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Steve's Reviews > Crashed: How a Decade of Financial Crises Changed the World
Crashed: How a Decade of Financial Crises Changed the World
by
by
This volume does a great job explaining the financial meltdown that began in 2007. I particularly found the author's discussion of liquidity, or rather the lack of liquidity, to be of interest. The first half of this book is strong and, I believe, sets the historical standard for the crisis from 2007-2012. The second half, however, reads as a general survey, presenting little insight to those who follow world affairs. For example, the author, it seems, dwells unrelentingly on that chain-smoking, unemployed, alcoholic cousin at the Thanksgiving table, Greece. I think it was Eric Hobsbawn who commented that writing history so close in time to actual events is dicey business; Mr. Tooze proves it so.
This book lacks any feel for life on the front lines during the crisis. To satisfy that deficiency, I offer up no less notable an observer than . . . me. I wrote the following in August 2017:
The Financial Meltdown (2008-2009): An Education
Gifted authors have well documented the 2008-2009 financial crisis and its aftermath. More good stuff is surely to come. As a contribution to the record, what follows are the modest, personal reflections of an unimportant former investment banker who had a bleacher seat view of events.
The Prelude
All seemed well in those pre-crash years. For those who lived through the dot-com bubble, the period immediately following seemed relatively calm. From a distance the financial markets showed little cause for concern, reflected in bond yields and general equity valuations. The 10-year Treasury began 2003 at 4.05% and ended 2007 at 4.10%. The S&P 500 had moved from a 2003 low of ~830 to a 2007 high of ~1560. Despite the gains, the stock market did not then seem overvalued. The S&P 500 forward price-earnings ratio was ~15x in 2007, compared to a 1999 high of ~25x. We had seemingly learned our lesson: in the end, a dollar must be worth a dollar. What pain we endured to learn that clicks and page views were not proper valuation metrics. The financial world was a safe place again, right?
Alice and The White Rabbit
But there was one nagging annoyance: Alice in Wonderland at the workplace. Since the first bank was founded, bankers held relationships with customers who in turn did business with the bank. It was obvious who played the role of banker and that of customer. Beginning in the early 2000s, a white rabbit appeared in investment banks. The power structure of the large banks changed. Groups who held questionable relationships with hitherto unknown entities assumed greater control of securities and banking business lines. Traditionalists, who covered companies like P&G, 3M or IBM were perplexed. Enormous amounts of money were being generated and yet it wasn’t apparent exactly how. The white rabbit was the structured products industry.
When formed in the 1980s, that industry, though complex, was relatively easy to understand. A financial institution aggregated mortgages or credit card debt, then sold a package of securities that contained those assets to fixed income investors. It seemed an understandable and reasonable business model. By the early 2000s, securitization had become extremely opaque. Terms like CLO, CBO, CDO, Super Senior or equity tranche were among the trade’s argot.
Unlike the centuries-old relationships between bankers and customers, the structured products teams were working with newly-formed, little-known, entities that managed large asset pools. The pool managers evolved as something of a cottage industry in response to accounting and regulatory changes that made it prohibitively costly for banks to hold certain assets on their own balance sheets. What these managers did was a mystery to those of us in the bleachers. A whole lot of attention was being paid to what seemed like “two persons and a Bloomberg terminal�-type operations.
The white rabbit continued hopping, milling with a few other Lewis Carroll characters. And then in 2007, began the gradual, slow-motion, melt-down. We traditionalists had no clue of what was to unfold. Yes, we reached the final chapter of Alice’s adventures. The white rabbit hopped away. What word best describes its footprints? Carnage? Ruin? Calamity? Was it Warren Buffet who remarked that only when the tide goes out do we see who is swimming unclothed? For when the tide went out, we then saw how the structured products business was engineered.
What did we see? An unholy alliance among government, rating agencies, investors, and banks.
