"The Moneys Gone. Now What?"

"The losses from the worldwide financial implosion are only now being tallied up. Adjusting to the reality is proving hard. That difficulty is the unifying fact in much of the news these days — as well as in the mass public outrage over Bernard Madoff, a man who stole primarily from the well-off. Much of the anger is coming from people who did not lose a dime from his Ponzi scheme but who have lost plenty in the stock and real estate markets and would dearly love to find someone to blame.

All those who lost a lot — and a lot is defined differently for each person — now face similar decisions. Do they admit they are permanently poorer, and adjust both their spending and their sense of how successful they have been? Or do they seek to deny reality and hope that somehow the good old days will return?

That problem can be seen in the scandal du jour, the bonuses paid to executives at the American International Group. They still think they deserve to be treated as highly successful people running a large financial company. The fact that it would have collapsed if not for the government’s repeated bailouts is viewed as an insignificant detail. And it could also be seen this week in a legislative proposal being pushed by art museum directors in New York that would bar museums in financial difficulty from selling artwork to raise money to pay other bills. Even without such a law, one museum that sold artwork is to be punished by not being allowed to borrow art from other museums. There was outrage earlier this year when Brandeis University announced plans to close its art museum and sell the paintings. The university’s endowment was devastated by bad investments. What do people opposed to the sale of paintings think suddenly poor institutions should do? Close? Seek government bailouts? Should Brandeis close down a few academic departments, or cut back on scholarships, to keep its art?

Brandeis is hardly the only college whose endowment has contracted sharply. I suspect that when the final numbers are in — and colleges are not exactly rushing to disclose the sad details — it will turn out that colleges as a group did far worse than the stock market while the market was doing horribly. That is because colleges followed the herd. They poured money into so-called alternative investments, which had appeared to be so successful for Harvard and Yale. Alumni clamored to know why their college could not show similar returns, and some colleges that could ill afford big losses put most of their endowment into hedge funds. It turns out such funds could be extremely risky. Those colleges, like many other suddenly less well-off investors, now face decisions. Should they shift to less risky investments with the money that is left, thus giving up the profits that will come if the market does bounce back, as some hope it has already begun to do? Or should they hang in there and risk even bigger losses?

In the meantime, a host of college construction projects have been suspended because the money that was to pay for them is gone. Those decisions, rational as they may be, are putting further downward pressure on the economy just as the college building binge fueled by previous stock market profits helped to stimulate the economy. Colleges now fear that projects under way could drain endowments even more if donors are unable or unwilling to honor earlier pledges. Before it is all over, some trustees will no doubt be forced to resign as scapegoats for what turned out to be bad investment policies.

State and local governments with pension plans are facing similar issues. Rather than raise taxes or hold back promised benefits, it was easier to assume generous stock market returns would continue forever. Faced with underfunded state pension plans, New Jersey even sold taxable bonds to raise cash to put into the funds. That would save the state money if profits from the funds’ investments exceeded the interest paid on the bonds. It would cost a lot if the market plunged. Now New Jersey wants to find villains to blame. This week it sued former officials of Lehman Brothers, saying they lied about the firm’s financial position before it collapsed. Gov. Jon Corzine, who used to run Goldman Sachs, said “we intend to hold Lehman executives and directors accountable for the fraud and misrepresentation that caused more than $100 million in losses to New Jersey’s pension funds.”

That sounds like a desperate effort to stave off facing reality. Even assuming that the directors and executives are liable, it is hard to see why New Jersey should rank ahead of other investors. If the money is split among all investors, none are likely to collect more than a small fraction of their losses, even if all the defendants are forced into bankruptcy.There has been a lot of talk about how much Richard Fuld, the former chief executive of Lehman Brothers, was paid, but he does not have bottomless resources. Much of his pay came in the form of stock and options that he never cashed out and that are now worthless. I was never a big fan of Mr. Fuld. He is responsible for Lehman taking large risks in mortgages and financing it with excessive borrowing. He did not understand how the world had changed by early 2008. The firm passed up chances to raise billions of additional dollars in capital. Some of the money it did raise went into buying depressed assets, on the assumption they would recover quickly. That now seems foolish, or worse, but it is evidence that Lehman’s top management did not think the firm was in danger until it was too late. If this case goes to trial, it will provide a defense.

As a society, we are not as rich as we thought we were. The Federal Reserve now estimates that American households as a group are poorer than they were four years ago, even before adjusting for inflation. That had not happened in any four-year period since the Fed began making those estimates more than half a century ago. It is not an easy reality to adjust to. But simply assuming that we deserve to live as if it had not happened will only make things worse."

- Floyd Norris’s blog on finance and economics is at nytimes.com/norris.
http://www.nytimes.com/2009/03/20/business/20norris.html?ref=business