Monday, October 6, 2008

Lehman bankruptcy = $150+MM loss for San Mateo school districts

Wow. Over dinner, my friend, Mike, mentioned that Lehman's bankruptcy caused school districts in San Mateo county to lose hundreds of millions of dollars. I was shocked to hear this because despite hearing about all of the disasters on Wall Street, I expected any effects out in the Bay Area to be secondary effects.

How did this happen? By California state law, school district funds are held by the county, and San Mateo County had a large percentage of its assets held in Lehman bonds. In a cruel twist of fate, Menlo Park City School District, which had a AAA bond rating (highest possible rating), had just issued $30M in bonds to finance the renovation of its schools. So this school district, which had done its job in running an extremely fiscally responsible operation and, furthermore, had used its strong credit history to finance better schools for its students, was directly impacted by fallout on Wall Street.

Now you can argue that the county should never have had its assets held in such risky assets, but it is a sad story nonetheless. How do you explain to a 10-year old that in addition to their home being taken away by foreclosure, that their favorite teacher is being fired and that their playground isn't going get new monkey bars anytime soon?

News article here:

So I was thinking about how we got to this situation, and I keep coming to the conclusion that it was a horrible chain of selfish decisions -- none, in and of themselves, 100% at fault, but all contributing to the fallout. It's like a horrible example of Macolm Gladwell's Tipping Point gone right. The start was Clinton's policy of encouraging home-ownership for everyone and Greenspan's outrageously low interest rates. Then it was financial firms taking advantage of this cheap credit (basically free money) and the over-securitizing of financial assets. This inventivized mortgage companies to push mortgages (often illegally) onto unqualified home buyers. That was the tipping point. This basically sent the financial industry into overdrive as it had an overload of mortgages that it could trade and make money off of. This created a recursive cycle that resulted in the creation of trillions (with a T as in TONS) of dollars of fake value. Now those trillions of fake money are being unwound out of our global economy.

The problem that I have is that all these players knew EXACTLY what they were doing. It was not a situation where the blind were leading the blind. The major actors in this play were extremely intelligent and capable individuals. But the reward of payoff for all of them was enough to take the risk. Clinton and Bush had political gains in mind. Greenspan had a reputation as a financial mastermind to hold up (do you think it was a coincidence he left his office at the time he did?). The bankers all had huge bonuses at stake.

Now I don't have any problem with capitalism and free-market economics, but they are not a solution to everything. I don't think supporters of these systems ever consider the down-side cost. They only consider the upside reward. Yes, people who work hard and are talented should be rewarded for their good work. But, people who are by-standers should not bear the outsized responsibility for the cost. THAT is the problem with a free-market system; it never will be run truly like a free-market system. It's an option-call for the people with the biggest upside.

We are seeing exactly what happens when we try to impose too much of a free-market system on an economy. For that reason, I cannot support a McCain presidency. On top of the extreme incapability of Palin, McCain has always been a strong supporter of free-market economics. While he claims he is now all about reform, reform, reform, and maverickism (whatever that means), I cannot trust him to implement any reasonable reform.

Let's hope that Obama can be a voice of reason for the next 4 years.