Lehman Preferred Series "J" Preferred (fka LEHJQ)

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Thursday, November 5, 2009
Post-Lehman 'zombie economy' era

A year following last year's collapse of Lehman Brothers, are we entering a new post-Lehman "zombie economy" era?

The term "zombie bank" was originally used to denote banks that were propped up by government funding. In Japan's case, such funding was provided to avoid the bankruptcy of their domestic banks following the collapse of their real estate bubble in 1991. Yet despite such "free money" in the form of governmental financial support, many of such financial institutions did not derive profit -- the very mandate of private institutions. Instead, they had the physical form of a living bank, but in form only, not in spirit. In other words, "zombie banks" were banks that superficially looked like a bank from the outside, but did not act like a real one in terms of creating positive value. In the 18 years since then, Japan has yet to fully recover from the bursting of its real estate bubble.

Similarly, around the time of the 2008 subprime mortgage financial meltdown, financial regulators across the globe made great efforts in front of the media to show a concerted and unified effort that they were actively engaged in thwarting a tailspin into a deep financial abyss not seen since the Great Depression of the 1930s. In the U.S. case, the initial financial bailout package involved nearly $700 million, separate from other related bailout funding for used cars (i.e., the government's "cash for clunkers" program), mortgage loan modification programs, and other related programs that in total well exceeded $1 trillion.

One main risk that U.S. regulators faced was how to avoid the same financial quandary in the United States for its subprime crisis as Japan faced during its real estate bubble crisis in the early 1990s. During last year's debate relating to the passage of the bailout bill, many Republicans argued that institutions that failed to make a profit should be left to their own devices, and not receive government funding, in the Darwinian spirit of the free market system. The Democrat faction was more divided with many arguing to support, and thus provide government funding for such a bailout program, even if it risked substantially worsening the U.S. deficit.

Because of the subprime mortgage crisis, and subsequent U.S. government's massive bailout and stimulus packages, funding power shifted from private banking institutions in New York City to the federal government in Washington, D.C.

Since the Lehman fallout, we have born witness to an era where many formerly prominent institutions in the private sector are in the unusual position of playing an almost subordinate role to the public sector. This was most evident when large financial titans like Citigroup and Bank of America received government funding to maintain their financial viability, or at least the perception of financial viability.

The power shift to the public sector and government represents a distinct shift in terms of what type of financial era in which we live.

Following the collapse of Lehman Brothers in Sept. 15, 2008, we now may live in a post-Lehman "zombie economy" era.

A zombie economy is like a zombie bank, but at a macro scale. It can be described as an era that has the following characteristics. First, it is an economic era in which many formerly large and prominent institutions have, are or may be at risk of failing. This was certainly the case of such institutions as Bear Stearns and Lehman Brothers last year, just to name a few. Second, this is then followed by a massive public sector effort to resuscitate such institutions. But for such government efforts, such institutions would in effect be corporate corpses with no sustainable life (i.e., they would be declared bankrupt and liquidated). Third, in our ongoing post-Lehman zombie economy era, a notable period of anemic or flat growth will continue in the private sector, domestic consumption, financial markets, and consumer sentiment in the short to medium term. Fourth and finally, institutions that both received and did not receive government bailout funding will exist but will remain relatively dormant and relatively risk-averse. This is due to their own internal risk assessments, but also due to a new post-Lehman regulatory framework that covers broad-ranging areas, including wages for executives.

In form, a post-Lehman "zombie economy" era may look like near-healthy economies seen in the past. But in this new reality, economic growth will not exhibit the full breadth and depth of life of economic eras in the past.

A zombie economy is not a "U," "W," or "L" type of economic forecast. If anything, it is an era whereby the largest pickup in growth has already been realized from March to October this year. This may then be represented by a square root symbol with a squiggly (rather than flat) line that reflects a narrow bandwidth of market and economic fluctuation, both positive and negative.

With so many so-called experts trying to predict the type of "recovery" we may experience going forward, keep this in mind: only two people were truly able to accurately predict the downfall that foreshadowed the global subprime mortgage crisis -- Robert Shiller (at Yale University) and Nouriel Roubini (at New York University) -- so how are we trust that so many "experts" will get it right this time?