March 27, 2008 | posted by Michael Baxter in credit crunch | comments (1) |

Maybe it’s time to take stock.  Stand back from all the recent hullabaloo, and take an objective look at what has been going on during the last few months.

We keep hearing that we are experiencing a crisis made in America, and it is down to reckless subprime lending,  but is that really the problem?  Today we try to  look beneath the surface and attempt to put the mass of news and data and speculation that has done the rounds of late into context.

But before we get going consider this:  When London’s mayor Ken Livingstone was in New York a couple of years ago he was asked why London was enjoying such a boom.  He replied “two words, Sarbanes Oxley.”   In the wake of the collapse of Enron and WorldCom, regulators in the US overreacted.  They imposed an absurdly tight regime of regulations and New York suffered.

The economy is a hugely complex beast.  Economic history has been littered with crises – but they have never been the same.     Some believe we can understand the present and predict the future by examining the past, but that is just not true.   The future is unpredictable, change the only constant.

Well, actually, there is an exception to that rule.   Mark Twain once said, “History doesn’t repeat itself, but it rhymes.”   Maybe be the rhyming is provided by the one thing that never changes, and that is human nature.  Travel back into the past, travel to the other side of the world – look at people from the world’s religions,  and there is one thing that is the same, human nature.

And one aspect of this constant known as human nature, is our tendency to overreact.   We always have done, we always will.

During the down point of the Russian crisis in 1998, the entire Russian stock market was valued less then Sainsbury’s.    Markets had overreacted.

Take as another example, the dotcom crash.  One moment, companies were jumping over each other to move into the dotcom world, the next moment, Internet investing had become a dirty word.    During the early years of this decade, dotcom business became a joke.  Online shopping was dismissed by many as a no-hoper,  online advertising,  as a non-starter.  Yet we now know, the negative sentiment of the early noughties was just as inappropriate as the hype of the late ‘90s.

Earlier this decade, stock market indices plunged.    The FTSE 100 went close to 3000 points – and new solvency rules forced pension funds to sell their investments in equities just as the market appeared to be nearing bottom, and in the process created a new bottom.

Fortunes were made during this period.    Google’s early backers made a mint, Russian oligarchs were fashioned when the Russian economy was in chaos.  Investors who thought ahead and put money into mainstream stock markets three years or so ago, made a fortune.

Conversely, investors who refused to run with the pack when the overreaction was in the direction of hope, also made it big.  Joseph Kennedy, the father of the late president ensured fame for life when he sold his stocks in 1929 after a taxi driver asked for his advice on what shares to buy.  The father of the United State’s most famous political dynasty reasoned that if taxi drivers had entered the buying-frenzy market, then it was clear things had gone too far.

Yet history is also littered with individuals who just could not see the inevitable fate awaiting a bull market.     The most spectacular example is Sir Isaac Newton, who got caught up in the investment bubble of his day.      He had invested heavily into the South Sea craze of that time, reasoned the market had risen too much and bravely sold.      He then watched in horror as the market continued to rise and he bought back in, only to then see the bubble burst.   Sir Isaac had forgotten that what goes up, comes down, and lost £20,000 in the process – a fortune for those days.

If you can be sure of one thing in the current economic panic, it is this.  The panic will go too far.  It will overcorrect.   And that’s where opportunity sits.

March 27, 2008 | posted by Michael Baxter in credit crunch | comments (0) |

In the 1930s of course the overreaction went too deep.     Hope was zapped from ordinary men and women workers.     And the government didn’t know what to do.    The then president Franklin D. Roosevelt implemented the New Deal, and took the advice of the great economist of that era, Keynes, and tried to push hope back into the economy.  It only partially worked. Some say he didn’t go far enough, and that it ironically took World War II, and the resulting massive surge in government spending, to lift the economic gloom.

But, while the US failed to grapple with the underlying problems of the 1930s, the lessons remained for today, and one academic man in particular made it his business to understand the crisis of that era in as much detail as possible.  This academic’s name is Ben Bernanke.  It is all rather fortuitous, because today, Bernanke is the chairman of the Fed – the most powerful central banker in the world – and upon his shoulders rests the responsibility of ensuring the US suffers no 1930s-style depression.

Many laugh off the idea that the US could face depression.  They even dismiss with scorn the idea the US could follow Japan and experience a lost decade.    Bernanke himself has insisted that there will be no 1930s-style depression.

Yet look at his policies.  At a time of surging inflation, he is cutting interest rates at an extraordinary pace.  Rates have fallen from 5.25 per cent to 2.25 per cent in less than six months.    It’s unprecedented. Meanwhile, the Fed has been pumping money into the economy,  it has even taken on bank mortgage debt, and lent against it.   He may be telling us there is no 1929/1930s crisis in the offing, but Bernanke’s actions belie his words. 

Many say the root cause of the current crisis is too much debt, and yet Bernanke is dealing with the crisis by trying to tempt us into borrowing.

We said above that each economic crisis in history is different. The danger is that Bernanke, by putting into practice all the solutions to economic crisis he learned from his studies, could be making things worse.

The causes of the current crisis are surely quite different from the factors that caused the 1930s depression.    

Actually, the policies Mr Bernanke is pushing are quite similar to those employed by his predecessor Alan Greenspan, who also dealt with economic crisis by slashing interest rates.       But many say it was the policies of Greenspan that created the current financial mess.  Earlier this year Patrick Artus, one of France’s most influential economists, said Greenspan was a “very bad” Fed chairman. In an interview with Bloomberg he said, “Greenspan was an arsonist and a fireman combined.” 

There is a danger that Benrnanke is trying to solve the current crisis by pouring the nearest liquid to hand over the subprime fire.  But it is possible the metaphorical liquid he has so rapidly reached for is the equivalent of petrol.