Investors Feel The Pain of Lehman Bros. Collapse

RENEE MONTAGNE, host:

This is Morning Edition from NPR News. Good morning, I'm Renee Montagne.

STEVE INSKEEP, host:

And I'm Steve Inskeep. We're spending a good deal of this morning trying to figure out one thing. It's the economy; what's going wrong, what the candidates will do about it, and in a moment, how much we really need to worry. In this part of the program, we begin with the Wall Street firms whose trouble knocked more than 500 points off the Dow Jones Industrials yesterday. Lehman Brothers is bankrupt, the giant insurance company AIG is in trouble, and federal officials are trying to figure out what to do. Here's NPR's Chris Arnold.

CHRIS ARNOLD: Yesterday afternoon with the stock market down around 300 points and falling, Treasury secretary Henry Paulson was trying to see the glass half full. Given the collapse of another major Wall Street investment bank over its exposure to bad mortgage loans, Paulson seemed to be saying things could be a lot worse.

Secretary HENRY PAULSON (Treasury Department): We're not going to move through this in a straight line. There are going to be some real rough spots along the road, but I believe we're making progress. And when I look at the way the markets are performing today, I think it's a testament to the way the financial industry has come together.

ARNOLD: A couple of hours later, though, things looked even uglier with the Dow down 504 points. Some investors were worried that the government wasn't doing more to help. Paulson's been wearing a different hat these days. When Bear Stearns and then Fannie Mae and Freddie Mac were in trouble, Paulson rode to the rescue with saddlebags full of money. But now he's taking more of a tough-love approach. He's there to listen and encourage financial firms to work together, but so far he's refused to keep putting taxpayer dollars at risk.

Secretary PAULSON: The situation and the facts around Bear Stearns were very, very different to the situation we are looking at here in September. And I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers.

ARNOLD: Some analysts say it's good that the government let Lehman fail. They think that might get Wall Street to fix its own mess instead of waiting for bailouts. Andy Kessler is a former hedge fund manager and analyst who now writes about Wall Street.

Mr. ANDY KESSLER (Former Hedge Fund Manager; Writer): This happens every cycle. And, you know, I used to work on Wall Street, and I competed against Drexel Burnham and Shearson and Dean Witter and E.F. Hutton, and they're gone. And, you know, each of them made some mistake or another along the way. And this is nothing new. I mean, I don't think we've entered a new era of the 1930s and the Depression.

ARNOLD: Kessler says the investment banking industry basically had too many players. Some competition and technology had squeezed a lot of the profit out of it. They couldn't make money executing stock trades for customers like they used to. That led some to get overleveraged and to gamble on risky investments, like all those loans to people who it turns out couldn't pay them back. So, he says, the more badly managed firms are now going under.

Mr. KESSLER: At the end of the day, no one really measures them because someone else steps up and takes over their business. And quite frankly, a lot of the people that work at those firms, the better of them, you know, get jobs across the street.

ARNOLD: But other people aren't so optimistic. Nariman Behravesh is chief economist at the forecasting firm Global Insight. We've talked to him a lot over the past year as the credit crisis has dragged on.

Dr. NARIMAN BEHRAVESH (Chief Economist, Global Insight): I have to be honest with you, I am worried. This is big, it's scary, and the biggest concern is it might get out of control, because all of a sudden we're looking at not one but a series of investment banks and now a major insurance company in deep trouble. And I think this is quite a bit bigger than anybody thought it was.

ARNOLD: Behravesh is referring to the giant insurance company AIG which saw its stock fall 60 percent yesterday alone. And after that, the company's credit rating was downgraded. There are now worries about whether AIG will be the next firm to fail. That would send another big shock through the financial system. So Behravesh is growing skeptical that the government can avoid a huge bailout here.

Dr. BEHRAVESH: I'm a big believer in free markets, and I can understand why the Treasury and the Fed don't want to keep bailing out. Investment banks that have gotten themselves into trouble, however, resolving this crisis this way, I think is very messy.

ARNOLD: Behravesh thinks the federal government is going to have to take the bad loans off of all these companies' books, like it did back in the 1980s in the savings and loan debacle. Otherwise, he worries the current crisis could cause a lot more damage to the nation's banking system and lead to a severe recession. Chris Arnold, NPR News. Transcript provided by NPR, Copyright NPR.