Europe has reached acute danger point.

Failure to save East Europe will lead to worldwide meltdown
The unfolding debt drama in Russia, Ukraine, and the EU states of Eastern Europe has reached acute danger point.

By Ambrose Evans-Pritchard
Last Updated: 2:05AM GMT 15 Feb 2009

Comments 91 Comment on this article

If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East.

Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Stephen Jen, currency chief at Morgan Stanley, said Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.

"This is the largest run on a currency in history," said Mr Jen.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.

Under a "Taylor Rule" analysis, the European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

But I digress. It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, told me the region may need €400bn in help to cover loans and prop up the credit system.

Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights.

Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

"This is much worse than the East Asia crisis in the 1990s," said Lars Christensen, at Danske Bank.

"There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU."

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter.

If Deutsche Bank is correct, the economy will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt.

The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

So we watch and wait as the lethal brush fires move closer.

If one spark jumps across the eurozone line, we will have global systemic crisis within days. Are the firemen ready?

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4623525/Failure-to-save-East-Europe-will-lead-to-worldwide-meltdown.html

Europe's leaders need to wake up to their own recession

Europe's leaders need to wake up to their own recession
French and German leaders have repeatedly called for an overhaul of the global financial system.

By Pierre Briançon, breakingviews.com
Last Updated: 1:09PM GMT 13 Feb 2009

In spite of a poor personal relationship and differences on many other matters, Nicolas Sarkozy and Angela Merkel seem to agree on what the French president calls "the reform of capitalism". Calls for more regulation on banks, hedge funds, rating agencies, short-selling or tax heavens - to name only a few - play well in both Paris and Berlin.

There's a bit of schadenfreude in continental Europe at the crisis of the now much-criticised "Anglo-Saxon" model. That's understandable, after years of being talked down to by the model's practitioners and leading beneficiaries in the City and Wall Street - even though French and German banks tried hard to play with the big boys. But European leaders understandably want to seize the moment to push for greater coordination of global rules, so that tighter regulations in one country won't be undercut by deregulation in another.

Global reforms are certainly desirable, but regulation should not be at the top of the European agenda right now. There are more pressing matters.

The recession is deepening throughout the continent and governments have failed to come up with credible stimulus packages. Germany's GDP is expected to contract by some 2pc this year, France's by more than 1pc. EU members have responded with some sensible ideas, but many are tempted by the dangerous sirens of protectionism and economic nationalism - most recently demonstrated by the French auto industry bailout plan.

This weekend's meeting of finance ministers from the G7 group of industrialised countries in Rome will be the first opportunity for European finance ministers to meet Tim Geithner, their new US colleague. Instead of trying to put regulation on top the agenda, the Europeans should focus on the deepening recession.

Without sensible and coordinated policies to share the economic pain and get the financial system back in operation, the bad times could become much worse. If governments don't rise to the urgent economic and financial challenges, they may find there won't be much left to regulate.

For more agenda-setting financial insight, visit www.breakingviews.com


http://www.telegraph.co.uk/finance/breakingviewscom/4611966/Europes-leaders-need-to-wake-up-to-their-own-recession.html

Bond market calls Fed's bluff as global economy falls apart

Bond market calls Fed's bluff as global economy falls apart
Global bond markets are calling the bluff of the US Federal Reserve.

By Ambrose Evans-Pritchard
Last Updated: 7:22PM GMT 08 Feb 2009

Comments 80 Comment on this article

The yield on 10-year US Treasury bonds – the world's benchmark cost of capital – has jumped from 2pc to 3pc since Christmas despite efforts to talk the rate down.

This level will asphyxiate the US economy if allowed to persist, as Fed chair Ben Bernanke must know. The US is already in deflation. Core prices – stripping out energy – fell at an annual rate of 2pc in the fourth quarter. Wages are following. IBM, Chrysler, General Motors, and YRC, have all begun to cut pay.

The "real" cost of capital is rising as the slump deepens. This is textbook debt deflation. It was not supposed to happen. The Bernanke doctrine assumes that the Fed can bring down the whole structure of interest costs, first by slashing the Fed Funds rate to zero, and then by making a "credible threat" to buy Treasuries outright with printed money.

