A highlight the chain of events so that we can all remember the big picture, not just the daily headlines in isolation. This is off memory, so not all events might have happened exactly in this order. Nonetheless, this is just a hypothetical macro prediction, so take it with a salt grain. The scene: After a 2001 dot.com bust, rates are low, and the appearance of a major bull market takes shape as we march towards 14,000 on the dow. Things are good. We have Goldilocks left and right on CNBC, and it’s good times once again. Then, something goes terribly wrong: 1. bear stearns hedge fund blows up (aug '07). this was strange to many, as they are known for great risk management. it turns out they’re not the only one. 2. bnp paribas halts redemptions from their subprime bets 3. fed starts cutting rates 4. subprime mortgage businesses go BK 5. CP market freezes up 6. write downs begin in earnest for major banks (C, ML) 7. questions about the values of AAA SIVs, and CDOs start arise, SEC wants market to market but there is no market to mark them 8. fed continues to slash rates, but market, especially financials, continue to fall despite this “bullish” move for them. 8. Real Estate start valuation decline in earnest. Resets really pickup now. 9. Bye Bye Countrywide. Welcome do thin ice Washington Mutual 10. The biggest banks in the world oust their top guys - their stocks plunge 11. Fed slashes rates, markets slide off; recession begins 12. the USD continues to take a hit, hitting lows and favor with the world (metals continue to outperform the equity markets). 13. bond insurers face downgrades, bailouts, and derivative write-downs begin predictions now 14. Fed keeps slashing rates (2.5% now) 15. credit derivatives are written down from major banks; nonperformance 16. markets continue selloff, confidence gets low 17. ARMs continue to reset, policymakers create a federal plan to protect homeowners 18. fed slashes rates (2%), market has temporary rally which fades, because: 19. Corporate defaults begin; CDS blow up; major writedowns, and loss of confidence. 29. selling of sound securities now, almost a panic mode. 39. CB’s start loading up on Gold 49. interest rates spike; usd dollars flood the market 59. a historic buying opportunity for equities presents itself 79. recession ends, consumption picks up, equities begin to finally trend higher.
I’m in an area of finance that unfortunately is deeply involved in all this. Every day is one bad thing after another. It is really getting ridiculous.
Great post. I would add— somewhere between 20-29-- several bond insurers finally lose their triple-A by Moody’s and S&P. 50- Bernanke’s beard turns grey.
As someone in leveraged finance I agree with pinkman… when you think that it can’t get worse… also the one thing that I would add is the roughly $200bn overhang of hung private equity deals, which now is looking like it would take a 10% loss to move, and 15% to 20% if you had to move it quickly, expect more mark to market losses from banks on commitments for these as the market is significantly down from the lows in August for loans
So what’s really historic about this in my view are: 1) Excessive monetary intervention is really f-ing dangerous. The roots of this problem are in the wildly easy money period of 3-4 years ago when the Fed couldn’t find an interest rate low enough to suit them. The country needed a couple of years to reprice risk and mull over ideas like concentration of people represents its own risk and the Fed decided that they could circumvent all that by handing people money. Duh. It created many of the problems we have now. Alas, Ben and company are all heady with about 30 years of Fed-deification and didn’t learn that lesson. What problems are they creating now? 2) Bad risk transference can destroy wealth at amazing rates. The convergence of the low interest rates with the idea that all risk can be transferred and thus made irrelevant was especially dangerous. So there is lots of bad debt out there because it was extended to people in silly ways. It’s just not at all clear what wealth has been directly destroyed by that. A mortgage originator sold some stupid person a negative am loan that neither of them understood and then eventually it ended up in some structured product at Citibank that nobody there understood. Bummer. Ultimately, though, that shouldn’t affect the inherent value of the house or the human capital of the person who owes the money. Unfortunately, we are finding that it wipes out a bunch of the institutions we need to keep things running (like home equity loans and banks) and has caused a huge dead weight loss. The key for govt is to figure out how to fix these institutions so that we ameliorate that loss and stop the bleeding. Does anybody think that handing out tax credits for people to blow on stupid stuff and dropping interest rates precipitously are even mildly constructive steps toward that? The real historical value of this will be in how we save those institutions and how long it takes.
Do you think the liberal/academic background of Bernanke biases him towards inflationary policies?
Good post. I’d like to see a similarly concise timeline for Japan’s recent bubble since I’ve heard so many comparisons. Does anyone have a good source to point me towards? Google found me this: http://en.wikipedia.org/wiki/Japanese_asset_price_bubble but I’d like to read up a little more.
I just found out the ax is coming hard today. I believe I’ve been spared…for now.
I would blame the credit bust on ridiculous residential housing valuations methodology. Also, stock price should hit the inflection point before the recession is officially over as the stock market is a leading indicator of the economy, IMO.
Young_Prof Wrote: ------------------------------------------------------- > Good post. I’d like to see a similarly concise > timeline for Japan’s recent bubble since I’ve > heard so many comparisons. Does anyone have a good > source to point me towards? Google found me this: > http://en.wikipedia.org/wiki/Japanese_asset_price_ > bubble but I’d like to read up a little more. This doesn’t feel at all like the Japanese price bubble to me. That was fueled by this odd kind of nationalism that only the Japanese seem to be able to muster and there were all kinds of weird justifications for asset prices that amounted to something like they’re worth a lot because Japanese trust other Japanese not to let them drop. Yeah, right.
