Dan's Papers - February 20, 2009 - This Last Christmas Might Be Our Last Big Shopping Spree

In the first chapter of the book I wrote called In the Hamptons, (Harmony, 2008) I describe how I sat across from a man who was, at the time, the most important person in the Hamptons. He was Merton Tyndall, president of the Bridgehampton Bank. It was 1963. I had been running Dan's Papers for three years. And now, for the first time, I needed to borrow money in the springtime to publish the paper through the autumn here in the Hamptons.

I sat across from Tyndall and showed him the orders I had renewed for the upcoming year. I would have out only two issues before the end of the month when I could send out my bills. I wouldn't get paid until late July. I would need $1,000 to tide me over.

Why this chapter is so interesting is that Tyndall, after hearing my little speech and doing the adding and subtracting, opened a drawer to his desk, took out a checkbook and simply wrote me a $1,000 check. He never had me sign anything. But I had promised I would pay it back and he believed I would.

Two years later, after paying that money back and borrowing increasing amounts each subsequent year, he called me up at the office to apologize. I was 24 years old at the time. Tyndall was about 70 and had been president of the bank for 30 years. "You need to come in here and sign something," he said. "This group called the FDIC had come in - they monitor the banks - and I need to have your loan in writing. I really don't see why. You've always paid it back. But I guess you better come down."

Back then, any loan made by anybody was carefully monitored by the federal government. Bankers made about 80% of all loans, and they worked on the "three principle." They made loans at 3%. And they left the office at three in the afternoon. All was right in the economic world

The other 20% of loans were made by people outside the system, who lent money to those who could not get loans at banks. They borrowed from people who charged higher interest rates. And they usually lent for a shorter term. It was a risky business, but they were used to it. And that kind of banking was not regulated very much.

As time went by, however, the non-bank lenders became more aggressive, and found more and more ways to lend money and tread on the sacred ground that only bankers had been allowed before. Eventually, during the Reagan administration, the bankers said they'd like to be able to lend the sorts of instruments the non-bank people lent. And soon thereafter, the system expanded. And that marked the beginning of our present problem.

I think the mindset of America in the pre-Reagan days was to live within your means, borrow only when you had to, (house, car) and if you wanted something you couldn't afford, you put it on "lay away." They'd hold it for you until you got the money. Then you could buy it.

But today there is a new mindset. We no longer use "lay away." We use credit cards. We take it home now, and we pay for it as we go down the road later.

Huge numbers of people got extremely rich living off the interest charged the ordinary citizen for the credit card debt that was now the new way of doing things. And the reason was that with the new philosophy, there was 10 times as much money being borrowed as was borrowed under the earlier system.

If Wall Street was only a small part of the American economy in 1960, it soon grew to massive proportions. In 2001, earning a living by living off interest paid represented a staggering 5% of the entire American economy. Last year, the number had soared up to 8%. If the whole American economy is $12 trillion a year, nearly $1 trillion of it is paid out to the banking, credit card, Wall Street and loan industry.

And that is why the Hamptons and other wealthy enclaves in America have been booming. Someone in this business makes, on average, more than $1 million a year. They buy whatever they want, and they still have money left over. They spare no expense. They cannot even spend it all.

This past October, Ben Bernake, who is in charge of all the money in America, got down on his knees and literally begged the leaders of the U. S. Senate to "bail out" Wall Street.

The term "bail out" is an unfortunate term. What he was really begging for was $700 billion to keep Wall Street in business, because, all of a sudden, all the firms on Wall Street, all at the same time, had simply stopped lending money to anybody whatsoever. It was an astounding development. There WAS no banking business.

The triggering of this mass stoppage was caused by the sudden inability of ordinary people to pay their mortgages. Tens of millions of them had been sold sub prime mortgages, which often consisted of three years of monthly payments at amounts they could afford, followed by 20 years of monthly payments they could not afford. The belief had been, when they took out these loans, was that that future better jobs would get them the money to pay the loans. And if that didn't happen, they could always sell their house for higher amounts than they paid for it. So there was nothing to lose.

Except that now, suddenly, there was. Two years ago, the price of real estate leveled off. Sales at higher amounts found no takers. And so, like a great ponzi scheme, the real estate mortgage market now developed people who could not make their payments. Houses were foreclosed. And banks holding the mortgages were left to foot the bill.