Mr Bernanke has been repeating this threat since early December. But talk is cheap. As the Fed hesitates, real yields climb ever higher. Plainly, the markets do not regard Fed rhetoric as "credible" at all.

Who can blame bond vigilantes for going on strike? Nobody wants to be left holding the bag if and when the global monetary blitz succeeds in stoking inflation. Governments are borrowing frantically to fund their bail-outs and cover a collapse in tax revenue. The US Treasury alone needs to raise $2 trillion in 2009.

Where is the money to come from? China, the Pacific tigers and the commodity powers are no longer amassing foreign reserves ($7.6 trillion). Their exports have collapsed. Instead of buying a trillion dollars of extra bonds each year, they have become net sellers. In aggregate, they dumped $190bn over the last fifteen weeks.

The Fed has stepped into the breach, up to a point. It has bought $350bn of commercial paper, and begun to buy $600bn of mortgage bonds. That helps. But still it recoils from buying Treasuries, perhaps fearing that any move to "monetise" Washington's deficit starts a slippery slope towards an Argentine fate. Or perhaps Bernanke doesn't believe his own assurances that the Fed can extract itself easily from emergency policies when the cycle turns.

As they dither, the world is falling apart. Events in Japan have turned deeply alarming. Exports fell 35pc in December. Industrial output fell 9.6pc. The economy is contracting at an annual rate of 12pc. "Falling exports are triggering a downward spiral of production, incomes and spending. It is important to prepare for swift policy steps, including those usually regarded as unusual," said the Bank of Japan's Atsushi Mizuno.

The bank is already targeting equities on the Tokyo bourse. That is not enough for restive politicians. One bloc led by Senator Koutaro Tamura wants to create $330bn in scrip currency for an industrial blitz. "We are facing hyper-deflation, so we need a policy to create hyper-inflation," he said.

This has echoes of 1932, when the US Congress took charge of monetary policy. We are moving to a stage of this crisis where democracies start to speak – especially in Europe.

The European Central Bank's refusal to follow the lead of the US, Japan, Britain, Canada, Switzerland and Sweden in slashing rates shows how destructive Europe's monetary union has become. German orders fells 25pc year-on-year in December. French house prices collapsed 9.9pc in the fourth quarter, the steepest since data began in 1936. "We're dealing with truly appalling data, the likes of which have never been seen before in post-War Europe," said Julian Callow, Europe economist at Barclays Capital.

Spain's unemployment has jumped to 3.3m – or 14.4pc – and will hit 19pc next year, on Brussels data. The labour minister said yesterday that Spain's economy could not "tolerate" immigrants any longer after suffering "hurricane devastation". You can see where this is going.

Ireland lost 36,500 jobs in January – equal to a monthly loss of 2.3m in the US. As the budget deficit surges to 12pc of GDP, Dublin is cutting wages, disguised as a pension levy. It has announced "Rooseveltian measures" to rescue the foundering companies.

The ECB's obduracy has nothing to do with economics. It fears zero rates as a vampire fears daylight, because that brings the purchase of eurozone bonds ever closer into play. Any such action would usher in an EMU "debt union" by the back door, leaving Germany's taxpayers on the hook for Club Med liabilties. This is Europe's taboo.

Meanwhile, Eastern Europe is imploding. Industrial output fell 27pc in Ukraine and 10pc in Russia in December. Latvia's GDP contracted at a 29pc annual rate in the fourth quarter. Polish homeowners have had the shock from Hell. Some 60pc of mortgages are in Swiss francs. The zloty has halved against the franc since July.

Readers have berated me for a piece last week – "Glimmers of Hope" – that hinted at recovery. Let me stress, I was wearing my reporter's hat, not expressing an opinion. My own view, sadly, is that there is no hope at all of stabilizing the world economy on current policies.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4560901/Bond-market-calls-Feds-bluff-as-world-falls-apart.html

WEF 2009: Global crisis 'has destroyed 40pc of world wealth'

WEF 2009: Global crisis 'has destroyed 40pc of world wealth'

The past five quarters have seen 40pc of the world's wealth destroyed and business leaders expect the global economic crisis can only get worse.

