In my office, I have a photo of an old Quotron machine from the eighties. On it, the following jumps out at the trained eye: DJIA -508. The photo was taken on Monday, October 19th, the day that the Dow Jones Industrial Average fell 22.6%. Yesterday, it was déjà vu---another 508 point drop, but this time the point total did not amount to 22%, but 5.1% was plenty, thank you very much!
The selling was not prompted by anything new—same old credit crisis which has now morphed into blind fear. After gains at the start of the session, stocks turned down steadily and the losses accelerated, leaving the Dow down 508.39 points, or 5.1%, at 9447.11, its lowest close since Sept. 30, 2003. The Dow shed nearly 13% in the past 5 trading sessions, the largest drop since September 2001. The 1403.55-point decline was the Dow's biggest 5-day drop ever, and that doesn't include a 778-point drop on Sept. 29. The Dow is now down 33% from its record high reached almost exactly a year ago.
The damage was worse for the S&P 500, which closed yesterday below the psychologically important 1000 level for the first time since Sept. 30, 2003. The S&P fell 60.66 points, or 5.7%, to 996.23. Its 14.6% five-day decline is the biggest since the five days that included the October 1987 stock-market crash and the index stands 21% lower than it was just one month ago. The S&P 500 is now down 36% from its peak a year ago, almost to the day, on October 9, 2007. The NASDAQ fell 108 points or 4.3% to 1862.
If you woke up early this morning, the news did not seem much better. But then at 7:00 am, history was made: in a coordinated global effort, the world’s central banks announced cuts in target interest rates. The US Fed, the European Central Bank (ECB), the Bank of England, the Bank of Canada, Sveriges Riksbank and the Swiss National Bank all reduced their respective policy interest rates by 50 basis points or a half of a percentage point. The Fed's open market committee voted unanimously to cut its target to 1.5%, the ECB to 3.75%, the Bank of England to 4.50% and the Swiss to 2.5%. The dramatic action was intended to help stem a growing global financial crisis. The Fed noted that “The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability."
The unprecedented action is a good step forward, leading me back to October, 1987. At that time, fear gripped investors and everyone bailed out simultaneously. While our crash was not as dramatic because it took place over the course of weeks, not in a single day, this period will likely be seen as what academic Charles Kindleberger called the “revulsion stage” of a crisis---the indiscriminate and contagious selling of distressed assets that leads “banks to stop lending on the collateral of such assets.” When such fear grips the markets, investors (and speculators) are quick to generalize-punishing many for the sins of the few. That’s the most dangerous phase of any crisis—when market implosions start to take on a self-reinforcing life of their own. It is worth noting that sometimes the painful “revulsion” stage sets up the next phase of the process, where investors and markets remember how to breathe.
In 1987, the stock market regained its footing after October 19th and the crash marked the low point for stocks in 1987 and by year-end, the Dow actually showed a gain for the year! Within nine months, stocks recovered all of the losses incurred on October 19th and the US economy never went into a recession as a result of the crash. Given the unwinding that is occurring, it is doubtful that we will avoid recession this time around, but sometimes it is helpful to return to other turbulent periods to help us put our current situation in context a bit more.
Showing posts with label credit crisis. Show all posts
Showing posts with label credit crisis. Show all posts
Wednesday, October 8, 2008
Monday, September 29, 2008
“Let them suffer”
After watching the Sunday news programs, I learned that most Americans despise the Treasury’s proposed $700 billion plan to address the illiquid mortgage related assets that are plaguing the financial system. One pundit noted that the calls are about 300 to 1 in opposition to the plan. Most of these folks are not looking for more nuance or accountability with the plan—they just want “greedy Wall Street to suffer.”
I understand the frustration---how could it be that traders, speculators, hedge funds, lawmakers and government regulators brought the US economy to the brink? The answer is as old as the Dutch tulip mania: when asset values rise, most participants across the board fall prey to greed and excesses of the cycle. Maybe the only people against the plan are those who did nothing wrong and now have to pay the price for the bad behavior of others. To those folks, this plan simply reeks and feels patently unfair.
