The Economics of Enough_ How to Run the Economy as if the Future Matters - Diane Coyle [70]
FIVE Trust
On wednesday 10 september 2008, Lehman Brothers was worth about $5 billion on the New York Stock Exchange. Its shares had lost three quarters of their value during the year, so that valuation was already much lower than the $60 billion it had been worth in early 2007. By the end of the week, it was worth just $100 million or so to its shareholders and owed more than $600 billion. A weekend rescue attempt by the authorities failed, and the bank, founded in 1850, went bust.
Its demise sent shares in other banks tumbling as well. More bankruptcies were feared. The big American investment banks were all (except for Goldman Sachs) taken over by commercial banks or changed their status to ensure the Federal Reserve would save them from failing. The banking crisis wiped out investment banking, and in the few weeks that followed caused declines in share prices that amounted to about $10 trillion globally.
It isn’t only banks that are vulnerable to sudden corporate death, destroying value almost literally overnight. There were other startling examples before the financial crisis. Enron was worth $70 billion at the peak of its share price ($90/share), in August 2000. Just over a year later it was bankrupt and worthless. Enron’s auditor had been Arthur Anderson. Its value in turn was destroyed by the scandal; the huge accountancy firm, founded in 1913, vanished. WorldCom was another giant company whose value evaporated in scandal. At the peak of its might in 1999, it had a market valuation of $150 billion and reported annual revenues of $39 billion. By 2002 it was almost worthless and the assets it held were sold to other companies.
These are the biggest corporate and financial collapses of recent times but there have been others. They have included long-established and respected names and have occurred in Europe and elsewhere—Parmalat in Italy, Northern Rock and Royal Bank of Scotland in the United Kingdom, Satyam in India. Enron was a relatively new creation but many other companies that vanished in recent times were formed in the nineteenth century or even earlier.
These recent examples were destroyed by the dynamite of innovative financial transactions, which were powerfully destructive, especially when used with criminal intent to defraud. In other recent bankruptcies, deliberate fraud may have been absent but the destructive effect of complex derivatives was similar. Their CEOs and boards had not understood that for all the complexity of the off-balance sheet and offshore vehicles and securitized assets and sophisticated derivatives, finance is really very simple. It transfers the benefit of economic activity from one person at one time to somebody else at a different time and in a different place. If the chain of transactions is not built on solid foundations of trust, it will disintegrate. The failed companies had no idea whose fortunes were now linked with theirs.
This is why large and seemingly substantial corporations and banks could implode. Banks in particular have no value where there is no trust. This is why, historically, banks have always made such a show of their impressive buildings and marble and wood panelling. The grandeur is meant to signal to depositors that they are not fly-by-nights who will run away with their money rather than lending it out cautiously and repaying it with interest on demand. It’s also why the 2007–8 financial crisis puts the issues of trust so fully at center