The Actors:
Government
It is no surprise that the 2008/2009 melt-down began with government. Government had set the stage through decades of public policy for what followed, fostering home ownership and minimizing borrowing costs for homeowners. As expected, firms advantaged themselves through government behavior. Wall Street is very good at profiting from cracks in government policy. Through time, those cracks became chasms.
Rating agencies
The rating agencies are for-profit entities that constantly seek new ways to grow revenues. Rating structured product securities was an important growth element to those firms. It is only somewhat less surprising that the rating agencies could be buffaloed - anyone who has worked on Wall Street knows the reason for this. They proved themselves to be (unwitting?) pigeons in this poker game. They also suffered relatively few consequences, compared to their contribution, in the wake of the crisis.
Institutional investors
Institutional investors relied upon the banks and the rating agencies to affirm the quality of their purchases. It was somewhat surprising that investors would be so ignorant of the underlying risks they were bearing, relying far too heavily on the rating agencies and bankers. Aren’t institutional investors paid to assess risk independently? Well, it turns out that’s not how it works. If the rating agencies were to rate Imelda Marcos’s shoes AAA and we had a Bloomberg terminal, we could easily sell old Imelda’s shoes off to the highest bidder. This is only a mild exaggeration, sadly. To be fair, fixed income investors are known for doing their homework with non-investment grade securities (below BBB-). Most of the structured product securities were sold as investment grade (BBB- and higher), however. It was something of a shock to realize that fixed income investors put so much faith in the rating agencies and so little thought into their decisions.
The banks
Finally, there were the banks. Large banks employ large staffs of risk managers. Their job is to . . . manage risk. This works as expected in ordinary times. When large sums are being earned, though, let’s just say those risk managers can be a bit malleable. Further, the sheer size of profits awed CEOs into fawning support - best not to ask too many questions. Operating in this system, the structured products bankers were the classic actors in the principal-agent problem.
The Drama
The excruciating slow pace of decline
The downturn in the financial markets began with events in early 2007. Nearly two years passed from that time to the S&P 500’s bottom. If you were an investor in the S&P 500, you bore a 56% loss from peak to trough. Investors in Bank of America, AIG and Lehman saw losses of 94%, 99.5% and 100%. The US government bond market became the safe haven for investors. From mid-2007 to the end of 2008, the iShares 20+ Year TBond ETF moved from ~$84 to ~$122, a 50% increase in price for a risk-free asset.
Why did it take so long for the market to incorporate information into prices? In this era of instant information, shouldn’t security prices have immediately reacted to the possible consequences of the structured products excesses? The answer was no. Why not? A few thoughts come to mind: (1) Structured products themselves were opaque. Who issued them, who owned them and what they contained were not obvious to those in the bleachers. (2) Because Wall Street’s structured products groups generated so much revenue, there was a powerful institutional bias toward maintaining the status quo. (3) Governments created the Band-Aid du jour to mend each newly-opened wound, thus slowing and prolonging the crisis. (4) Rather than immediately re-rating the financial system, the rating agencies produced a sort of rolling thunder, issuing one downgrade after another over an extended time period. (5) Regulatory forbearance occurred globally, where the true effects of economic outcomes were prevented from being recognized publicly. If an institution were to fail a financial regulatory test, such as a risk-based capital measure, the regulator changed, or temporarily ignored, the test’s thresholds.
Extraordinary government responses
Governments, behaving in unprecedented fashion, lowered interest rates to zero or negative levels and then left them at those levels. Since the dawn of civilization, it has been an unquestioned rule that the lender of 10 goats shall receive at least 11 goats upon repayment. No longer. Governments also took unprecedented action when they provided liquidity against certain asset classes, like mortgage backed securities, direct investment into financial institutions (effectively nationalizing major banks), and indirect backing to funding for various financial firms.
Though the crisis in total was measured in years, individual situations arose in real-time, requiring immediate government response. With imperiled entities like Lehman and Bear Stearns, there was no time for reflection. Given the realities of trading, action was often needed before market openings. The response times governments faced were measured in hours rather than months, weeks or even days. The results were seemingly random. Each of common stock, bond and preferred stock owners were treated differently depending on the crisis of the moment.