By Edmund Conway in Davos
Last Updated: 5:42AM GMT 29 Jan 2009

Steve Schwarzman, chairman of private equity giant Blackstone, said an "almost incomprehensible" amount of cash had evaporated since the financial crisis took hold.
"Business will be very different," he added.
His comments came on a day of the World Economic Forum characterised by the gloom of its participants and warnings that the crisis will endure for some time. News Corp chief executive Rupert Murdoch kicked off the meetings by warning that the atmosphere was worsening – despite global economic confidence plumbing the lowest depths on record.
"The crisis is getting worse," he said. "It's going to take drastic action to turn it around, if it can be turned around, quickly. I believe it will take a long time."
Executives participating in an economic brainstorming session said that despite the trauma caused by the economic and financial problems, another crisis at some point in the future was inevitable.
Sir Howard Davies, director of the London School of Economics and a former Bank of England policymaker said: "The outlook is pretty grim. Things are not good and business surveys are coming out showing they're getting even worse."

http://www.telegraph.co.uk/finance/financetopics/davos/4374492/WEF-2009-Global-crisis-has-destroyed-40pc-of-world-wealth.html

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Asia needs to fully wake up to the scale of the West's economic crisis

Asia needs to fully wake up to the scale of the West's economic crisis
Asia is not going to rescue the world economy.

By Ambrose Evans-Pritchard Last Updated: 10:06AM GMT 04 Jan 2009
Comments 28 Comment on this article

The news from Japan, China, and the Pacific tigers has moved from awful to calamitous since the global industrial system snapped in October.
A raw reality is being laid bare. The mercantilist export model of the East is proving dangerously geared to the debt-driven excesses of the West. As we go down, they go down too. Some are going down even harder.
Japan's industrial output contracted by 16.2pc in November, year-on-year. "For an economy which lives from the prowess of its industrial exports, this is simply earthquake," said Edward Hugh from Japan Economy Watch.
Japanese exports fell 26.7pc. Real wages fell by 3.1pc, the seventh monthly fall. Taken together, the figures are worse than anything during Japan's "Lost Decade". They have a ring of 1931.
The fall-out in Japan has already shattered the authority of premier Taro Aso. His approval rating has dropped to 21pc. The cabinet is in revolt. The world's second biggest economy no longer has a functioning government.
Credit Suisse warns that Japan could slide into deflation of minus 2pc by the autumn. Since interest rates are already near zero, which means that real rates will rise as the slump deepens – the surest path to a liquidity trap.
Kyohei Morita from Barclays Capital estimates that Japan's GDP shrank at an annual rate of 12.2pc in the fourth quarter. "It's shocking," he says. Singapore has already reported. Fourth-quarter GDP contracted at an 12.5pc annual rate.
Taiwan's exports fell 28pc in November. Shipments to China dropped 45pc. Korea's exports dropped 18pc in November and 17pc in December.
"We are looking right in the face of an unprecedented regional depression," said Frank Veneroso, the investment guru.
"If there is one part of the global disaster that is not reflected in today's massacred markets it is this Asian debacle. The source of the collapse appears to be above all a contraction in China."
One has to careful with Chinese figures. When I covered Latin America in the 1980s, veteran analysts watched electricity use to gauge economic growth since they could not trust official data. It is striking that China's power output fell 7pc in November.
Asia has clearly failed to use the fat years to break its dependency on the West. It has stuck doggedly to its export strategy – by holding down currencies, or by subtle policy bias against consumption.
In China's case it has let the wage share of GDP drop from 52pc to 40pc since 1999, according to the World Bank.
The defenders of this dead-end strategy are now coming up with astonishing proposals to put off the day of reckoning. Akio Mikuni, head of Japan's credit agency Mikuni, has called for a "Marshall Plan" to bail out America by cancelling $980bn of US Treasury bonds held by the Japanese state.
This debt jubilee does have the merit of creative thinking, but it is entirely designed to keep the old game going. "US households won't have access to credit they have enjoyed in the past. Their demand for all products, including imports, will suffer unless something is done," he said.
Let me be clear. I make no moral judgment on the "neo-Confucian" model, nor – heaven forbid – do I defend the debt depravity of the West.
A stale debate simmers over whether the Great Bubble was caused by Anglo-Saxon and Club Med hedonism, or by an Asian "Savings Glut" spilling into global bond markets and fuelling asset booms, as Washington claims. It was obviously a mix.
Two cultural systems interacted through globalisation, locking each other into a funeral dance.
The point is that this experiment has now blown up. Whether or not we slam straight into a global depression depends on how we – East, West, all of us – handle this.
The top sources of net global demand as measured by current account deficits over the last 12 months have been the US ($697bn), Spain ($166bn), Italy ($71bn), France ($57bn) Australia ($57bn), Greece (53bn), Turkey ($47bn), and Britain ($46bn).
Most are tightening their belts drastically, and in the case of Britain the shift has been so swift that the arch-sinner may soon be in surplus. If they are draining world demand, then world demand is going to collapse unless others step into the breach.
The surplus states – China ($378bn), Germany ($266bn) Japan ($176bn) – have not yet done so, which is why the global economy went off a cliff in October, November, and December. Beijing is planning a $600bn fiscal blitz.
But how much of it is an unfunded wish-list sent to local party bosses? It will not kick in until the middle of the year, an eternity away.
For now, China is dabbling with protectionism to gain time – a risky move for the top surplus country. It has let the yuan fall to the bottom of its band. Vietnam has devalued. Thailand and Taiwan are buying dollars.
Watching uneasily, the Asian Development Bank has warned against moves to "depreciate domestic currencies".
Anger is mounting in the West. Alstom chief Philippe Mellier has called for a boycott of Chinese trains.
"The Chinese market is gradually shutting down to let the Chinese companies prosper. There's no reciprocity any more," he told the Financial Times. Optimists say the collapse in oil prices will give Asia a shot in the arm. Governments are still flush, with ample scope for fiscal rescues. Asia's central banks are sitting on $4.1 trillion of reserves.
They have the means, perhaps, but do they have the will to act in time? Or do Beijing, Tokyo, Taipei, Kuala Lumpur, – and indeed Berlin – still cling to their assumption that others will spend for them?