But those same people need to ask themselves whether they are willing to live with the alternative, where the government refuses to act and makes the financial geniuses suffer their massive losses – the poor dears might have to sell those Porsches! That notion may provide some sense of satisfaction or schadenfreude to the good guys, but it also significantly raises the risk that a downward spiral could infect the broader economy.
As Joe Nocera noted in the New York Times on Sep 27, 2008, ideological opposition risks seeing the economy “go down the tubes…Henry Paulson is not what you’d call a socialist-nor is Ben Bernanke or President Bush…no deal, no credit markets…And if that happens, the consequences will be far more pressing than the failure of a Morgan Stanley or Goldman Sachs. You won’t be able to get a mortgage. Credit card rates will skyrocket. Businesses will be unable to expand and grow. Unemployment will rise. Every part of our economy depends on the credit markets…if we do not claw our way out of this crisis, the country will face a severe recession.”
For those who cling to a notion of revenge or “damn the consequences-I'm not going to allow money to go to those who screwed up,” ask yourself how you think capitalism might fare if the current panic leads to a massive downward spiral in asset prices and a further contraction in housing. If you choose to allow an economic experiment unwind in such a way, then be prepared for a multi-year recession, ala Japan in the nineties. If you vote for no action and choose to risk a life-altering hurricane instead of a bad storm, then you should be prepared for a 201(k) instead of a 401(k).
Life is not as simple as “Let them suffer,” because the suffering of others could cause devastating damage to all of us, potentially risking the entire economic and financial structure of the United States. One thing is for sure: there will be plenty of time to address the issue of who is to blame for the mess and how we can better regulate financial institutions in the future. For now, the government must deal with a US economy that is under enormous pressure and do its best to prevent it from infecting the broader economy.
I understand the frustration---how could it be that traders, speculators, hedge funds, lawmakers and government regulators brought the US economy to the brink? The answer is as old as the Dutch tulip mania: when asset values rise, most participants across the board fall prey to greed and excesses of the cycle. Maybe the only people against the plan are those who did nothing wrong and now have to pay the price for the bad behavior of others. To those folks, this plan simply reeks and feels patently unfair.
But those same people need to ask themselves whether they are willing to live with the alternative, where the government refuses to act and makes the financial geniuses suffer their massive losses – the poor dears might have to sell those Porsches! That notion may provide some sense of satisfaction or schadenfreude to the good guys, but it also significantly raises the risk that a downward spiral could infect the broader economy.
As Joe Nocera noted in the New York Times on Sep 27, 2008, ideological opposition risks seeing the economy “go down the tubes…Henry Paulson is not what you’d call a socialist-nor is Ben Bernanke or President Bush…no deal, no credit markets…And if that happens, the consequences will be far more pressing than the failure of a Morgan Stanley or Goldman Sachs. You won’t be able to get a mortgage. Credit card rates will skyrocket. Businesses will be unable to expand and grow. Unemployment will rise. Every part of our economy depends on the credit markets…if we do not claw our way out of this crisis, the country will face a severe recession.”
For those who cling to a notion of revenge or “damn the consequences-I'm not going to allow money to go to those who screwed up,” ask yourself how you think capitalism might fare if the current panic leads to a massive downward spiral in asset prices and a further contraction in housing. If you choose to allow an economic experiment unwind in such a way, then be prepared for a multi-year recession, ala Japan in the nineties. If you vote for no action and choose to risk a life-altering hurricane instead of a bad storm, then you should be prepared for a 201(k) instead of a 401(k).
Life is not as simple as “Let them suffer,” because the suffering of others could cause devastating damage to all of us, potentially risking the entire economic and financial structure of the United States. One thing is for sure: there will be plenty of time to address the issue of who is to blame for the mess and how we can better regulate financial institutions in the future. For now, the government must deal with a US economy that is under enormous pressure and do its best to prevent it from infecting the broader economy.
Monday, September 22, 2008
President Paulson and VP Bernanke
President Bush didn’t announce it, nor did Congressional leaders. Rather, it was US Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, his intellectual backer, who proposed a vast bailout of financial institutions in the US, requesting unfettered authority to purchase up to $700 billion in distressed mortgage-related assets from private firms, after which it will try to resell them to investors. Given the experience of these two, it is preferable that they run the show amid the escalating financial crisis and become the shadow president and VP of the US economy.
