Wednesday, November 21, 2007

Investment banks erred by chasing future mortgage profits

WASHINGTON _ Big-name investment banks are taking a financial beating this year, leaving many Americans to ask: Just how did all these Wall Street bankers in their $5,000 John Lobb shoes manage to step in you-know-what?

The answer is simple: They made the same mistakes as the rest of us, just with more zeros attached to them and bigger consequences for the U.S. economy, if not for their own $625 John Lobb wallets.

Those mistakes are why the heads of Merrill Lynch and Citigroup have been ousted in recent weeks, why household names such as Bank of America and Wachovia are announcing billion-dollar losses and why more trouble is brewing.

Individual investors frequently lose money by chasing past returns, deciding on future investments by looking at past performance instead of future market conditions. Investment banks did just that amid the booming housing market. They mirrored each other's moves as they raced into ever-shakier lending. Some estimates suggest that collectively they'll lose more than $400 billion.

"They are basically a herd of sheep. They all go into it together," said A. Gary Shilling, a financial consultant and television commentator who warned in 2005 and 2006 of troubles to come. In the 1980s, banks followed each other into massive Latin American debt. Later, he said, they all got burned together by losses in manufactured housing.

In hindsight, the risks from an overheated housing market seem obvious. But in a now-famous July interview with London's Financial Times, then-Citigroup CEO Charles Prince appeared to confirm the sheep metaphor when he shrugged off the imminent danger.

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing," he said.


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