Wall Street didn't just lose hundreds of billions of dollars in the current financial crisis. It lost its good name, too.
It has long been viewed as the triple-A-rated center of the financial world, a trusted place to invest, and a role model for emerging financial centers around the globe.
But that was before Wall Street banks emerged as the central villains in the biggest financial crisis since the Great Depression. Before the exotic securities backed by risky mortgages that they created — and peddled around the world to investors — plunged sharply in value, causing economic mayhem. Before banks, insurers and mortgage companies started to fail at an alarming rate.
And, most important, before the Bush administration sought — and so far has failed to get — a $700 billion Wall Street bailout to avoid a 1930s-style economic collapse.
As a result, Wall Street's image has taken a major hit. People don't think as highly about Wall Street as they once did.
"People have long looked up to the U.S. financial system as a paragon of sophistication and efficiency, but now they realize that it is a false illusion," says Michael Panzner, author of Financial Armageddon and an upcoming book, When Giants Fall: An Economic Roadmap for the End of the American Era. "Wall Street as the center of finance is losing its place in the world."
Wall Street's reputation has suffered "a big black eye" that is not likely to fade from world view anytime soon, says Vanguard Group founder and ex-CEO John Bogle.
"This is a financial crisis brought on by Wall Street greed," says Bogle, who in November will release a book, Enough, which takes aim at Wall Street. "This has been the most speculative period in financial market history."
This isn't the first time in recent history that Wall Street, driven in large part by greed and multimillion-dollar paydays, has acted badly and put its reputation at risk. In the late 1990s analysts were slapping buy ratings on Internet stocks while badmouthing the companies in private. Earlier this decade, accountants and top executives at some Fortune 500 companies were caught cooking the books, and several mutual funds were caught profiting at the expense of their shareholders.
But the public relations fallout this time is far more serious: Wall Street's misdeeds have rocked the foundation of the U.S. and global financial system to its core. U.S. financial markets have been put on the brink of failure, shining an unflattering light on our free-market system. Fear of a systemic meltdown has wiped out $3.6 trillion in stock market value this year and knocked the Dow Jones industrials down 18.2%.
Customers leave when trust is lost
It's one thing to have tech stocks crash. Or put a crooked CEO behind bars for fraud. Or kick an unsavory analyst out of the business for hyping stocks. It's quite another to put the entire system at risk, says Axel Merk, president and portfolio manager at Merk Investments. "In the tech-stock bust, the system worked as it was designed," he says. "Checks and balances were in place. You had some business failures, but the financial system did not fail."
Sydney Finkelstein, a professor of management at the Tuck School of Business at Dartmouth College, says the shocking failure of once-vaunted investment banks Bear Stearns and Lehman Bros. shows just how important reputation, image and confidence is to the healthy functioning of financial markets. Both firms were undone by customers who stopped doing business with them after losing faith in the firms' ability to make good on trades and debts.
"What are these companies? Their assets are their people, reputation and expertise. And these are not things you can sell in times of trouble," Finkelstein says.
Finkelstein thinks the current mess tops all other Wall Street crises of recent vintage, including the dot-com meltdown and the savings-and-loan crisis of the late 1980s. The reason: Wall Street's massive losing trade on real estate loans has created a level of uncertainty and economic instability that is unparalleled in modern financial history. It also put Main Street at risk.
"Nobody expected it, and nobody knows what is going to happen next," Finkelstein says.
When controlled, greed is good
Main Street investors are livid with Wall Street for putting their financial lives in peril.
"Wall Street knew what the risk was but did not care," says Lindsey McMahon, a Florida-based real estate agent. "I have lost faith. We need to take the bull by the horns and fix the situation, fire all the people in position of authority, eliminate golden handshakes. It will take a lot of real work to earn back respect."
Adds Matt Korol, a 53-year-old information technology manager from Seattle: "The financial system is more closely related to a Ponzi scheme than to something that is inherently trustworthy. Greed is ultimately what makes markets work. We can't legislate greed out of existence, but we can put appropriate controls in place to make sure that markets do not get too skewed by the excesses."
But Wall Street isn't the only villain, says former Securities and Exchange Commission chairman Arthur Levitt. Regulators, lawmakers, the Federal Reserve and the Treasury Department all share blame for not keeping a closer eye on banks and brokerages and for allowing the proliferation of opaque and complex credit instruments brandishing exotic acronyms like CDOs, CMOs and CDSs.
"Our system has been badly regulated and poorly overseen," Levitt says. "The U.S. regulatory system has got to change dramatically. People tend to fear what they don't understand and what is hidden from them, and a vast portion of the market is totally hidden from public investors. We have to know what the derivatives markets are doing, who owns what positions, what the hedge funds are doing."
Wall Street's global standing suffers
A big repercussion of Wall Street's fall from grace is its tainted prestige with foreign investors. Foreigners who once looked up to Wall Street and mimicked its investment principles and techniques now question whether that is a wise approach, says Sung Won Sohn, an economics professor at California State University. "Now they are saying, 'What can we do different? We don't want to be another Wall Street.' "
Many think Wall Street has lost the power and prestige it used to command. "It is going to be many years before international investors regain their confidence in Wall Street," Sohn says.
Adds veteran Wall Street strategist Barton Biggs of hedge fund Traxis Partners, currently in Europe meeting with investors: "It is shocking the level of disillusionment with Wall Street." He says it could take five to 10 years to restore trust.
If investors around the world no longer see the U.S. model as the only way to run markets, it could foster a new era of more independent thinking and speed the rise of new financial capitals around the globe, says Peter Schiff, president of Euro Pacific Capital.
"Wall Street risks losing its prominence to foreigners just like the auto and textile industries did," Schiff says. "More deals will take place … in places like Hong Kong, Dubai, Shanghai and London. More and more companies will list their shares on other stock markets."
Despite its black eye, there is still hope that Wall Street can repair its tattered image.
Earning back the trust of investors at home and around the world can be done, but it takes time, says Muriel Siebert, the first woman to own a seat on the New York Stock Exchange and president of brokerage Muriel Siebert & Co.
"There will be a period where we have to go out and prove ourselves. And after the sale of Merrill Lynch to Bank of America, and Lehman going broke, that will take time. You just can't change a name on a firm's door and have everybody say, 'New name, new firm. I trust them.' "
Bogle rattles off three quick fixes: "We need more simplicity and less complexity. We need more investing and less speculation. We need more value and less cost."
Byron Wien, a veteran Wall Street strategist and current chief investment strategist at hedge fund Pequot Capital Management, also believes confidence in Wall Street will be restored.
We'll get through this mess
Sure taxpayers and Main Street feel offended that Congress will have to bail out "Wall Street's so-called fat cats," he says. But the sense of crisis will pass if Congress passes a rescue plan that stabilizes markets and restores a sense of financial well-being to Main Street, Wien says.
Wall Street survived the '87 crash, the near meltdown of hedge fund Long Term Capital Management in 1998, the tech stock crash and 9/11, Wien says. "Memories are short. We have recovered from every previous calamity. This is a serious situation, but not life-threatening."
A successful bailout package is key, Wien says. In addition, excessive use of debt must continue to come down, and the economy must skirt a serious recession. "If all those things happen, we are on the road to re-establishing our prestige."
Betting aggressively against a resurgence of U.S. economic might is a bad idea, says Scott Black, president of Delphi Management. "We are still the lynchpin of the free-enterprise system around the world. Everyone has an inherent vested interest in the U.S. doing well."
Don't count out the American people, either, he says. "This country was built by people who said, 'I can,' not 'I can't.' Our entrepreneurial spirit has not been extinguished by this latest crisis."