On Friday, Paulson first announced a structural solution for the problem of toxic financial assets in the system. At that time, the concept being floated was along the lines of the Resolution Trust Corp., a key tool to liquidating holdings of failed savings and loans in the late 1980s and early 1990s. The news helped calm investors and pushed stocks to essentially unchanged on the week.
It’s hard to believe that it was just one week ago that we were wrestling with the failure of Lehman Brothers, purchase of Merrill Lynch by Bank of America and the near-implosion of AIG. On Thursday, it was clear that the case-by-case, reactive approach to the crisis was not enough to prevent widespread panic across financial markets. To help stabilize the broader economic and structural problems plaguing the market, Paulson and Bernanke, himself a student of the Great Depression, gathered Congressional leaders and scared them straight. The lawmakers emerged from the meeting visibly shaken, but ready to swallow the bitter pill that Paulson and Bernanke prescribed. By yesterday, it appeared that the US was entering unchartered territory of the credit and housing crisis that would require a new regulatory structure.
Paulson noted that “lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing” and that cancerous mortgage-backed securities had become “frozen on the balance sheet of banks of banks and financial institutions…the inability to determine their net worth has fostered uncertainty about mortgage assets and even about the financial conditions of the institutions that own them.” As Joe Nocera pointed out in the New York Times, “Nobody understands who owes what to whom — or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances.”
There are hoots and hollers that we have morphed from capitalism to socialism over the course of a week. To that, one has to wonder whether such free-market adherents were willing to see the entire system seize up and watch idly as the global economy entered what could have been another Great Depression. With a number of terrible choices, Hank Paulson and Ben Bernanke chose the one that seemed the least odious. As Bernanke told colleagues last week, “There are no atheists in foxholes and no ideologues in financial crises.”
The plan is a proactive, systematic approach that attempts to stabilize confidence, which should temper the severe price action and prevent a seizing-up of market liquidity. The action demonstrates that US authorities were unwilling to sit idly and watch the economy slide into a Japanese-like, decade-long malaise. The results of the exceptional government intervention will be written about in history books, but for now, investors are hopeful that with time and this powerful policy response, confidence will be restored and markets and the economy will eventually recover.
On Friday, Paulson first announced a structural solution for the problem of toxic financial assets in the system. At that time, the concept being floated was along the lines of the Resolution Trust Corp., a key tool to liquidating holdings of failed savings and loans in the late 1980s and early 1990s. The news helped calm investors and pushed stocks to essentially unchanged on the week.
It’s hard to believe that it was just one week ago that we were wrestling with the failure of Lehman Brothers, purchase of Merrill Lynch by Bank of America and the near-implosion of AIG. On Thursday, it was clear that the case-by-case, reactive approach to the crisis was not enough to prevent widespread panic across financial markets. To help stabilize the broader economic and structural problems plaguing the market, Paulson and Bernanke, himself a student of the Great Depression, gathered Congressional leaders and scared them straight. The lawmakers emerged from the meeting visibly shaken, but ready to swallow the bitter pill that Paulson and Bernanke prescribed. By yesterday, it appeared that the US was entering unchartered territory of the credit and housing crisis that would require a new regulatory structure.
Paulson noted that “lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing” and that cancerous mortgage-backed securities had become “frozen on the balance sheet of banks of banks and financial institutions…the inability to determine their net worth has fostered uncertainty about mortgage assets and even about the financial conditions of the institutions that own them.” As Joe Nocera pointed out in the New York Times, “Nobody understands who owes what to whom — or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances.”
There are hoots and hollers that we have morphed from capitalism to socialism over the course of a week. To that, one has to wonder whether such free-market adherents were willing to see the entire system seize up and watch idly as the global economy entered what could have been another Great Depression. With a number of terrible choices, Hank Paulson and Ben Bernanke chose the one that seemed the least odious. As Bernanke told colleagues last week, “There are no atheists in foxholes and no ideologues in financial crises.”