Institution............../.Common.../Preferred/.Bonds....../.Clients
FHMA+FHLMC......./.Loss........../.Loss......../.Saved....../.Saved
Lehman+WAMU...../.Loss........../.Loss......../.Impaired/.Saved
AIG+BofA+Citi......../.Impaired../.Saved....../.Saved....../.Saved
Bear+Merrill.........../.Impaired../.Saved....../.Saved....../.Saved
Goldman+MS........../.Saved......./.Saved....../.Saved....../.Saved
Afterwards
Mockery of technocracy
For all the planning from technocrats in government, the crisis proved a mockery. Decisions were made on the fly. Inconsistencies abounded. Why were Lehman and WAMU allowed to go down when all other major institutions were saved? The simple way to handle a crisis was to throw the full weight of the government behind any large failing enterprise. Thus begat the phrase too big to fail.
Investors are now conditioned to recognize the willingness of governments to support the integrity of large financial institutions, skewing the risk/reward dynamic for securities of those entities. Why should the senior notes of a large bank be viewed differently than an equivalent risk senior note of a brewer? And if banks are just extensions of the federal government, then perhaps they should be owned and operated as such?
Authority bias
We want to believe those in the know badly, so badly we’ll pay for access to those authorities. The crisis exposed a tremendous amount of authority bias. For the authorities know no more about the future than the person on the street. The authority does have access to a larger set of real-time data, presumably. Perhaps they have a better appreciation for risk, yet that does not lead to a better understanding of the future. The crisis demonstrated the limited value added from notable financial institutions, advisors and managers, none of whom foresaw the oncoming crisis or its extent.
The unquoted value of cash
When the markets began to sell-off heavily, why didn’t investors immediately respond? Financial prices, it turns out, do not fully reveal emotions. There is a non-quoted value of holding cash, what economists refer to as liquidity preference. Fear is the culprit. Some called it the fear of catching a falling knife. If a security were trading for $100 on day 1, $80 on day 2, $60 on day 3, why even think of investing on day 4? You could invest at $40, only to see your investment worth $20 one day later.
It was well known on Wall Street that private equity investors were told by their limited partners not to place a call for cash, even though the LPs would have been legally obligated to deliver cash. It was also known that there were instances of large institutions being denied access to revolving credit facilities even though the banks had a similar legal obligation.
Holding a dollar was worth much more than a dollar, it seemed. There was no corresponding price quote, however. That’s why there is a paradox in investing. Market declines are the time to be investing, not shying from investing. We see the value of securities. The value of holding cash is intangible.
Failure to let market forces reach equilibrium
Because governments intervened to prevent Adam Smith’s invisible hand from exerting its proper influence, a set of consequences, some intended, some unintended, followed. This begs the question, what would have happened had government not responded with such accommodations? Several financial institutions would likely have gone bankrupt including most large securities firms. Depositors at several banks would have experienced losses to at least some of their deposits above FDIC limits. Fixed income investors in many surviving financial institutions would have seen the value of their securities significantly reduced. Money market investors would have suffered losses, an unthinkable outcome prior to the crisis. Collateralization requirements in structures like derivatives would have forced counterparty losses. In short, the system and many, many Americans would have been instantly hurt badly. Would it have been best, though, to let investors and managements that took risk bear the consequences of that risk? Regulators would have then upheld the rules of the road for all. After the pain, wouldn’t the system have reached equilibrium and sparked a rebuilding? Wouldn’t the world have relearned an important lesson about risk and return?
As it was, government intervention took the hurt and spread it over many years. Many investors and managements that took risk avoided the consequences of that risk due to government action. We preserved the financial system. At what cost? In substance, government action has taken from savers and taxpayers and given to those borrowing institutions many of which should have failed. This action has played out over a decade so, like inflation, the impact is hidden from direct view. To a bank, the cost of goods sold is represented by their cost to borrow money. Borrowing costs for banks have been at record lows now for nearly a decade, much in an attempt to salve wounds. Is this really what is meant when we speak of American capitalism?
