Is this really the worst financial crisis in decades? The answer may be
delivered this week, when we learn whether Eric Dinallo, the New York State
Insurance Superintendent, has managed to organise a rescue of the monoline
bond insurers, the relatively small and previously obscure businesses that
lend their top-notch credit ratings to several trillion dollars of financial
obligations issued not only by American municipalities, but also by
infrastructure projects across Europe and many of the public-private
partnerships that are building hospitals, schools and railways across
Britain.
If a bailout for these bond insurers is finalised next week, the deadline
envisaged by many Wall Street bankers and recently confirmed by Mr Dinallo's
boss, Eliot Spitzer, the Governor of New York, then this announcement could
well mark the turning point in the global financial crisis. If not, then
credit downgrades among the bond insurers will trigger tens or even hundreds
of billions of dollars of additional losses and bank write-offs. But will
this really be the worst financial crisis the world has faced, as so many
experts suggest?
Looking at what the stock market is actually doing, as opposed to what
analysts are saying, the impression is less extreme. Bank shares have
undeniably taken a big hit since August, but comparing these movements with
the ones that happened in previous financial crises, it is hard to conclude
that this is the crisis of a lifetime. US banks are only 20 per cent below
their long-term average in relation to the S&P 500, while financial
stocks generally are right on their 20-year average - and the fall in
relative values has been neither steeper nor deeper than it was in the late
1980s and the late 1990s. The bears can respond, of course, that the present
level of bank shares merely proves that shareholders are still in denial
about the damage that is being done and far worse losses are still to come.
For example, Meredith Whitney, of Oppenheimer, who made a name for herself
in the autumn by being the first to predict the demise of Citicorp, argued
last week that the stock could fall by a further 15percent to 50per cent
because the bank would have to cut its dividend yet again. But there is a
different way of looking at such dire predictions.
If the worst that the most bearish of analysts on Wall Street can say about
the world's poorest-performing big bank is that it will have to cut, or even
eliminate, its dividend to rebuild capital ratios, this amounts to a rather
moderate sort of crisis in comparison with what happened to the Japanese and
Asian banks in the 1990s or to the US and European banks in the Latin
American debt crisis. In those cases, it was not only a few mismanaged banks
rebuilding their capital by cutting dividends. In 1982, when Mexico and
Brazil defaulted, every leading American, British and European bank
effectively became insolvent, with non-performing loans worth more than 100
per cent of equity capital. And most of them, including Citibank, Deutsche,
Chase Manhattan, Lloyds and Midland, remained effectively insolvent until
1988. The situation in Japan in the 1990s was even worse.
Why, then, are so many experts describing the present credit crunch as the
worst financial crisis in living memory? A typical view is this comment last
week by David Rosenberg, the chief economist of Merrill Lynch: “We confess
that we have been in the business for 25 years and have never - and repeat
never - seen a cycle like this one.” Looking back over my own 30 years of
experience of financial markets, it strikes me how often I have heard almost
identical statements in past financial crises, usually emanating from the
finest brains in the business: Alan Greenspan, who described LTCM in 1998 as
the worst crisis in his 60-year working lifetime; Robert Rubin, who was not
joking when he described his rescue of the Mexican peso as The Committee to
Save the World; and George Soros, who reacted to Black Monday in 1987 with a
single chilling sentence: “This is 1929.”
Such extreme reactions might, of course, have been justified. Maybe each
successive crisis really was worse than the one before - in which case, this
crescendo of chaos may, indeed, be approaching its apocalyptic climax. On
reflection, however, two less sinister explanations for the mounting sense
of panic seem more likely. The first is that 25 or 30 years, the typical
career for even the most experienced investors and bankers, mark a fairly
brief period in economic history, covering only two or, at most, three
economic cycles. It is hardly surprising, therefore, that people are
constantly amazed by each new cycle that comes along - and find it difficult
to see it in historic proportion.
Secondly, and more interestingly, when we look back through history - or think
about the underlying economics of business cycles - we realise that every
financial crisis and bear market in the past has
been a buying opportunity because we can see, with hindsight, that the world
never did come to an end. Yet if everyone in the market knew that previous
financial crises and bear markets always created buying opportunities, then
a new bear market could never occur, unless large numbers of investors
believed that the latest financial crisis was somehow different - and worse
- than any that had gone before. If people believed that this was just an
average sort of crisis, they would now be buying instead of selling, and
there would be no crisis.