The plan is a proactive, systematic approach that attempts to stabilize confidence, which should temper the severe price action and prevent a seizing-up of market liquidity. The action demonstrates that US authorities were unwilling to sit idly and watch the economy slide into a Japanese-like, decade-long malaise. The results of the exceptional government intervention will be written about in history books, but for now, investors are hopeful that with time and this powerful policy response, confidence will be restored and markets and the economy will eventually recover.
Friday, August 22, 2008
Cover Your Fannie...and Freddie too
“IT MAY BE CURTAINS SOON FOR THE MANAGEMENTS and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac. It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses.”- Jonathan Lang in Barron’s August 18, 2008
And so began phase two of the Fannie and Freddie “deathwatch” on Wall Street. Perhaps you thought that the crisis over the two government-sponsored enterprises (GSEs) had passed in July when the Treasury Department stepped in and quelled frayed nerves. The Barron’s article highlighted the fact that the continuing decline in real estate values has led to a spike in mortgage delinquencies and foreclosures, which in turn have severely damaged the balance sheets of both Fannie and Freddie.
While the two companies may be adequately capitalized according to their regulator’s current definition, according to Barron’s, “On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.”
While both companies maintain that they have enough money to weather this storm (remember when Bear Sterns said the same thing a week before it practically filed for bankruptcy?), it has become clear that the GSEs need to raise cash and fast. But who in his right mind would take the plunge right now? Two weeks ago, the companies added another $3.1 billion in losses to the $11 billion they had already reported in recent quarters. Talk about throwing good money after bad!
When in doubt, you can count on good ol’ Uncle Sam to provide the big-time safety net. Last month, Congress gave the Treasury Department the authority to lend money to the firms or take an equity stake in them. It is estimated that the federal government would have to pump approximately $20 billion into each company, possibly through a guarantee rather than through a direct injection of capital. Legislation passed last month allows the government to do so to stabilize financial markets and to prevent disruption in the mortgage industry. Barron’s noted that a government bail-out might “take the form of a preferred stock with such seniority, dividend preference and convertibility rights that Fannie's and Freddie's existing common shares effectively would be wiped out, and their preferred shares left bereft of dividends.”
Time is ticking for Fannie and Freddie but one thing is for sure: investors are convinced that the government will take steps to end the patient’s suffering. We can only hope that the end is swift and as painless as possible.
And so began phase two of the Fannie and Freddie “deathwatch” on Wall Street. Perhaps you thought that the crisis over the two government-sponsored enterprises (GSEs) had passed in July when the Treasury Department stepped in and quelled frayed nerves. The Barron’s article highlighted the fact that the continuing decline in real estate values has led to a spike in mortgage delinquencies and foreclosures, which in turn have severely damaged the balance sheets of both Fannie and Freddie.
While the two companies may be adequately capitalized according to their regulator’s current definition, according to Barron’s, “On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.”
While both companies maintain that they have enough money to weather this storm (remember when Bear Sterns said the same thing a week before it practically filed for bankruptcy?), it has become clear that the GSEs need to raise cash and fast. But who in his right mind would take the plunge right now? Two weeks ago, the companies added another $3.1 billion in losses to the $11 billion they had already reported in recent quarters. Talk about throwing good money after bad!
When in doubt, you can count on good ol’ Uncle Sam to provide the big-time safety net. Last month, Congress gave the Treasury Department the authority to lend money to the firms or take an equity stake in them. It is estimated that the federal government would have to pump approximately $20 billion into each company, possibly through a guarantee rather than through a direct injection of capital. Legislation passed last month allows the government to do so to stabilize financial markets and to prevent disruption in the mortgage industry. Barron’s noted that a government bail-out might “take the form of a preferred stock with such seniority, dividend preference and convertibility rights that Fannie's and Freddie's existing common shares effectively would be wiped out, and their preferred shares left bereft of dividends.”
Time is ticking for Fannie and Freddie but one thing is for sure: investors are convinced that the government will take steps to end the patient’s suffering. We can only hope that the end is swift and as painless as possible.
