The Long Crisis

Posts Tagged ‘financial crisis’

On September 15th, 2008, the 158 year old investment bank, Lehman Brothers, filed for bankruptcy in Federal court. It was the biggest bankruptcy in American history and nearly brought down the world’s financial system.

CNN has complied comments from those financial executives who remember the panic well. A few of their comments follow.

Mohamed El-Erian : Chief Executive and Co-Chief Investment Officer of PIMCO:

“On the Wednesday and Thursday before Lehman filed for Chapter 11, I asked my wife to please go to the ATM and take as much cash as she could. When she asked why, I said it was because I didn’t know whether there was a chance that banks might not open. I remember my wife sort of pausing and saying, “Are you serious?” And I said, “Yes, I am.” We had long felt that the world was increasingly in disequilibrium, and by March of 2008 we decided that things were critical and that the unthinkable was thinkable.”

Meredith Whitney: Well known and highly regarded investment analysist: Shouldn’t have let Lehman fail:

“I don’t think they should’ve let Lehman fail. The rules didn’t seem uniformly applied. And it’s very hard to get individuals comfortable with investing if different rules are being applied to different people.”

Neel Kashkari: Former Assistant Secretary of the Treasury and supervisor of TARP: A real-life, terrifying experiment

“We were now forced to live a real-life, terrifying, financial-markets experiment: Would the failure of a major investment bank really lead to the catastrophe that we feared? When blue-chip industrial companies called us later that week, having trouble funding themselves, we learned that our worst fears were coming true.”

You can read the entire account at CNN under the title “ When Wall Street Nearly Collapsed”.

The big remaining questions are: 1.)How do things stand one year after the Lehman bankruptcy? 2.) Does the 50% stock market rally mean that we have restructured our financial system and reduced the risk of systemic failure?

By own view is that 1.) We have concentrated systemic risk, not reduced it, and 2.) no we have not, we have increased it.

The trillions of dollars that Treasury and the Fed have poured into the financial system have certainly supported a higher stock market as some of those dollars have flowed into stocks. However, the flaws in the system have not been repaired, only papered over.

And I do mean paper as the government has created huge amounts of new “money” out of a few computer keyboard strokes. This fiat paper money has been created by the issuance of huge amounts of new debt. As much of the problems within the financial system and the real economy are a by product of excessive debt it stands to reason that they can not be solved by creating even more debt. Then there is the risk that the creation of so many new dollars will send the dollar into a tail spin on the foreign exchange market. This could lead to a much higher inflation rate for the US.

Lehman was not the only investment bank to disappear, only the one the government let collapse into bankruptcy. Merrill Lynch was “saved” by a shotgun wedding with Bank of America. Then there was Bear. On March 24,2008 JPMorgan agreed to up the bid to $10 a share in stock and to purchase 95 million new shares of Bear Stearns, giving JPMorgan an immediate 39 percent stake in the collapsed brokerage firm. The deal, which closed May 30,2008 brought to an end an 85-year-old institution. You can read the full story at The New York Times.

Well established investment banking firms were reduced to rubble in the 2008 financial meltdown. Goldman Sachs, JP Morgan, and other financial firms, like AIG, were saved by government bailout funds. As a result, unfortunately, risk is now concentrated in fewer hands and it seems like at least some of the “too big to fail” firms are up to their old dirty use of excessive leverage tricks that helped to bring on the disaster.

The big money center and larger regional banks are still sitting upon a mountain of toxic waste mortgage assets that are likely worth only a fraction of the value that they are carried at on the banks books. In short, few if any of the structural weaknesses that contributed to the financial meltdown have been repaired. The risk of another emergency of some sort is still high. Very likely, since so much additional debt has been placed into play the next crisis will be even larger and more of a disaster than the last.