In other words, to create any financial crisis - even a fairly mild one -
there has to be a widespread belief that things are much worse than ever
before. In terms of market psychology, the view that “this crisis is
different from every other” is really just an echo of the cry “this time is
different” that is always heard at the top of a bull market.
But although worldly-wise commentators invariably ridicule all suggestions
that structural conditions in a bull market are healthier than in previous
cycles, they often fall for the belief that structural conditions in a
cyclical downswing are worse than ever before. Such structural deterioration
may actually be true in certain periods. It happened, for example, in Japan
in the 1990s. In general, however, the fear of exceptionally deep and
prolonged bear markets is less rational, and more emotional, than the hope
that bull-market trends will persist.
Periods of fear are more susceptible to irrationality than periods of hope -
and not just because of the obvious psychological link between fear and
panic. Experience and economic theory show quite clearly that
profit-motivated individuals tend to keep capitalist economies expanding,
while nobody (apart from unreformed Marxists or al-Qaeda terrorists) has
comparable incentives to push the economy into a prolonged slump. Moreover,
governments and central banks in modern mixed economies with a decent
understanding of demand management and collective-action problems also have
clear incentives to promote growth rather than cause depressions. This does
not mean that depressions never happen, because market incentives can
temporarily break down and policymakers can make big mistakes.
On balance, however, to bet on a prolonged slump is to bet against economic
theory and human nature. “This time is different” is much more likely to be
true on the way up than on the way down.
anatole.kaletsky@thetimes.co.uk
Maybe nobody has the incentive to push the world economy into a prolonged slump. But some institutions do seem to have made profits from the current crisis. Shorting on UK banks has doubled in the last few weeks. I read reports that Goldman Sachs had made ~$1bn by taking short positions on the US subprime investments. There must be huge market bets on the crisis deepening.
Lindsay Duncan, Edinburgh, UK
I think Anatole Kaletsky is right - provided that the monetary authorities in Europe stop worrying about inflation as a limiting factor in lowering interest rates. In a serious financial contraction, the fact that commodity prices are rising because of rising demand in emerging markets does not threaten the kind of accelerating inflationary spiral that has been a worry for Central Banks in the past.
Higher rates are not the appropriate response in these circumstances because there is no danger of companies being able to pass on costs or raise wages thus feeding the inflationary spiral. Rising unemployment in the Western world, not yet apparent in the statistics will keep the lid on any inflationary runaway. It is a question of understanding the difference between lagging statistics that look backwards and leading statistics that point the way ahead. It takes time for the economic juggernaut to change direction but companies will soon be much less ready to take on staff or raise pay.
Robert Cookson, Milton Keynes,
Is this time different? No, but if one takes the longer view of US culture as it relates to housing, one finds about a fifty year trend that has to be readjusted. We first went to two income families, then both incomes became more equal, then new household necessities arose. Next, safety net type pensions went away giving rise to 401ks and the like...do it yourself.
Not being a nation of savers, we did not do it ourselves. Housing prices rose as interest rates declined and home prices reflected not only lower interest rates but the view that ever increasing equity in the homestead would replace retirement planning. New instruments came into being in the mortgage market with a worldwide demand for higher yield. Yield spreads between prime and sub-prime loans became near zero thanks to the rating agencies valuation of CMOs and their cousins. Meanwhile US folks borrowed on this new equity to subsidize new necessities. Then it stopped. Deleveraging is painful and takes some time.
William Blackburn, St. Petersburg, Florida
Dave.El Paso - you are not alone - but with inflation and falling interest rates, what else does one do to protect ones pension capital - sex, drugs and rock and roll?
marty, London, England
Credit card use to pay for things like food and every day things is not all the story. I use my card but pay it off each month,is there a measure of what is not being paid off each month?
There may be more cards,more people more earnings. So what about a real measure on card use.
Brian , Gladstone, Australia
brian ross, gladstone, australia
"In other words, to create any financial crisis - even a fairly mild one - there has to be a widespread belief that things are much worse than ever before. In terms of market psychology, the view that “this crisis is different from every other†is really just an echo of the cry “this time is different†that is always heard at the top of a bull market."
