Investors lost something more crucial than money in 2008. They lost faith.
In the United States, millions of people have given up on the capital markets as a place to save for their future - so says the financial industry. In the middle of December, two Wall Street lobby groups quietly released their latest survey of Americans' investment habits. Their data showed that 47 per cent of U.S. households own stocks or bonds, down from 57 per cent in 2001.
Here's the kicker: The survey was taken months before the autumn meltdown that sliced trillions of dollars off the world's paper wealth. If a similar poll were taken today, the ownership rate would doubtless be lower still. Even with the financial markets on the front pages this fall, a large chunk of the U.S. population has tuned out. In a poll of Americans conducted by the Pew Research Center in early December, fewer than half knew that the Dow Jones industrial average was trading at about 8,000 - even after being given four choices. The equity culture in the world's largest economy may not be shattered, but it's diminished.
In 2008, skeptics, doomsayers and non-believers on Wall Street and Bay Street were vindicated. This was not because the wizards of finance proved to be corrupt or dishonest (though there were enough accusations of that - Bernard Madoff's alleged monstrous Ponzi scheme being merely the worst). Nor was it because the Street's paid gurus made big mistakes. Errant forecasts by professional soothsayers are expected. What was so surprising is that the people closer to the action - the ones at the top of the world's largest banks and corporations - proved, time and again, to have so little idea of what was just around the corner. Most of them wildly underestimated the depth of the financial rot and economic dysfunction. Publicly, they appeared too complacent, especially before September.
The vignette that will be forever remembered is that of former Bear Stearns CEO Jimmy Cayne playing in a bridge tournament in Detroit, barely perturbed, as his firm crumbled in March. If he was guilty of inaction, others were burned by their own words. Less than two months after Bear's death, Vikram Pandit, Citigroup's rookie chief executive, dared to suggest that tens of billions he'd raised from private funds and wealthy offshore investors had "established a very strong capital base for today and the future."
The future didn't even last five months. By November, Citi was so desperate that it needed an emergency $20-billion (U.S.) injection from the U.S. government, on top of $25-billion given to it by the Treasury in October, to avoid possible collapse or nationalization.
These missteps weren't confined to Wall Street. On the morning of Sept. 5, Canada's financial elite gathered at Spruce Meadows, a world-class equestrian facility and conference centre in southwest Calgary. On the dais were four top bankers from Canada and Europe - Gordon Nixon of Royal Bank, Rick Waugh of Bank of Nova Scotia, Josef Ackermann of Deutsche Bank and Stephen Green of HSBC. The group agreed that this was a terrible crisis, the worst since the Great Depression. Yet more than one of them suggested there were signs of healing in the credit market. The tone was, if not optimistic, hardly depressing.
Five days later, Lehman Brothers' chief financial officer boasted that the firm enjoyed "strong liquidity." And four days after that, Lehman had no liquidity, filed for bankruptcy protectionand the credit market proved too sick to handle the upheaval.
By late September, the CEO volte-face had become a regular occurrence. When an analyst asked if he was considering selling new shares to raise cash, Jeffrey Immelt of General Electric said that wouldn't be necessary: "We just don't see it right now." Six days later it sold $12-billion in new shares, plus $3-billion in other securities, to Warren Buffett's Berkshire Hathaway. But GE, with a massive financial division that relies heavily on short-term debt, might have still had a liquidity problem without the help of the U.S. Federal Reserve.
Even the Oracle was in for a humbling. Fifteen days after his GE investment, Mr. Buffett used the pages of The New York Times to exhort Americans to buy stocks. In the subsequent five weeks, Americans rushed to sell them, and the Standard & Poor's 500 dropped another 15 per cent (though, in fairness, he had emphasized he wasn't making a short-term market forecast). Having previously - and presciently - denounced derivatives as financial weapons of mass destruction, Berkshire Hathaway lost more than one-quarter of its value between Oct. 1 and Dec. 22, largely because it came to light that Mr. Buffett had produced a multibillion-dollar potential liability by using - what else? - derivatives to essentially bet on the stock market.
Not even a half century of stellar investment returns could earn the man the benefit of the doubt. This is one of the bigger consequences of the loss of faith.
It doesn't matter how strong the brand name is, or how rich or successful - the era of the "trust me" financial institution is over, and probably for a long time.
Look at Manulife Financial. On any list of Canada's most lauded financial companies, it would be at or near the top, right there with Royal Bank. Manulife is big, it's global, it has been a dividend-paying machine and it has done a lot of business selling financial products that give guaranteed returns to the buyers. How does that work, exactly, and what are the risks? Before this year, few thought to ask. They trusted. Not now, after the insurer had to turn to the big banks and markets for billions of dollars in capital.
There's no better brand on Wall Street than Goldman Sachs. Yet it has been hammered along with the rest of the banks. Why? Because it has accumulated $1.1-trillion in assets backed by less than $50-billion in equity.
And even if you slogged through hundreds of pages of financial statements, how well would you understand what made up that $1.1-trillion, really? To invest in, or lend to, such a company requires faith, and there's not enough to go around.
And compounding the public's loss of faith was the erratic performance of Goldman's most famous alumnus: Henry Paulson, the U.S. Treasury Secretary. Lured into politics in 2006 as a star member of the Bush cabinet, he might never live down his own 2007 prediction about the subprime mortgage problem. "I think it's going to be largely contained," Mr. Paulson said, echoing the words of Fed chairman Ben Bernanke.
"Think about the fact that the people that we're asking to solve the problems are the very people who assured us that there was no problem to worry about in the first place," said Peter Schiff, president of Euro Pacific Capital Inc.
Even so, early in the crisis, Mr. Paulson was praised for his handling of it. But much of the political capital he'd earned evaporated with his fumbling of the Troubled Asset Relief Program, or TARP. First he told the U.S. Congress that he had to get $700-billion to remove toxic assets, mostly mortgage-backed bonds, from the books of American banks. His initial bill, the size of a pamphlet, essentially wrote a blank cheque for the Treasury.
But weeks later, Mr. Paulson pronounced it a bad strategy and decided to put $250-billion directly into the banks instead. Strangely, for a guy who claimed to take moral hazard seriously, the money was offered on the same lenient terms to all banks, regardless of how decrepit their balance sheets were. (Thus the U.S. taxpayer is getting a 5-per-cent return on money lent to Susquehanna Bancshares of Pennsylvania, while Mr. Buffett earns 10 per cent on his investment in General Electric.) TARP's focus shifted again, to consumer finance. But then tens of billions were sucked out of the bailout program by American International Group, General Motors and Chrysler.
Mr. Paulson was exposed as a guy who was just making it up as he went along. But then, so were his former colleagues and rivals at Goldman, Morgan Stanley, Merrill Lynch and elsewhere.
These are the same firms that collectively advise millions of investors on where to put their money, yet they couldn't spot their own problems early enough to avoid multibillion-dollar losses. No wonder the average American is growing skittish about stocks and bonds.
Derek DeCloet