businesses. Given the generally greater tolerance for risk, the growth in general business expansion made rapid strides. But the bust on Wall Street will put the brakes on such rampant expansion and certainly demand a more careful analysis of the expected performance on such businesses. Many of these businesses have already cut back or gone under (for an example, see the Financial Times story at ft.com/cms/s/0/095142b8-8c30-11dd-8a4c-0000779fd18c.html).
The private sector was not the only beneficiary of easy money. State and local governments also benefited. Higher tax revenue and liberal use of the bond market allowed expansion of government programs, from infrastructure to education to benefits for the disadvantaged. The aftermath of the financial crisis will make it much more difficult to undertake these tasks.
It is hard to tell at this time in what ways the current financial wreckage will change the shape of credit intermediation in the U.S. economy. It will certainly not eliminate risk inherent to business and financial operations. But it is most likely to lead to greater regulation and accountability.