Tuesday, August 19, 2008
The Best May Not be Yet to Come
In my family, we love to ask the following trivia question: What was written on Frank Sinatra’s gravestone? The answer: “The Best is Yet to Come”, the title of the song written by Cy Coleman with lyrics by Carolyn Leigh and famously sung by old Blue Eyes himself in 1964. I thought about that classic after reading a particularly downbeat assessment of the global credit crisis yesterday.
According to Professor Kenneth Rogoff, a leading academic and a respected former chief economist of the International Monetary Fund from 2001 to 2004, it’s going to take some time before we can croon those famous lyrics. Speaking at a conference in Singapore, Rogoff said “The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come.”
How much worse could it get, you ask? Rogoff contends that the problems could devolve further and cause the failure of a large US bank within months. “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one — one of the big investment banks or big banks.” So far, only eight federally regulated banks or thrifts have failed this year, but more than 100 others are on the government’s watch list.
I find this particular prediction both ominous and welcome. Of course if a major US institution were to fail, there would be widespread panic and markets would get roiled for the third time this year. The first time occurred when Bear Sterns came within hours of filing for bankruptcy in March and the second instance was the Fannie Mae/Freddie Mac melt-down in July, which has continued into August, as concerns reignited about the government sponsored entities’ viability this week. Shares of Fannie and Freddie plummeted to their lowest levels since the early 1990s yesterday, amid fears that both would be nationalized sooner than later.
To some extent, a third crisis would not be a big surprise, although the guessing game of which firm might actually meet its maker could become a sport in and of itself. Odds-makers would probably make Lehman Brothers tops on their “death” list, but don’t count out another biggie like Merrill Lynch or Citi from the dubious distinction, or perhaps another firm that is not on the radar right now. Regardless of whether or not there will be an outright failure, it is indeed likely that divestment and consolidation of the financial services industry will go on for some time.
But perhaps a third phase of cleansing is necessary for us to put in a bottom in this mess and that would definitely be a welcome occurrence. Of course the bottom does not mean that everything is going to turn around quickly, but it would signal an end to the worst part of the suffering. Then, and only then, we just might be able to sing a few lines of the following and hope that better times are just around the corner.
“The best is yet to come, and wont that be fineYou think you’ve seen the sun, but you ain’t seen it shine”
According to Professor Kenneth Rogoff, a leading academic and a respected former chief economist of the International Monetary Fund from 2001 to 2004, it’s going to take some time before we can croon those famous lyrics. Speaking at a conference in Singapore, Rogoff said “The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come.”
How much worse could it get, you ask? Rogoff contends that the problems could devolve further and cause the failure of a large US bank within months. “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one — one of the big investment banks or big banks.” So far, only eight federally regulated banks or thrifts have failed this year, but more than 100 others are on the government’s watch list.
I find this particular prediction both ominous and welcome. Of course if a major US institution were to fail, there would be widespread panic and markets would get roiled for the third time this year. The first time occurred when Bear Sterns came within hours of filing for bankruptcy in March and the second instance was the Fannie Mae/Freddie Mac melt-down in July, which has continued into August, as concerns reignited about the government sponsored entities’ viability this week. Shares of Fannie and Freddie plummeted to their lowest levels since the early 1990s yesterday, amid fears that both would be nationalized sooner than later.
To some extent, a third crisis would not be a big surprise, although the guessing game of which firm might actually meet its maker could become a sport in and of itself. Odds-makers would probably make Lehman Brothers tops on their “death” list, but don’t count out another biggie like Merrill Lynch or Citi from the dubious distinction, or perhaps another firm that is not on the radar right now. Regardless of whether or not there will be an outright failure, it is indeed likely that divestment and consolidation of the financial services industry will go on for some time.
But perhaps a third phase of cleansing is necessary for us to put in a bottom in this mess and that would definitely be a welcome occurrence. Of course the bottom does not mean that everything is going to turn around quickly, but it would signal an end to the worst part of the suffering. Then, and only then, we just might be able to sing a few lines of the following and hope that better times are just around the corner.
“The best is yet to come, and wont that be fineYou think you’ve seen the sun, but you ain’t seen it shine”
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