… some more points… 1. Rogue Trader 2. Oil hits 100 bucks. 3. Dollar hits all-time low.
JoeyDVivre Wrote: ------------------------------------------------------- > Young_Prof Wrote: > -------------------------------------------------- > ----- > This doesn’t feel at all like the Japanese price > bubble to me. That was fueled by this odd kind of > nationalism that only the Japanese seem to be able > to muster and there were all kinds of weird > justifications for asset prices that amounted to > something like they’re worth a lot because > Japanese trust other Japanese not to let them > drop. Yeah, right. Regardless of the causes, I was looking to read about how their economy reacted to an environment categorized by real estate turmoil and low interest rates. You make a good point about different causes of the situation, but do you feel that this negates the benefits of comparing the long-term results?
Hey compare away and I would never tell anyone not to study financial history. I just don’t think there are a lot of lessons in that to be learned for our current spot which does not come close to meaning that there aren’t important lessons there.
JoeyDVivre Wrote: ------------------------------------------------------- > Hey compare away and I would never tell anyone not > to study financial history. I just don’t think > there are a lot of lessons in that to be learned > for our current spot which does not come close to > meaning that there aren’t important lessons there. Eh, fair enough. Appreciate the opinion.
I’m pretty sure the whole thing started well before Aug '07. The housing market began to cool somewhere in Fall of '06. Subprime had already become a buzzword by March/April of 2007 and the reckless lending practices were being curtailed significantly.
I think the closest historic parallel of today is the 1970s and stagflation. The problem is that I can’t think of what the investment implication is, other than gold, energy, and maybe TIPS. Mark Twain said it best, I think (like many things): “History doesn’t repeat itself, but it does rhyme.” There are three big differences I see: 1) I am not aware of lax credit standards being contributors to the stagflation of the mid-to-late 1970s. 2) The trigger of the 1970s crises was the Arab Oil embargo (triggered in turn by the results of the Yom Kippur War of 1973-74). Oil prices are rising, but not as suddenly and dramatically as then. However, that combined with credit crunch and housing deflation might be a substitute. I know that fiscal policy to fund the Vietnam war and Great Society also brought about inflation, but the supply shock of oil prices is what (I understand) pushed the country into stagflation. 3) Arab money in the 1970s came back (largely) to US banks as petrodollars, so the financial accounts balance was not heavily disrupted. I’m not so sure that a similar proportion of dollars leaving the US for oil and other imports are going to be coming back.
corporate credit stumbled at the end of june. that was when the market puked back dollar general, food service, and servicemaster and the last time a cov-lite loan cleared.
We didn’t even have securitized mortgages in the '70’s. There really couldn’t have been a credit crisis because there just weren’t credit markets like there are now. There was corporate, govt, muni debt and it was pretty simple stuff.
there was a credit crisis in 1990. HY issuance went from $30 billion in 1989 to $1 billion in 1990. damn guiliani
If you want to look at how bad the bank reserve situation is, go http://www.federalreserve.gov/releases/h3/Current/ H.3 (502) Table 1 For Release at 4:30 p.m. Eastern Time January 31, 2008 AGGREGATE RESERVES OF DEPOSITORY INSTITUTIONS AND THE MONETARY BASE Adjusted for changes in reserve requirements(1) Seasonally adjusted unless noted otherwise Millions of dollars -------------------------------------------------------------------------------------------------------------------------------------------- Reserves of depository institutions Other borrowings of depository institutions from the Federal Reserve, NSA -------------------------------------------------- Term ----------------------------------------------- auction Date total(2) non- required excess Monetary credit, total primary secondary seasonal borrowed(3) NSA(4) base(5) NSA -------------------------------------------------------------------------------------------------------------------------------------------- Month(6) 2006-Dec. 43315 43124 41507 1808 811822 191 111 0 80 2007-Jan. 42171 41960 40665 1506 813455 211 187 0 24 Feb. 42454 42424 40956 1498 813448 30 8 0 22 Mar. 42321 42267 40686 1635 814991 54 21 5 28 Apr. 42715 42635 41189 1525 817205 79 32 0 48 May 43197 43093 41760 1436 818799 103 14 0 90 June 43606 43419 41904 1702 820085 187 43 0 145 July 41915 41653 40251 1664 821476 262 45 0 217 Aug. 44922 43948 40100 4822 824512 975 701 19 255 Sep. 42540 40973 40798 1742 821732 1567 1345 0 221 Oct. 42507 42252 41056 1450 824713 254 126 13 115 Nov. 42646 42281 40970 1676 825653 366 315 0 50 Dec. 42585 27154 40837 1748 823448 11613 3818 3787 1 30 2 weeks ending(7) 2007-Dec. 5 43993 43794 42170 1822 824857 199 158 0 41 19 40834 37001 39666 1168 822014 3833 3798 2 34 2008-Jan. 2 44040 8733 41647 2393 824534 30000 5308 5286 0 21 16 41574 198 39864 1710 820879 40000 1377 1371 0 6 30p 41639 -8751 40179 1460 821298 50000 390 385 0 5 ---------------------------------------------------------------------------------------------------------------------------------------------