It is a time not for investors to rejoice but to be extremely cautious. One year after the Lehman Brothers bankruptcy many analysis and government officials think that the “worse is over”. However, remember these are the same guys and gals who didn’t see the financial meltdown coming until it was too late. As underlying problems have not been fixed the long crisis is probably just getting started. For example, the problems developing with the commercial real estate market are not reassuring.

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Financial Reckoning Day Fallout, Surviving Today’s Global Depression, by bestselling authors William Bonner and Addison Wiggin, is the fully revised and updated 10th anniversary edition of their celebrated book that foretold much of the financial chaos of today.

The beauty of both editions is that they tell the tale of financial trickery, mass delusions, and government intervention in the way free markets are supposed to work, in a highly entertaining and informative fashion. This is an important book about finance and markets in a world gone mad. It is far removed from the dry and often boring financial topic books one may have poured over in college or in the finance section of your favorite bookstore.

At times you will be strangely tearing up with laughter while reading about the most depressing subjects. The wit displayed by Bonner and Wiggin is only matched by the accuracy of their forecasts. You will quickly discover that the authors are keen students of history. Their belief that history does repeat itself is clear. Humans seem to forget about their tragic mistakes within a generation or two and then go on to not only repeat the mistakes but to enlarge them.

Bonner and Wiggin believe that in the present crisis the leap to trillions as an accounting unit, from merely billions, places a new spin on the consequences of governments trying to cure problems caused primarily by the use of excessive debt by creating even more debt.

That there can be no good ending to the present US financial crisis clearly dawns upon the reader as facts are presented in the book. However, even with disaster looming just around the corner you will find yourself amused and even laughing at how ridiculous and silly the human condition is on this little planet earth.

One statement made early in the book is that “The severity of a depression is inversely correlated with government’s efforts to stop it.” When one examines the Herculean efforts of the Obama administration to prevent a depression by creating trillions of dollars in new federal debt one can only think that this depression will be deep and long indeed.

If you are an American baby boomer the chapter “The Hard Math of Demography” provides a chilling reminder of how much drastic change you will see within your lifetime. If you are a young adult, say in your twenties or thirties, you will see that your life style experience will likely be far more fugal than your parents. And that without careful planning you may live out a life of financial misery.

While written in a most entertaining matter, with a multitude of amusing antidotes, readers of all ages will find “Financial Reckoning Day Fallout” to be chock full of ideas and revelations that are worth thinking about. Serious thought. The health of your financial future may depend upon it.

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Accurate and timely financial forecasting has always been difficult. Especially today, with so many distortions at work in the economy, I can confidently say that no one knows with any degree of precision what the future may bring. Still I believe that there is a strong possibility that in 2010 the tender green shoots of 2009 will be violently chopped down to be replaced by a feast by a flock of black swans from hell. And that our economy will be the meal.

The concept of “Black Swans” was developed by Nassim Nicholas Taleb and refers to high-impact, hard-to-predict, and suppose to be rare events beyond the realm of normal expectations. In portfolio management these are events that are computed to be well outside of the range of statistical probability and are therefore of such a low risk they are not considered relevant to the risk management of the portfolio.

Unfortunately, in 2007 and 2008 black swan events happened so close together and had such a disastrous effect on the world economy that “rare events” were occuring one after the other. Clearly the hedge fund operators and bank traders had mispriced risk by huge margins. Black swans were everywhere.

Nassim Taleb was right with his statements that black swan events happen far more often than anticipated by number crunchers and portfilio managers. I have previously posted in my Taipan Investor Blog about Black Swan Events. Those readers not that familiar with the black swan concept may want to read the post before pressing forward.

Financial events in 2009 have paved the way for a flock of really nasty black swans to emerge in 2010 – the black swans from hell. Since by their very definition black swan events usually happen without warning forecasting their arrival is indeed a tricky business. However, actions already taken by the United States government, various USA state governments, and governments of other developed and developing nations move forward the probability of 2010 being a black swan hell off the charts. Here is why.

1.) Governments Attempting to Cure Problems Caused by Too Much Debt by Issuing More Debt.