This paragraph accurately outlines the World Banking Cabal's method of operation. They create these crisis, and during the crisis profit immeasurably . The entire technique is described in the internet film, "The Money Masters" which can be viewed on the Information liberation site. The best way to deal with these crisis in a more or less permanent manner is to close down the private Bank of England, and turn over the creation and distribution of the Pound to the new, nationalized Northern Rock, renaming it perhaps, The English National Bank. You will be glad you did.
victor compton, Cherbourg, France
The problem with "It's not a serious crisis but a buying opportunity" is that over the past several months each time there's been a substantial dip in stock prices I've poured more cash into the market to buy "bargains," but I've grown tired of that game.
Perhaps I'll live to see my bargain purchases pay off.
Whatever the case, I'm not worried that my kitchen table won't continue to have bacon on it of a morning. Even so, I'd be pleased if Citi didn't cut its dividend again.
Dave, El Paso County, Colorado/USA
Doomsday? No. A very long, protracted recession in the US? Yes. Please do all of us a favor and stop ignoring the fact that people are now using credit cards to pay for their normal expenses, such as utilities and food, instead of new products. That has not been a trend in ANY living memory. Add the fact that OPEC will follow through on cuts in oil production, causing a further need for credit card debt. How about some insight on what will happen once the idle construction workers in the US housing market and all those dependent on their income (retailers, administrators) stop receiving unemployment benefits. To ignore the simple fact that the average consumer is much too far in debt, and will be for many years to come, is to ignore the basis of the current world economy. Consumers drive markets, and when they fail to consume, those markets markets shrink and sometimes disappear. Please factor these simple facts into your logic.
Juan, Brownsville, TX, USA
Um, I think that the point made by Kaletsky is a strange one. I agree, the economy is cyclical. Usually around the ten year mark. Subsequently a downturn or crash was overdue.
What I don't understand from Anatole is his analogy that "this happens, the world will not end".
What has happened recently can be equated to that of a volcano. The initial blast has hit and everyone has panicked, fleeing before the destruction i.e. selling stock in droves.
What Anatole has failed to note is that the market is still experiencing aftershocks. These haven't receded, no one knows if more damage will be meted out and more importantly... where(i.e Northern Rock)
There's no point making smug comments about it all "coming good in the end". A bad investment could see further losses for those already shaken (some badly damaged) by what has occurred. Hence 'bear' market.
I feel Anatole only ever talks up the market and on that basis I'd say there are still a few lava flows heading our way.
charles, oxford, Great Britain
What is different this time?
The level of US debts have reached a threshold of no return; more debts demand lower interest rates to stay afloat.
We have an abrupt deflationary spiral or - more likely - "providing liquidity" adequatly... which means inflation.
Redistribution by inflation is what one could call "opportunities".
Peter Vernunft, Berlin, Germany
The reason its all going to collapse is quite simple...they threw away the keystone and without it the economy will fail along with everything else.
Hugh E Torrance, London , England
During bullish periods, the risks of new investment where payoff is uncertain are usually covered partially or fully by preceding successful investments. Failure or loss in relation to a longer timespan can thus be seen as temporarily standing still rather than regression.
For those who have already taken substantial losses at the start of a bear market, or who carry risk of ruin if unable to liquidate in an orderly way the picture may appear bleaker.
Perhaps the asymmetry of perception as to future outcomes during the bull and bear modes may also be unduly distorted by the modern trend to preference for all carrot rather than a balance of carrot and stick.
Historically the demographics of market participants has been relevant, with older cohorts with long memories having had an experience (and learned coping strategies) different from those who have not ‘seen it all before.’
dr venables preller, Warminster, UK
I have been a broker, stock analyst and investor since 1957. Apart from cherry picking special situations there is only one thing to know about investing and that's if there is too much liquidity all prices go up - as money needs a home- and if it's in short supply prices will go down as people sell assets to survive. The sub prime crash will probably take $500 million out of the money market. So long as the Chinese and Arabs can invest more than that suporting bank shares and illiquid major corporations at current prices then the current "crisis" is simply a correction of the type that takes place every decade when the banks lend too much money to bad risks. They probably have but could decide not to invest and wreck havoc on the West but that would ruin their own markets such as oil and hard goods and this is a golden chance to get greater control over Western strategic assets This time it's not the end of the road- but it's a lesson to avoid the next one - if we can.
john bentley, Loule, Portugal
No truly great catastrophes are preceded by rumours, such as this one is. Real bloody catastrophes, like 1929 (shudder) are more like train wrecks. You're broke before you know it.
