Being a movie buff, I always look to films as a handy metaphor for whatever is going on in the world. One of my favorites right now, as it was back during the technology stock bubble of the 1990s, is The Matrix. It is a movie about two realities, one virtual, one concrete. As I wrote about the tech stock bubble back then: "Internet stocks seem to exist in some Matrix-like virtual reality where a completely different financial physics applies. In this Web wonderland, revenue growth would always accelerate, prices continually advance, and actual profits forever lurk just around the bend."
The same scenario strikes me today when it comes to current events. You have the financial economy—Wall Street—where the fundamental, inescapable realities of risk and reward were ignored, and which is now suffering a tremendous upheaval. And then you have the "real economy," where Main Street exists, which is chugging along for the most part despite the housing implosion and credit crunch.
Yet just as in The Matrix, where what happens in the virtual cyberworld can directly affect the real world, what happens on Wall Street affects Main Street. That is why all those angry E-mailers who want to "let Wall Street burn" are really missing the point. A financial meltdown would ultimately result in an economic meltdown.
At the end of T he Matrix, Neo, the hero , says, "I don't know the future. I didn't come here to tell you how this is going to end." Well, I will tell you how I think this all will probably end: more nationalization, more government control. AIG was probably only the beginning. I urge you to take a look at this analysis from the Cleveland Federal Reserve of Sweden's banking crisis in the 1990s, which also had a real estate bubble at its core. Here is a key passage:
The first victims of the economic downturn were two of Sweden's six largest banks, Första Sparbanken and Nordbanken. After they announced in the fall of 1991 that they could no longer meet the regulatory capital requirements (8 percent of assets), the state eventually guaranteed all their existing liabilities, took full ownership of Nordbanken, and helped Första Sparbanken with a loan guaranty to the owners. Within a year, a third major institution, Gota Bank, became undercapitalized. When its largest owner refused to provide additional funds, the state guaranteed all its liabilities to prevent a meltdown; Gota declared bankruptcy the same month. Once again, the state took ownership of the bank. After acquiring Nordbanken, the state owned 22 percent of all banking-system assets.
Yeah, something like that, I think, is in our future. Already folks on Capitol Hill are talking about an RTC-style vehicle to buy bad mortgage debt. And it won't matter who is president. Either Barack Obama or John McCain will want to solve this problem ASAP.