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4093676/Asia-needs-to-fully-wake-up-to-the-scale-of-the-Wests-economic-crisis.html


Also read:
Decoupling dies as half the globe hits crunch
http://www.telegraph.co.uk/finance/markets/2820887/Decoupling-dies-as-half-the-globe-hits-crunch.html

Financial crisis: Everything you need to know

Financial crisis: Everything you need to know about the meltdown but were afraid to ask.
Who got us into this mess, what did they think they were doing, and how do we get out of it?

By Emma SimonLast Updated: 4:04PM BST 13 Oct 2008

A trader in Frankfurt reacts to the latest turmoil in the markets Photo: REUTERS
Q: How have the banks got into this situation?
A: The problems started with the now notorious sub-prime mortgages in America. Banks granted home loans to people who had little chance of repaying them, but then sold these debts on to other banks, often packaged up with other less risky debts. Invariably these debts, and other high-risk securities, were sold on again. But then it became apparent that some of these loans would not be repaid, and banks were left holding "toxic'' debts.
More worryingly, banks were now unsure which institutions were most exposed to these bad investments, and drew back from lending to each other, amid concerns that the money would not be repaid if a bank failed.
The collapse of Lehman Brothers, the US investment bank, last month intensified this fear and effectively paralysed global money markets. Since then, central banks and governments have been hatching plans to restore liquidity and confidence in the banking system, so oiling the wheels of capitalism again.
Q: Why do banks need to lend to and borrow from each other?
A: Most people assume that banks work on that old-fashioned notion of only lending out the money taken in on deposit. But this rarely happens today. The money taken in as savings is invested in the money markets - in other words, lent to other banks for the best possible rate. Banks then borrow from these same markets and sell on this money, at a premium, to customers in the form of mortgages and personal loans.
If banks are unable to borrow from each other, and from these money markets, then they are unlikely to be able to offer competitive borrowing deals for consumers, and we may have to go back to the days when mortgages were "rationed'' and depended solely on deposits.
This also explains why banks would be unable to repay savers if these decided en masse to empty their accounts. Such a run on a bank can drive a profitable institution to the brink, potentially taking savers' money with it.
Q: So is my money safe in the bank?
A: Before Northern Rock collapsed a year ago, few people would have worried about the safety of their money in a British bank or building society. But with Northern Rock, Bradford & Bingley, HBOS and now Icesave running into difficulties, the security of our savings has become more important than the interest rates they earn.
Despite these problems, savers have yet to lose a penny. The closest savers have come to losing out has been with Icesave, a subsidiary of the Icelandic Landsbanki Bank. British savers saw their money frozen, and there were fears that the Icelandic compensation scheme would not pay out. But Alistair Darling, the Chancellor, confirmed that the Government will reimburse savers in full through the Financial Services Compensation Scheme (FSCS).
Q: Are all savings guaranteed?
A: No. The Government has been careful not to offer a blank cheque underwriting the nation's savings in full. It was only able to make this pledge to Icesave's UK savers because of the "exceptional'' economic circumstances.
Given the market volatility, savers should ensure that they have no more than £ 50,000 with any one bank, as this is the maximum that is guaranteed to be protected under the FSCS. This limit often applies to all brands offered by one banking group.
Take care with foreign-owned institutions, as very often you will have to reclaim the first euro20,877 (£ 16,500) from an overseas compensation scheme. If you are nervous, then stick with the UK, where at least as a vote-wielding citizen your money should be the top priority for the authorities.
Q: Why are share prices still falling? Has the Government bail-out failed?
A: Last week the Government unveiled a £ 500 billion rescue package for British banks. This trumped the US rescue plan in both size and scope, pumping liquidity and capital into our struggling banking system.
Although the plan is complex, at its core are three main policies:

• to offer extended borrowing facilities so that banks can access funds from the Bank of England;


• to recapitalise banks by injecting money directly into them in exchange for a stake in the bank; and