Eugene, Heidelberg, Germany
The article in the Times talks about losses of $500bn on CDO's backed by sub prime mortgages in America.
Whilst the forecast incidence of default is likely to be relatively accurate, I would suggest it underestimates the value per default if house prices continue to deteriorate.
Furhermore, it should be noted that about half of all foreclosires are now on properties purchased for investment, showing it is not just a sub prime problem but a credit bubble and asset valuation issue. This will manifest itself increasingly in other groups of customers and within other jurisdictions (namely the UK, Spain and Ireland).
Finally, it should be noted that only 19% of US mortgages are packaged up and sold as bonds - whilst these may be written down earlier, loans on banks balance sheets will continue to be written down as they happen over the next 2-3 years.
In the words of Hank Paulson in January of this year - "we are only at the beginning".
harry e, London,
On the understanding that markets and economies do not move in tandem, then what the stockmarket is doing is irrelevent. When viewed from bottom up (ie earnings actual and predictive) maybe things do not look so bad. But when viewed from bottom down - then things do not look so good. There is not only a lack of confidence out there, there is also a squeeze on buying power as prices of essentials as well as burgeoning mortgage commitments force consumers to retreat. Everywhere the property price bubble looks set to burst and this can only worsen things. In the UK and the US sovereign budgets are tight, inflation is looming, from huge demand from China and India etc and the prospects for interest rate cuts may look a good idea, but what about inflation later? Who in the western world (public or private spending) is going to buy all the things that make up growth ?
We may not be in for a prolonged slump, but we are in for a significant turndown.
Davd Nammory, Liverpool,
Everybodys talking about a bear market. I thought you had to have a permit to keep a wild animal and anyway I think it rather cruel to keep wild animals in captivity.
Regards
leo, durham, UK
If the media would just simply report on the Wantagate matter and why the Wanta settlement is crucial to the global economy, we wouldn't have to worry about people jumping out of trees. Cut down the dead trees and grow new ones. The corrupt banks will close down and we can all watch the Global Kookie Krumble along with the latest version of the acrobatic team called the "Flying Wallendas" without a safety net.
Bonnlass, Concord, USA
Surely "Looking back over my own 30 years of experience of financial markets....", you will notice that "This time is different" is actually equally untrue going up or down?
And it is totally incorrect to say that "unreformed Marxists or Al-Qaeda terrorists" are the only ones who have incentives to push economies into prolonged slumps. Look at the money market activities of George Soros in the '90's for one. I didn't see him being too worried about what happened next.
Alex Ritchie, Salisbury, UK
Truly great catastrophes are rarely, if ever, preceded by rumours. The bona fide blood-letters, such as 1929 (shudder) manifest themsleves like train wrecks, or your wife’s infidelity. You’re broke before you know it; and you’re always the last to know. That’s the thing about Nemesis. She walks on clouds.
Eugene, Heidelberg, Germany
Excellent assessment Mr Kaletsky. Just as we all thought a test of the lows was due with further Hedge Fund redemptions and the end of short covering of stock options the stock market delivers a further rush of end of day buying. This doesn't feel like a bear market now and as long as the general belief is that we are in one, it won't happen.
Will, Lincoln, UK
The bigger problem for the UK is it's lack of productivity.it produces so little.With millions retiring early and even more in "Uni" - otherwords, massaged unemployed. Untill the UK invests more in a variety of real production,even asset price inflation caused by floods of free money won't create lasting prosperity.It will create an illusion, a feel good factor for a period-but the longer the bubble expands ,(regardless the mechanism for pumping it up),the bigger and louder will come the "pop".
