Investment Bank Meltdown

In March, Wall Street had five major investment banks. After today, there are two (Goldman Sachs and Morgan Stanley). Bear Stearns, Lehman Brothers, Merrill Lynch—three former giants—gone. Gone.

Justin Lambert, writing in the Wall Street Journal (subscription), credits Hank Paulson for making sure the U.S. in its current financial crisis doesn’t repeat Japan’s mistake of the 1990s, when government authorities kept propping up banks facing liquidation and thereby prolonged the crisis for a decade. Some banks have to fail for the rest to survive and for the system to recover.

Since Paulson last March helped Bear Stearns place its assets under JPMorgan Chase’s umbrella (the government had to rescue Bear Stearns because of its significant derivatives market holdings), the Federal Reserve then extended short-term government credit to threatened financial institutions (didn’t work for Lehman because creditors wouldn’t lend to it anyway), and the previous weekend, Paulson nationalized Fannie Mae and Freddie Mac to save the mortgage market and bring the two giants’ mismanagement under control. One can argue that the net effect of each action, including Paulson’s letting Lehman fail, helps the economy.

One measurement of how well government's actions work is Wall Street’s short-term reaction. Right now, my FOX INDEX, which measures the distance to a healthy market (12,000 Dow, 1,300 S&P, 2,500 NASDAQ) is over 1500 points from being well—a long way. Obama should be able to capitalize on this latest financial crisis, true front-page news. When times are bad economically and Republicans are in charge, voters gravitate back to Democrats.