• to guarantee all new debt issued by banks, effectively making their corporate bonds as safe as Government-backed gilts.

But these radical measures failed to stem the stock-market rout, and bank share prices continued to head south.
This does not necessarily mean the bail-out has failed. The Government will argue that this is a long-term plan to put the banks on a firmer financial footing. Yesterday's pledge by G7 finance ministers to pump public money into banks to prevent their collapse could also translate into a recovery in share prices.
Q: So what is spooking investors? Is there much worse news to come?
A: It isn't just a lack of confidence in the banks that is driving share prices downwards. Fears of a recession are causing shares to be sold off in many companies. In a recession, consumer spending, already down, will dip further. This will affect companies' profits.
There are also fears that recession and unemployment could lead to more toxic debt. It is not just sub-prime mortgages: credit card debt and car finance deals may also have to be written off if consumers can no longer meet repayments.
Q: The credit crunch has been around for a year - why did it get so much worse this week?
A: Panic is breeding panic. The fact that the much-lauded rescue plans, coupled with a global interest-rate cut, have done little to staunch the rout may have raised the fear factor, as it is clear that Government and banks have little else to throw at the problem.
Q: The Government pumped money into the system before. Why didn't this work, and why do they think more money now will do the trick?
A: The Government already had a £ 100 billion Special Liquidity Scheme in place which allowed banks to borrow from the Bank of England. This has been doubled in the hope that, by giving banks access to more money, they will start lending to consumers again.
Q: This is an extraordinary amount of money. Are we going to have to pay more tax as a result?
A: This plan puts taxpayers' money at risk, but will not necessarily mean they lose out. If the plan revives banking fortunes then the Government could make money for taxpayers by having bought into the banks at such a low ebb. The money lent to them through the liquidity scheme will also have to be paid back. But if it doesn't work, we could be paying for generations, through higher taxes or cuts in public spending.
Q: Why should we pay more tax to save the banks? They got themselves into this mess.
A: It is not hard to see why this rescue package has been so controversial. Many people wince at public money being used to bail out an industry that has shown little restraint in pay and bonuses. But without this help, more banks would fail, causing misery for all. Bank collapses could put savers' money at risk; reimbursing that could cost the taxpayer far more.
Q: How far can share prices fall?
A: This is the billion-dollar question. Following the bubble in technology stocks in the late 1990s, the FTSE 100 share price index peaked at 6,950 in December 1999, before falling to a low of 3,287 in March 2003. We are still marginally above this point. However, the factors driving this crash are different and prices could head still lower.
Q: Is it too late to get out now?
A: If you have left it this late to get out of the market, it is probably too late and you are just crystallising large losses. Experts' advice is to wait for recovery, which will - eventually - come.
Q: Will shares just bounce back?
A: We have no way of knowing what the recovery will be like. In the 2003 crash, share prices recovered swiftly. But many experts are drawing parallels with the 1930s or 1970s, when recession stalled a recovery for years. There is also the salutary lesson of Japan. In December 1989, the Nikkei index peaked at 39,000 before suffering a catastrophic loss, sparked by a banking crisis. Today, almost 20 years later, it stands at just about 8,000.
Q: I don't own shares. Why should I care about the stock market?
A: You probably have investments that are exposed to equities, be it a pension, unit-linked savings, an endowment, trust fund or savings bond. Their value will have fallen by roughly a third over the past year, depending on what shares your plan is invested in. A stock-market collapse will also deepen a recession, resulting in job cuts.
Q: Why is my mortgage rate still high when base rates have been cut?
A: Many British banks have passed on this interest-rate cut, but there have been exceptions, including Abbey, Nationwide and HSBC. Most banks are not re-pricing new mortgage deals, because these are largely based on Libor - the inter-bank lending rate - and this has remained stubbornly high.



