What brought the country to the brink? - Very simply, the reckless, verging on idiotic, residential mortgage lending that took place starting in 2004 combined with the use of modern technology to design exotic financial derivatives that almost nobody fully-understood the consequences of. The massive use and distribution of these derivative products was almost completely funded by debt.
Why did it happen? - The crisis was fostered by a culture of greed that has permeated this country since the "dot com" explosion of the 90's. This culture reached its apex on Wall Street, where the "Wall Street Whizzes" felt that no amount of money was enough. It was nurtured and brought to maturity by the easy money policy of the Federal Reserve under former chairman, Alan Greenspan.
This resulted in the most excessive and imprudent lending and use of leverage seen in U.S. history. The consequences should have been realized by all at least 3 or 4 years ago. I assure you the eventual consequences of their actions were evident to the Wall Street Whizzes. However, why should they have worried? They already would have made a vast fortune from it. Their personal wealth would be secured before the problem became evident. Others could deal with the carnage. The others turned out to be the United States and the taxpayers.
What hasn't happened in the financial crisis? - The impact has been limited to the financial industry, which has been devastated by the losses sustained in the residential mortgage lending market and the losses related to credit default swaps and other derivative products.
At the peak of the financial crisis on Wednesday, September 17 as financial institutions became concerned about extending credit to anybody; thereby almost causing a meltdown of the U.S. financial structure, the Federal Reserve and Treasury stepped-in and proposed the bailout package. This brought renewed life to the credit markets. However, while this scenario evolved, U.S. industrial companies (both manufacturers and distributors) had their strongest balance sheets since the 1970's. There has been no massive borrowing by America's industrial companies during this period, nor has there been any meaningful disruption in the manufacturing and distribution segments of our economy. The immediate impact has been limited to the financial markets, and this is where the impact will be contained.
As I survey the landscape, although the economic figures indicate the country is in a recession or an economic downturn (define it as you like), the profits of U.S. industrial companies remain strong. The results for public companies indicate that although profitability is moderating, it remains at historically high levels. My clients are realizing moderate to strong profit growth this year. In my opinion, the intermediate and long-term impact of the financial crisis on the economy is going to be negligible, if any. I believe that by the 2nd half of 2009 the country will be coming out of the economic downturn. My major concern regarding future economic performance is the amount of guarantees that have been made by the Federal Reserve and Treasury. These could possibly lead to a significant worsening of the Federal deficit. If it does, it will exacerbate our dependence on foreign countries and provide further opportunities for foreign sovereign wealth groups. In this scenario, without foreign governments increasing their already large purchases of U.S. debt instruments, we will likely have a significant increase in the inflation rate and a further weakening of an already weak dollar. Obviously, this foreign ownership of America is not only a political concern, but it also has potential long-term business consequences. However, despite the aforementioned concerns, I believe the financial crisis will have limited impact on the intermediate and long-term economy.