By James T. Hammond
SCBIZ Daily Staff

COLUMBIA -- Local economists predicted the investment-banking meltdown in New York over the weekend would further weaken an overall weak economy in South Carolina and nationwide as the stock markets opened sharply lower Monday.

But they also said they don’t expect any specific institutions to fail here as a result because most have diversified their portfolios to minimize the risk of any single investment.

As expected, New York investment bank Lehman Brothers filed for bankruptcy protection after it failed to find a buyer, and Merrill Lynch said it agreed to be purchased by Bank of America.

Lehman Brothers has distinctly Southern roots, beginning in the mid-19th century as a cotton brokerage in Montgomery, Ala.

Its involvement in South Carolina included the 1950 reorganization of the utilities industry to create South Carolina Electric & Gas Co. Recent clients have included the University of South Carolina, which used the investment bank as its adviser on debt management.

Doug Woodward, an economist with the University of South Carolina’s Moore School of Business, described the weekend’s events as “a prelude to worse things to come.”

He said such financial crises inevitably lead to a broad slowdown in the overall economy as credit tightens in the aftermath.

“I don’t mean to be a pessimist, but this is pretty bad,” Woodward said.

Lehman Brothers’ downfall, Woodward said, stems directly from its role in fueling the subprime home loan binge.

“You have a lot of fictitious capital; the underlying basis for the mortgage-backed securities was these people’s ability to pay. They didn’t have the ability to pay, and now it’s coming back down like the law of gravity,” Woodward said.

The general public will likely feel the pinch in their retirement funds, which tend to be dominated by stocks.

“People’s 401(k) funds are no better off than they were in 2001,” Woodward said.

And businesses will have more trouble getting loans.

“Credit markets are going to be frozen for at least a year. It’s going to take a long time to get out of this. It’s going to mean slower growth for all of us,” Woodward said.

The long-term effects could include growth in the financial services industry on South Carolina’s border.

“Will more banking be done in Charlotte (N.C.)? Will some of that spill over into South Carolina? That’s an interesting story to follow up on. But for the short term, I think it’s just going to mean slower growth for all of us,” Woodward said. “There’s no way to spin this but negative.”

Tim Koch, a professor of finance at the Moore School and department chair, said the financial crisis is not specific to South Carolina.

“We have a pretty severe financial crisis in this country and the world, and Lehman Brothers is just the latest casualty,” he said. “I don’t think we’ll feel it more than the rest of the country.

“These large institutions have inadequate capital. Their asset quality is so poor that other companies don’t want to trade with them. When this happens, the big institutions really restrict credit. Borrowers, large and small businesses, find it more difficult to get loans, and when they can, the terms are more strict. Rates and down payments are higher.”

Koch predicts the slump will continue until housing prices level out.

“Financial stocks have been beaten up and will continue to be beaten up until we get a floor on housing prices, and we are not near that now” he said. “Everyone believes houses are overvalued and will continue to fall. And we must continue to have this purging of bad assets by these big banks. They must write them down to market values and clean up their balance sheets.

“That’s what happened to Merrill Lynch. They didn’t think they could do it so they had to sell. They didn’t want to sell to Bank of America, but they had to do it or continue to get beaten up in the markets.”

Bank of America has strength in its depositor assets, he said.

“There’s an implied government guarantee with these big institutions like Bank of America,” Koch said. “The government is not going to let them fail.”

Lehman Brothers, an investment bank, facilitates mergers and acquisitions; it underwrites securities and manages assets.

“They got into trouble by becoming very aggressive in creating these mortgage-backed securities, and they kept a lot of them in their own portfolio,” Koch said.

A long-term impact of the crisis, he said, could be to make Charlotte-based Bank of America a powerhouse down the road.

“I don’t think our institutions will be directly affected,” Koch said. “They’ll be affected indirectly in the overall stock market. They should be pretty well diversified. They typically don’t take that large a position in any one company.”