Physicists and financiers have much in common these days – they're both hunting basic reality in their realms. Last week, physicists at a giant particle-collider in Europe began to search for a subatomic entity so fundamental, they claim it creates mass. On Wall Street, a credit crisis has financiers seeking the fundamentals of what creates market value.
Many on Wall Street lost the fundamentals of doing business during an era of loose credit, complex deals that few understand, and blind hope in rising home prices. They also lost sight of three T's that undergird markets: trust, transparency, and truthfulness.
Now, with the collapse of several financial institutions and a dramatic fall in stock prices, Americans need to relearn the prudent use of credit in order to avoid taking on too much debt and putting too much faith in single markets, such as housing.
A two-year fall in house prices, caused by buyers who bought homes they couldn't afford with risky types of mortgages that should never have been offered, needs to fall further until the market locates the rock-bottom worth of a home to Americans.
A new government attempt to prop up that market, either with easy credit or forestalling foreclosures for months, will only re-create the same inflating conditions. It's time for home sellers to accept lower prices and for financial institutions to fess up about their assets.
One likely reason Treasury Secretary Henry Paulson didn't rescue Lehman Brothers last week was that the investment bank had six months since the collapse of rival Bear Stearns to fix its mistake of overborrowing to buy risky mortgage-related securities. It didn't know the worth of its assets.
Taxpayers can't rescue financial institutions that ignore signals to shape up while hoping for a federal bailout. Evacuation warnings for this hurricane were given long ago.
Like Americans with too much credit-card debt, investment banks have been allowed by Congress to take on debt with very little backup capital. That's why so many have fallen, unlike commercial banks that are required to keep reserves against potential losses.
Investment banks and many other financial players, such as mortgage brokers, now need enforced discipline to avoid a new era of risky debtmaking.
The Federal Reserve also needs to learn from its mistake of keeping interest rates too low in 2003 to prevent a housing bubble.
A credit-based economy that turns short-term money into long-term investments needs safeguards, such as capital reserves and transparency. These help handle the greed side of markets. When panic sets in, government must step in and perhaps take over private assets and resell them. That helps handle the fear side of markets.
Wall Street is now in fear mode, even as it learns lessons from its recent greedy era. One lesson is that bundling home loans and reselling them without anyone being held responsible for the risk of those loans creates financial black holes.
At Wall Street's big bang more than 200 years ago, when financiers first gathered under a buttonwood tree in Manhattan to buy and sell, the basics for creating wealth on good credit were established.
It's time for a return to basics that can create true value.