DennisJ, London, UK
Credit crunch? What crunch? My stepson has just bought a car on HP for a total of £8000 with no deposit. He is not on the electoral role anywhere and has no real credit history. The car is 6 years old and it is easy to see that either the loan will not get repaid or (more likely), in 5 years time he will be in debt for £15000. Will we never learn?
wendy, warrington,
Mr. Kaletsky I like your analysis of the situation - mainly because it agrees, broadly, with mine. And yet, still the doomsayers are predicting the end of the financial world as we know it (because the money's over here instead of over there or because this action is financed by debt as opposed to that action).
In any downturn, recession or call-it-what-you-will, the world does not suddenly stop growing trees or making bread or drinking water. What happens is that a collective depression overcomes those people who play abstract games with abstract money (while the rest of us get on with life).
It's faddish and illogical and the man who dares to predict its twists and turns risks making himself a fool. Me, I'll do what I've done the past twice in my life the "end of the financial world as we know it" struck: I'll admire the trees, eat the bread and drink the water - and, you know, I'll probably still be here when the money-game players get over their blues.
John Blackley, Winter Garden, FL
David Cameron need not aplogise over the 'Auschwitz gimmick'.
The endless obsession with the Holocaust is nowadays less about commemorating the dead, than enriching the living..
M.G.Sherlock, Colwyn Bay, North Wales
Truly great catastrophes are rarely, if ever, preceded by rumours. The bona fide blood-letters, such as 1929 (shudder) manifest themsleves like train wrecks, or your wife’s infidelity. You’re broke before you know it; and you’re always the last to know. That’s the thing about Nemesis. She walks on clouds.
Eugene, Heidelberg, Germany
I echo Erol. Of course things will get better. If we thought they werent we would all give up now. The real question is when will it get better to go back into the water without drowning. Tommorow? In a year's time? In 10 year's time?
ash, London,
Anatole, there are massive global economic imbalances that manifest themselves in the US (and UK) budget and trade deficits.
They have been allowed to persist thanks to massive amounts of cheap credit and the willingness of the Chinese, Arabs and others to invest their surpluses in the west's capital markets.
It was always unsustainable and now its unwinding.
Its not the end of everything, capitalism and free markets will always recover, but it will be very tough. I am 42. I have never seen a financial crisis develope so quickly and on such a scale. Pessimism is sensible at this point.
Robert, Pangbourne, berkshire
He doesn't mention the USA exporting its way out of trouble anymore ?
"we realise that every financial crisis and bear market in the past has been a buying opportunity" - I see, when over the last 18 years should we have bought into the Nikkei - perhaps keep holding for the long term ?
Tim, Shanghai, China
The question is not "is this crisis different from every other?†but rather "are there enough readily extractable oil and mineral resources to sustain another recovery leg?"
Mike, Hounslow,
There is a wealth of evidence that humans are very bad at allowing for unlikely but truly awful possibilities. We assume that a 1/1000 risk of being wiped out is "remote" and not worth considering.
We are also very irrational in how we value extra wealth and income. As we receive less additional utility from each pound we receive (there are only so many dinners you can eat; a £100,000 car is better, but not twice as good, as a £50,000 one) we should all, if rational, be quite risk averse.
One day we will learn the hard way; maybe this year, maybe in ten years time. But please, if and when, be stoical. Nobody cared to listen to the Japanese who were burned in 1989-91, and who are still waiting for the upswing twenty years later. Nobody should listen to the "property bulls" in Britain and the US.
Craig Ross, York,
'Buy, buy, buy!' into the suckers' rally.
Michael Murray, Bath, UK
So, the debt gets written off and 'we all go back to zero'?
I'd like to live on that planet too.
Nick, Weymouth, UK
warren buffet is buying!
adrian jegeni, kidderminster, england
The usual bullish guff you've been coming out with for the past 6 months or so (as things have steadily got worse). I expect more of the same in the next 6 months (as things continue to get worse). No hope of a mea culpa though.
Andy Hamilton, Nelson, NZ
The reason people don't buy in a bear market is not because they think things will never get better, but because they think things are likely to get worse before they get better,
Erol, Brighton, UK
This is really superb analysis--very, very much in line with the reality of the functioning of markets and the emotions of market participants, in my opinion.
Carl H. Stem, Overland Park, USA/Kansas