Central banks have now set a new boundary level for financial stimulus with zero or negative interest rates, trillions of dollars in government supplied liquidity, and inconsistent treatment of security holders in imperiled institutions. What happens in the next crisis when central banks ease, but not as far as the old boundary? What if they provide liquidity but not as much as before? What message does that send? Perhaps central banks will be forced to exceed the prior boundaries lest they not be taken seriously?
Hints of things to come?
Government protections and regulations enacted following the Great Depression created the impression that banking panics were a thing of the past. Not true it turns out. The loss of confidence in the financial system was an unanticipated and unforeseen surprise to all. It serves to remind us that despite all the efforts to insulate the financial system, panic cannot be prevented.
Looking at developing countries in crisis, we get an idea of just how far governments can go to control financial panic: bank deposit freezes/confiscations (Brazil), cash withdrawal limits (Greece), bank bail-ins (Cyprus), retirement account confiscation (Argentina), currency exchange controls, just to name a few. Will these tactics used by less developed countries now become policy in the developed world under crisis? What will it mean to hold cash in that world?
Conditions precedent for another major dislocation?
Given that nearly 75 years passed between the last two panics, there’s good reason to believe another panic is unlikely anytime soon. Yet we know that the massive government interventions of the past decade have seriously impaired price discovery in the markets. Clearly, the removal of government subsidies will have an impact. The conditions are set, therefore, for a significant market downturn even without a panic. What could serve as the spark? Will Europe be forced to break apart or to federalize? Will China’s financial system collapse? Is there a black swan lurking in the US financial system? It’s far more likely a downturn will come from something unseen or ignored today. Given the sheer size of government intervention, it’s also more likely to be later rather than sooner.
It’s comforting to hear market warnings from so many managers/pundits. We can be certain, with 99.97% confidence, that they are in error. There are too many sophisticated investors calling for a market correction for it to happen now and it just makes too much good sense. It’s when those investors surrender to the market that we should worry. Make no mistake, the mammoth government subsidies will produce major market dislocations at some time. The laws of nature tell us so. We don’t know when. No one does. Someone will, however, make a timely call on the market’s demise, for as they say, even the broken clock is right twice a day.
This book lacks any feel for life on the front lines during the crisis. To satisfy that deficiency, I offer up no less notable an observer than . . . me. I wrote the following in August 2017:
The Financial Meltdown (2008-2009): An Education
Gifted authors have well documented the 2008-2009 financial crisis and its aftermath. More good stuff is surely to come. As a contribution to the record, what follows are the modest, personal reflections of an unimportant former investment banker who had a bleacher seat view of events.
The Prelude
All seemed well in those pre-crash years. For those who lived through the dot-com bubble, the period immediately following seemed relatively calm. From a distance the financial markets showed little cause for concern, reflected in bond yields and general equity valuations. The 10-year Treasury began 2003 at 4.05% and ended 2007 at 4.10%. The S&P 500 had moved from a 2003 low of ~830 to a 2007 high of ~1560. Despite the gains, the stock market did not then seem overvalued. The S&P 500 forward price-earnings ratio was ~15x in 2007, compared to a 1999 high of ~25x. We had seemingly learned our lesson: in the end, a dollar must be worth a dollar. What pain we endured to learn that clicks and page views were not proper valuation metrics. The financial world was a safe place again, right?
Alice and The White Rabbit
But there was one nagging annoyance: Alice in Wonderland at the workplace. Since the first bank was founded, bankers held relationships with customers who in turn did business with the bank. It was obvious who played the role of banker and that of customer. Beginning in the early 2000s, a white rabbit appeared in investment banks. The power structure of the large banks changed. Groups who held questionable relationships with hitherto unknown entities assumed greater control of securities and banking business lines. Traditionalists, who covered companies like P&G, 3M or IBM were perplexed. Enormous amounts of money were being generated and yet it wasn’t apparent exactly how. The white rabbit was the structured products industry.