The reason this happened was that during these past eight years of the Bush administration, the number of young men and women going into the money management business had reached staggering proportions. And why not? The pay was staggering. Anybody wishing a high income would head in that direction.

And the banking industry made room for these people. They did it during the Bush administration by finding new ways to manipulate, buy, sell and insure these various loans they had. Whole new companies sprang up doing just that. They'd buy a mortgage and then get a rating company to rate it and then sell the mortgage to another company and take a cut out of it along its way. The new owning company might then get the mortgage insured by still another new insurance company springing up.

It was last summer that, for the first time, as a reporter, that I heard the term "bundled derivative." For those new people still wanting to get into this business, it was now possible to create a company that would purchase not just one mortgage, but whole bundles of them all put together, like bundles of newspapers.

Who knew what was in these bundles? Well, soon it was not even mortgages. It was second-generation paper called derivatives, which were agreements that were derivative of the original mortgage. And then they got bundled.

Last summer, I was introduced to a man who had made a fortune buying and selling bundled derivatives. I was too shy to ask him what they were, but when I asked somebody else what these bundles were, I found out that nobody really knew what was in them. They were now far removed from whatever they had been originally. This was far removed from any apparent regulation.

When the bad mortgages within the bundled derivatives began to be foreclosed upon, up the chain these requests went. But if the truth be known, nobody had made an accurate accounting of what was in many "bundled derivatives." You could trace a bad apple to it, though. And there it was. Surprise! Needless to say, suddenly, nobody wanted anything to do with bundled derivatives. And so when it was found out that buried all through Wall Street, like a virus, were flawed bundled derivatives, the big banking and Wall Street firms simply stopped lending anything to anybody. The earth stood still. And Bernake got down on his knees to ask Congress to throw money into this machinery to get it moving again. If it didn't and if this situation went on for very long, soon, companies large and small would start to fail for being unable to obtain the ordinary loans they needed to stay in business, just as I had needed such loan so long ago.

The $700 million was authorized and it was given to Wall Street banking and insurance firms with the caveat that they use the money to grease the wheels in the lending community to get things back to normal.

The money was never used for that purpose, however. In spite of the fact that a failure of lending this money would lead all of Wall Street to simply stay out of business until everything fell apart, the recipients of the money only used the money to patch up their balance sheets. They have all told the government that they will lend the money just as soon as somebody else lends the money.

From this point on into the immediate future, one business after another is simply going to shut their doors and let people go or downsize and lay off people because they cannot get access to the loans they need to keep going. And sadly, the more people they throw out of jobs, the fewer loans will be requested because there will be fewer and fewer paying customers out shopping - for retail, service, auto, real estate, landscaping, you name it.

None of this would have happened if, eight years ago, the new Bush administration had not begun to greatly curtail oversight over Wall Street. The economy built on credit rather than layaway worked when it was regulated. When the regulatory staffs were reduced and when their bosses were fired and replaced by free market executives from the firms that were supposed to be regulated, the seeds of the destruction were planted.

America will gain its footing when those frozen credit markets reopen. And if Wall Street can't or won't do it, then the Federal government will. And anybody who says this is socialism and we shouldn't do it is making the same mistake the Republicans made that prolonged the Great Depression.

Indeed, so far, we have avoided Great Depression Two because in the last few months the Federal government has been throwing vast sums of money at everything to try to get the credit markets to reopen. Nothing yet has done that, but at least they have propped everything up for awhile longer.

In the end, my guess is that the country will get back on track as both government and the private sector begin cautiously re-lending, with lots and lots of oversight to keep it all on the up and up.

Wall Street could reemerge only about a quarter as big as it was, with all those employees that worked with these third generation, bundled derivatives getting useful jobs as barbers, doctors, plumbers and schoolteachers.

And we'll be once again seeing layaways.

As for the Hamptons, it is my opinion that because this is Wall Street's last magnificently profitable year, we have just witnessed our last Christmas. It's been a somber group out shopping, but they have done it and though they have not spent with abandon, they have still spent.

Look for closed businesses, a lack of merchandise, a continuing fall of real estate prices, higher unemployment, government work projects, higher crime, active food pantries and soup kitchens and lots of pain.

Barack Obama is a very smart and dynamic and fearless man who has surrounded himself with experts. How long till we get back on our feet? Maybe six months from now we'll start to see some things beginning to turn back upwards. We are, as it is turning out, witnessing and being part of a very profound economic event.

But we'll get through it, stronger and better than ever, though perhaps making do with less.