Money Men Say It's Time To Pay Piper

A toxic cocktail of fear, uncertainty and confusion has replaced the heady blend of confidence and assured profits once in favor on Wall Street. Now the financial markets are reeling from a serious case of credit buzzkill.

"The worse the binge, the worse the hangover, and this was a pretty bad binge," said Alex Lieblong, president of Lieblong & Associates, a Little Rock money management firm. "The lending crap that had been going on the past four years was just insanity, and we're paying for it."

More and more loose credit secured by ever-appreciating real estate is transforming into bad loans often backed by undervalued real estate. The resulting turmoil on the national scene pushed Lehman Brothers Holdings Inc. into bankruptcy and drove cash-strapped Merrill Lynch & Co. into the arms of Bank of America in a $50 billion distress sale.

"We've hit the top with bad lending, bad borrowing and the government wanting everyone to own a house, even people who really couldn't afford to or know how to manage money," Lieblong said.

The chaos on Wall Street prompted an unusual public response from Arkansas investment bankers. Stephens Inc. and Crews & Associates issued statements during a recent four-day span to reassure clientele and staffers that their financial houses are in order.

"We are under no illusion that anyone would ride to our rescue, so you cannot ever take a risk that could jeopardize the ability of the firm to survive," said Warren Stephens, CEO of Stephens Inc.

"At the root of our nation's current financial problems are leverage and excess," said Rush Harding, CEO of Crews & Associates.

In Arkansas, the effects of too much leveraging, risk and easy credit are expected to be minimal compared with states such as California, where astronomical property values now are orbiting closer to earth.

The overarching concern is to stabilize the credit market and keep the wheels of commerce moving so the economy doesn't drift into a recession or worse. For the short run that will mean continued low interest rates as the federal government wrangles over how deep it will go into the financial chasm.

"We need to take steps to make sure this doesn't spiral into something worse," said Heath Abshure, Arkansas Securities Department commissioner. "If they are acting to prevent our current economy from getting worse, that's great.

"I'm just worried we're going to draft some short-sighted, poorly crafted legislation. I'm really, really scared of that.

"I worry that, in this interest to get something done quickly, we're going to find ourselves with something that isn't the best fix. We're at the stop-the-bleeding point and not fix-the-problem."

And the government is still grappling with what it will take to stop the bleeding after facilitating the March sale of Bear Stearns Cos. to JPMorgan Chase & Co. and taking over Freddie Mac and Fannie Mae, which hold or guarantee half the nation's mortgage debt.

"Most of the issues before us today were absolutely avoidable," said Mark Millsap, co-owner of Little Rock's Foundation Resource Management. "Had we as a nation addressed them in a timely fashion, we would likely not have the turmoil that is before us today."

Four years ago, Millsap advocated – in a guest commentary published in Arkansas Business – the dismantling of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac).

His concerns about too much leverage and too little accountability proved to be on the mark as big problems waiting to happen, even as the duo helped make mortgage lending more carefree.

It was an atmosphere that four years ago caused Millsap to wonder: "Is there anyone who does not qualify for home financing these days?" The intervening months confirmed that many who did qualify shouldn't have, as loans were bundled together and marketed as investments.

The same mortgage-backed securities that all but swamped Bear Stearns sent Lehman Brothers scrambling for bankruptcy protection with $60 billion in troubled real estate-related investments.

Why did Uncle Sam step in with an $85 billion emergency loan to keep American International Group Inc. afloat days after saying no to Lehman Brothers? To prevent an even worse ripple effect than the bankruptcy of the nation's fourth-largest investment banking firm.

AIG sold default insurance to holders of risky debt such as mortgage-backed securities, which hammered Lehman Brothers and so many others. If AIG couldn't make good on claims and remain solvent, the financial fallout would splatter a host of banks, investment firms and others.

No one wanted to contemplate the fiscal chaos that would ensue if AIG didn't have the money to stand behind those default policies. And AIG is a legitimate, regulated enterprise, unlike other players in the $46 trillion credit default market.

That's an area that gave rise to entities that weren't subject to regulatory oversight, and some of those default insurers had little capital to back up the risk protection they were selling. They were in cruise control – reaping huge profits, until claims started coming in.

"Every time everyone is making money hand over fist, people forget about the rules," said Elijah Cunningham, president of ValuePoint Partners Inc., a Little Rock money management firm.

Among those rules is the law of financial gravity: Investments that go up in value can come down in value.

Cunningham believes action by the government to restore confidence and stability to the credit market will happen, even if it requires the full $700 billion proposed.

"We do have a workable solution, and it's in process," he said. "This isn't a bailout. It's a purchase of assets, and it will work.

"The cost for what you have to do for the system is quite reasonable. You have to get the mortgages moving because they are at the epicenter of everything."

Financial service companies have written down about $300 billion in bad mortgage investments, and some forecasts have that figure climbing to $1 trillion.

The write-downs and financial meltdowns, though painful, are an expected outgrowth of a market seeking equilibrium.

"It will clean the system," Alex Lieblong said. "This whole thing is human nature. Greed is a terrible thing. The blame extends from Wall Street to Main Street. There is so much fault to go around it's incredible.

"All you had to do to get a mortgage was to fog a mirror. There was so much fraud going on out there it was scary. Now the market will overcorrect the other way."

Lax credit standards are expected to give way to more conservative standards, as the pendulum of public opinion swings back.

"It is going to be a tighter underwriting process, as it should have been all along," Cunningham said. "You're going to see a shift back to more of a deposit-based lending system. It wouldn't surprise me if we lost a third of the banks because the nation is over-banked. You may see a market where the banks eat their own."

Whatever comes of the shakeout, Lieblong is confident the financial markets and the economy eventually will bounce back.

"You have to go back and put it in perspective," he said. "Capitalism, sooner or later, works its magic. You just don't want to be overleveraged.

"Capital is the most precious thing you can have – not in life, but in investing."

Lieblong understands how the ups and downs in U.S. markets shake the global economy but doesn't see the current economic travails as a nation teetering on the abyss.

He cites a personal observation while touring hotel investments as a favorable sign of the times. A strong contingent of Eastern Europeans populated the support staffs.

"When I see Americans going to Eastern Europe [to find a job], I'll start worrying," Lieblong said. "Don't ever sellthis country short for the long run."