When formed in the 1980s, that industry, though complex, was relatively easy to understand. A financial institution aggregated mortgages or credit card debt, then sold a package of securities that contained those assets to fixed income investors. It seemed an understandable and reasonable business model. By the early 2000s, securitization had become extremely opaque. Terms like CLO, CBO, CDO, Super Senior or equity tranche were among the trade’s argot.
Unlike the centuries-old relationships between bankers and customers, the structured products teams were working with newly-formed, little-known, entities that managed large asset pools. The pool managers evolved as something of a cottage industry in response to accounting and regulatory changes that made it prohibitively costly for banks to hold certain assets on their own balance sheets. What these managers did was a mystery to those of us in the bleachers. A whole lot of attention was being paid to what seemed like “two persons and a Bloomberg terminal�-type operations.
The white rabbit continued hopping, milling with a few other Lewis Carroll characters. And then in 2007, began the gradual, slow-motion, melt-down. We traditionalists had no clue of what was to unfold. Yes, we reached the final chapter of Alice’s adventures. The white rabbit hopped away. What word best describes its footprints? Carnage? Ruin? Calamity? Was it Warren Buffet who remarked that only when the tide goes out do we see who is swimming unclothed? For when the tide went out, we then saw how the structured products business was engineered.
What did we see? An unholy alliance among government, rating agencies, investors, and banks.
The Actors:
Government
It is no surprise that the 2008/2009 melt-down began with government. Government had set the stage through decades of public policy for what followed, fostering home ownership and minimizing borrowing costs for homeowners. As expected, firms advantaged themselves through government behavior. Wall Street is very good at profiting from cracks in government policy. Through time, those cracks became chasms.
Rating agencies
The rating agencies are for-profit entities that constantly seek new ways to grow revenues. Rating structured product securities was an important growth element to those firms. It is only somewhat less surprising that the rating agencies could be buffaloed - anyone who has worked on Wall Street knows the reason for this. They proved themselves to be (unwitting?) pigeons in this poker game. They also suffered relatively few consequences, compared to their contribution, in the wake of the crisis.
Institutional investors
Institutional investors relied upon the banks and the rating agencies to affirm the quality of their purchases. It was somewhat surprising that investors would be so ignorant of the underlying risks they were bearing, relying far too heavily on the rating agencies and bankers. Aren’t institutional investors paid to assess risk independently? Well, it turns out that’s not how it works. If the rating agencies were to rate Imelda Marcos’s shoes AAA and we had a Bloomberg terminal, we could easily sell old Imelda’s shoes off to the highest bidder. This is only a mild exaggeration, sadly. To be fair, fixed income investors are known for doing their homework with non-investment grade securities (below BBB-). Most of the structured product securities were sold as investment grade (BBB- and higher), however. It was something of a shock to realize that fixed income investors put so much faith in the rating agencies and so little thought into their decisions.
The banks
Finally, there were the banks. Large banks employ large staffs of risk managers. Their job is to . . . manage risk. This works as expected in ordinary times. When large sums are being earned, though, let’s just say those risk managers can be a bit malleable. Further, the sheer size of profits awed CEOs into fawning support - best not to ask too many questions. Operating in this system, the structured products bankers were the classic actors in the principal-agent problem.
The Drama
The excruciating slow pace of decline
The downturn in the financial markets began with events in early 2007. Nearly two years passed from that time to the S&P 500’s bottom. If you were an investor in the S&P 500, you bore a 56% loss from peak to trough. Investors in Bank of America, AIG and Lehman saw losses of 94%, 99.5% and 100%. The US government bond market became the safe haven for investors. From mid-2007 to the end of 2008, the iShares 20+ Year TBond ETF moved from ~$84 to ~$122, a 50% increase in price for a risk-free asset.
