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Column: Wall Street gone wild? Hare are five painful lessons

There's plenty we need to re-learn the hard way in such deteriorating economic times.

Don't spend so much more than you have. Don't blindly assume a house will appreciate up and up, no matter what. Don't embrace luxury items, especially on credit, and convince yourself they are truly necessities of life.

All this sounds really basic — stuff that should appear in some book like the 1986 bestseller, All I Really Need to Know I Learned in Kindergarten. But somehow, we keep forgetting the fundamentals.

This recession comes with its own curveballs. So here are five new lessons, in the hope we do not repeat them any time soon:

1. De-leveraging. It's called "The Great Unwinding."

Wall Street firms used little of their own cash, instead borrowing heavily to invest in all kinds of exotic securities. That's great for big payoffs — if values keep rising. But when values fell, the same leverage multiplied the effect of investor losses.

Home buyers did the same thing by buying all those bigger-than-they-could-afford houses with no-money-down mortgages. We assumed home values would only rise and bail us out of our too-expensive monthly payments.

De-leveraging will take time and hurt many people (via foreclosure, bankruptcy and job loss) just as it wiped out Wall Street's Bear Stearns, forced giant Citigroup to beg for Middle East money to shore up its losses and pummeled Merrill Lynch.

2. If you don't know what it is, then don't buy it.

Years of low interest rates, the rise of hedge funds, quick-hit profits from real estate and a global search for investments flooded Wall Street with easy money. Buyers and sellers of securities backed by lots of U.S. mortgages failed to monitor the quality of their deals. Financial gurus kept selling new products investors did not understand but happily bought.

3. Calling Wall Street the capital of capitalism is like calling Hurricane Katrina a cleansing wind.

Wall Streeters love to act like Masters of the Universe. But when things get really rough, who bails them out? The Federal Reserve is quick to flood Wall Street with cheap money to pay for its excesses. Too bad the rest of the country's economy does not get the same preferential treatment in hard times.

4. Our habit of dropping interest rates to appease investors and borrowers has turned the U.S. economy into an easy-money addict.

Like Pavlov, former Fed chairman Alan Greenspan trained the economy to salivate and perform whenever he dropped short-term interest rates. Now Fed chairman Ben Bernanke follows the same path. The problem? Short-term rates are so low that the Fed has little left in its arsenal to help if the economy really tanks.

5. Bite the bullet sooner rather than later. If we wait too long to account for all those bad mortgages and related securities, we may suffer the fate of Japan in its 1986-1990 real estate bubble.

Japan failed to curtail a wildly speculative real estate market, then refused to make its banks acknowledge their bad loans. Result? A Japanese market crash so bad that it became known as the "lost decade." Japan's still making up for lost time.

Is the United States on a parallel course?

Robert Trigaux can be reached at [email protected]

Column: Wall Street gone wild? Hare are five painful lessons 03/22/08 [Last modified: Tuesday, March 25, 2008 1:56pm]
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