Fall of the Lehman- narrating in the Econ101 way: part 1

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The turmoil in the U.S. financial market is causing havoc all around the world. Economists and financial experts are trying to explain the situation using jargons many people don’t understand. Let’s attempt to explain it in layman’s terms.

What happened over the weekend (September 14, 2008)?

· Lehman Brothers, the fourth largest investment company in the Wall Street filed for bankruptcy under chapter 11.

· Merrill Lynch also was in utter distress and accepted the offer to be bought by Bank of America at the last moment.

· Rumors were widespread that AIG, the insurance giant was also in dire state and would soon collapse.

This news led to massive effect on stock markets all over the world. Many started believing that this is the beginning of this century’s “Great Depression.” In this write-up, let’s take a look at the situation in the United States economy. We will start exploring the impacts on other countries in future.

So what do all these things mean?

It is not difficult to understand that many of those directly involved in the financial sector including Lehman Brothers will likely lose their jobs. So, what? Many people posted on different websites that as jobs in manufacturing and other places were disappearing, investment bankers were earning in millions. It is time for payback. So, those employed in investment banking may lose jobs and a person who is in some other profession comfortably detached from the financial sector has nothing to worry about.

Wrong! If the Wall Street is going down, it is taking down everyone with it. Let’s take the example of Bert, a blue collar worker in a manufacturing company. As stock market tumbles, his company suffers massive financial loss and had to announce job cut. Joe, a construction worker was told that the current project won’t go through for indefinite period. Joe had no clue what went wrong. Well, as financial sector suffered massive loss, there was not enough credit (loan) available for home buyers. The demand for homes plummeted, hence was no need for more construction. So, no matter how detached one’s profession appears to be, the ripple effect could still engulf everybody.

Let’s review the situation from another perspective – as people expect that they are going to face economic hardship in the near future, they attempt not to spend on items which are not absolutely necessary. So, this will adversely affect retail sales and in turn another cycle of less demand for goods followed by more job cuts.

Well, even if one is certain (for some odd reasons) that his/her employment is secured, what happens to his/her vested savings/retirement is not so clear. Joana was planning to retire in 3 years. Guess what, her retirement got delayed. Whatever she had put in her retirement account hardly exists now. Similarly, many watched their children’s education fund dwindling. Besides, in months to come, as profits of companies will fall, many employers will find it lucrative to either stop offering health insurance or pass on the higher cost to employees in terms of higher premium/deductible/co-pay.

At this juncture, no one can accurately predict how far it is going to affect the economy. However, it is certain that many are going to face massive economic hardship in the near future. In the next part, we will explain what the government/Fed did to get out of the situation and whether it helped.