Why did it take so long for the market to incorporate information into prices? In this era of instant information, shouldn’t security prices have immediately reacted to the possible consequences of the structured products excesses? The answer was no. Why not? A few thoughts come to mind: (1) Structured products themselves were opaque. Who issued them, who owned them and what they contained were not obvious to those in the bleachers. (2) Because Wall Street’s structured products groups generated so much revenue, there was a powerful institutional bias toward maintaining the status quo. (3) Governments created the Band-Aid du jour to mend each newly-opened wound, thus slowing and prolonging the crisis. (4) Rather than immediately re-rating the financial system, the rating agencies produced a sort of rolling thunder, issuing one downgrade after another over an extended time period. (5) Regulatory forbearance occurred globally, where the true effects of economic outcomes were prevented from being recognized publicly. If an institution were to fail a financial regulatory test, such as a risk-based capital measure, the regulator changed, or temporarily ignored, the test’s thresholds.
Extraordinary government responses
Governments, behaving in unprecedented fashion, lowered interest rates to zero or negative levels and then left them at those levels. Since the dawn of civilization, it has been an unquestioned rule that the lender of 10 goats shall receive at least 11 goats upon repayment. No longer. Governments also took unprecedented action when they provided liquidity against certain asset classes, like mortgage backed securities, direct investment into financial institutions (effectively nationalizing major banks), and indirect backing to funding for various financial firms.
Though the crisis in total was measured in years, individual situations arose in real-time, requiring immediate government response. With imperiled entities like Lehman and Bear Stearns, there was no time for reflection. Given the realities of trading, action was often needed before market openings. The response times governments faced were measured in hours rather than months, weeks or even days. The results were seemingly random. Each of common stock, bond and preferred stock owners were treated differently depending on the crisis of the moment.
Institution............../.Common.../Preferred/.Bonds....../.Clients
FHMA+FHLMC......./.Loss........../.Loss......../.Saved....../.Saved
Lehman+WAMU...../.Loss........../.Loss......../.Impaired/.Saved
AIG+BofA+Citi......../.Impaired../.Saved....../.Saved....../.Saved
Bear+Merrill.........../.Impaired../.Saved....../.Saved....../.Saved
Goldman+MS........../.Saved......./.Saved....../.Saved....../.Saved
Afterwards
Mockery of technocracy
For all the planning from technocrats in government, the crisis proved a mockery. Decisions were made on the fly. Inconsistencies abounded. Why were Lehman and WAMU allowed to go down when all other major institutions were saved? The simple way to handle a crisis was to throw the full weight of the government behind any large failing enterprise. Thus begat the phrase too big to fail.
Investors are now conditioned to recognize the willingness of governments to support the integrity of large financial institutions, skewing the risk/reward dynamic for securities of those entities. Why should the senior notes of a large bank be viewed differently than an equivalent risk senior note of a brewer? And if banks are just extensions of the federal government, then perhaps they should be owned and operated as such?
Authority bias
We want to believe those in the know badly, so badly we’ll pay for access to those authorities. The crisis exposed a tremendous amount of authority bias. For the authorities know no more about the future than the person on the street. The authority does have access to a larger set of real-time data, presumably. Perhaps they have a better appreciation for risk, yet that does not lead to a better understanding of the future. The crisis demonstrated the limited value added from notable financial institutions, advisors and managers, none of whom foresaw the oncoming crisis or its extent.
The unquoted value of cash
When the markets began to sell-off heavily, why didn’t investors immediately respond? Financial prices, it turns out, do not fully reveal emotions. There is a non-quoted value of holding cash, what economists refer to as liquidity preference. Fear is the culprit. Some called it the fear of catching a falling knife. If a security were trading for $100 on day 1, $80 on day 2, $60 on day 3, why even think of investing on day 4? You could invest at $40, only to see your investment worth $20 one day later.
It was well known on Wall Street that private equity investors were told by their limited partners not to place a call for cash, even though the LPs would have been legally obligated to deliver cash. It was also known that there were instances of large institutions being denied access to revolving credit facilities even though the banks had a similar legal obligation.