The sad development of bubble economies in the recent past is well known. There was the dot.com bubble, the real estate bubble, the stock market bubble. the consumption bubble. As each bubble began to implode various governments of the world, lead by the US, tried to reinflate the old bubble or to inflate a new bubble. Even though the bubbles were largely caused by governments keeping interest rates far too low for far too long, all the while creating new fiat currency, governments seemed to say “what bubble”, let the good times roll. This misguided policy, which results in massive misallocations of capital, continues.

In the US, the Treasury Department will run a huge dollar deficit in 2010. The Obama administration said the economic downturn has been a bit worse than previously thought. It’s estimate for the 2010 budget deficit has been updated – increased by 19% – to $1.5 trillion. The Congressional Budget Office did its own count and came up with $1.4 trillion. Either way, when you get into the trillions it’s a hell of a lot of money. So much, in fact, that the human brain can’t seem to get a handle on it. Debt in the trillions will create fertile breeding grounds for black swans from hell.

2.) Confidence Building Rather Than Fixing Problems.

The year 2009 has lead to a multitude of reassuring comforting statements from all of the important con men and women, errrrrr, excuse me, government spokespersons, from President Obama, Ben Bernanke, Tim Giethner, and FDIC chairperson Sheila Bair. Not to worry, they all say in perfect harmony, green shoots are coming up everywhere.

In 2010, as the very temporary boost to the economy by programs like cash for clunkers and other stimulius programs falls away, the replacement of green shoots by black swans is almost certain to occur. The stimulius programs do not fix anything. We are not in a recession but in a depression caused by a systematic failure of our consumer based economy. While confidence building is an important function of government, leaders cheerleading without putting effective policies in place will lead to disappointment and anger.

Disappointment and anger will lead to more fertile breeding grounds for black swans.

3.) Feds Balance Sheet Already Doubled.

The Fed’s balance sheet is the monetary ballast for the whole economy. As the balance sheet expands, so does the amount of financial activity the economy can support. The problem is that in theory, the potential for inflation increases geometrically. Each new dollar on the Fed’s balance sheet could be multiplied into $10 in the real economy. Bernanke has already doubled the Fed’s balance sheet – buying up an additional $1 trillion worth of Wall Street’s toxic waste failures and the Federal Reserve Bank’s. According to Goldman Sach’s top economist, Jan Hatzius, Bernanke might have to buy another $2 trillion worth in 2010 – bringing the total to $4 trillion.

Black swans from hell must love those trillions.

4.) Number of Troubled Banks Keeps Increasing.

The FDIC reported on Thursday, August 27, that the number of troubled banks rose to 416 at the end of June, up from 305 at the end of March. Says MarketWatch: “FDIC said this is the largest number of banks on its ‘problem list’ since June 30, 1994, when 434 banks were on the list. Assets at troubled banks totaled $299.8 billion, the highest level since Dec. 31, 1993, the agency said.”

So far this year 84 FDIC insured banks have failed. With the FDIC’s funds to support bank failures fast approaching zero, it is highly likely that the FDIC itself will have to be bailed out in 2010. Who knows what type of black swan might show up to feast at a FDIC bailout?

While time and space do not permit a full listing of the potential back swans that 2010 may well bring to our weakened economy you can be assured that 2010 has a good chance of being a black swan heaven and an investors hell. 2010 ten has a real chance of surpassing 2008 as a prime year for black swans. Should a record number of black swans be recorded in 2010, however, the record may not last very long. With another round of mortgage resets peaking in 2011 the hell caused by black swans may be with us for a very long time.

Black Swans love to be underestimated. As uninvited guests it seems that they can wreck their havoc in spite of our best efforts to set up defenses. The challenge is to defend against what? Black swans arrive suddenly, attack spots that we don’t even realize are weak, and cause unforeseen consequences. The defenses we established often work against us and become their allies.

2010 is all too near. We had better brace ourselfs for a financial feast of the black swans.

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