Holding a dollar was worth much more than a dollar, it seemed. There was no corresponding price quote, however. That’s why there is a paradox in investing. Market declines are the time to be investing, not shying from investing. We see the value of securities. The value of holding cash is intangible.
Failure to let market forces reach equilibrium
Because governments intervened to prevent Adam Smith’s invisible hand from exerting its proper influence, a set of consequences, some intended, some unintended, followed. This begs the question, what would have happened had government not responded with such accommodations? Several financial institutions would likely have gone bankrupt including most large securities firms. Depositors at several banks would have experienced losses to at least some of their deposits above FDIC limits. Fixed income investors in many surviving financial institutions would have seen the value of their securities significantly reduced. Money market investors would have suffered losses, an unthinkable outcome prior to the crisis. Collateralization requirements in structures like derivatives would have forced counterparty losses. In short, the system and many, many Americans would have been instantly hurt badly. Would it have been best, though, to let investors and managements that took risk bear the consequences of that risk? Regulators would have then upheld the rules of the road for all. After the pain, wouldn’t the system have reached equilibrium and sparked a rebuilding? Wouldn’t the world have relearned an important lesson about risk and return?
As it was, government intervention took the hurt and spread it over many years. Many investors and managements that took risk avoided the consequences of that risk due to government action. We preserved the financial system. At what cost? In substance, government action has taken from savers and taxpayers and given to those borrowing institutions many of which should have failed. This action has played out over a decade so, like inflation, the impact is hidden from direct view. To a bank, the cost of goods sold is represented by their cost to borrow money. Borrowing costs for banks have been at record lows now for nearly a decade, much in an attempt to salve wounds. Is this really what is meant when we speak of American capitalism?
Central banks have now set a new boundary level for financial stimulus with zero or negative interest rates, trillions of dollars in government supplied liquidity, and inconsistent treatment of security holders in imperiled institutions. What happens in the next crisis when central banks ease, but not as far as the old boundary? What if they provide liquidity but not as much as before? What message does that send? Perhaps central banks will be forced to exceed the prior boundaries lest they not be taken seriously?
Hints of things to come?
Government protections and regulations enacted following the Great Depression created the impression that banking panics were a thing of the past. Not true it turns out. The loss of confidence in the financial system was an unanticipated and unforeseen surprise to all. It serves to remind us that despite all the efforts to insulate the financial system, panic cannot be prevented.
Looking at developing countries in crisis, we get an idea of just how far governments can go to control financial panic: bank deposit freezes/confiscations (Brazil), cash withdrawal limits (Greece), bank bail-ins (Cyprus), retirement account confiscation (Argentina), currency exchange controls, just to name a few. Will these tactics used by less developed countries now become policy in the developed world under crisis? What will it mean to hold cash in that world?
Conditions precedent for another major dislocation?
Given that nearly 75 years passed between the last two panics, there’s good reason to believe another panic is unlikely anytime soon. Yet we know that the massive government interventions of the past decade have seriously impaired price discovery in the markets. Clearly, the removal of government subsidies will have an impact. The conditions are set, therefore, for a significant market downturn even without a panic. What could serve as the spark? Will Europe be forced to break apart or to federalize? Will China’s financial system collapse? Is there a black swan lurking in the US financial system? It’s far more likely a downturn will come from something unseen or ignored today. Given the sheer size of government intervention, it’s also more likely to be later rather than sooner.
It’s comforting to hear market warnings from so many managers/pundits. We can be certain, with 99.97% confidence, that they are in error. There are too many sophisticated investors calling for a market correction for it to happen now and it just makes too much good sense. It’s when those investors surrender to the market that we should worry. Make no mistake, the mammoth government subsidies will produce major market dislocations at some time. The laws of nature tell us so. We don’t know when. No one does. Someone will, however, make a timely call on the market’s demise, for as they say, even the broken clock is right twice a day.
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