http://www.telegraph.co.uk/finance/personalfinance/3187716/Financial-crisis-Everything-you-need-to-know-about-the-meltdown-but-were-afraid-to-ask..html

World's burst-bubble economy

Reviving the world's burst-bubble economy seems further away than ever
In the US and in Ireland, governments have been scrambling again to support their banks.

By Ian Campbell, breakingviews.com

Last Updated: 6:25PM GMT 16 Jan 2009


For the economic prospects of these countries, and the world economy, that is troubling. Recession is only just beginning and yet many banks are holed.
Governments are being obliged to pour in more capital, adding to the huge liabilities they now face. This vicious circle augurs poorly for recovery.
It is not that governments should avoid intervening in banks. They are obliged to. To put public money into the banking system is the right thing to do because neither national economies nor the world can afford the collapse of large financial institutions.
Moreover, fresh losses at banks will make them more risk-averse and less inclined to lend into the economy, excerbating the recession. Economic recovery needs credit and the banks need economic recovery.
To restore their financial positions, banks must continue the retreat from high leverage and risk. But the large amounts of public money poured into them do not automatically mean they will be quick to lend more.
At present, neither is in a strong position to help the other. On the contrary, recession and low-growth risk are creating further asset losses for banks - and further recourse to government budgets already under huge strain.
Had Anglo Irish Bank become insolvent, the Irish government, whose fiscal deficit is already heading towards double digits, would have been liable for some 100bn euros in deposits - about half of Ireland's GDP.
The Irish government has guaranteed deposits in all its banks but could not afford to honour that guarantee without issuing debt that would far exceed the country's GDP. It is improbable anyone would want to buy it. Nor can Ireland resort to the money printing press for funding, as the US and UK governments may eventually do. Ireland no longer has its own pounds to print.
The worst afflicted banks are in countries which have experienced property price bubbles, like the US and Ireland. But as recession bites, more loans in more sectors and in more countries may turn bad.
All this makes it likely that governments will be forced to print more money. At present, central banks are buying financial assets but not directly funding governments. Before long, however, they may be forced along that sorry path - the same one traveled in the past from Argentina to Zimbabwe.
It's not yet the time. But monetising bad debt and devaluing paper money may in the end be the only way of reviving the world's burst-bubble economy.



http://www.telegraph.co.uk/finance/breakingviewscom/4272951/Reviving-the-worlds-burst-bubble-economy-seems-further-away-than-ever.html

The 2007-08 Financial Crisis In Review

The 2007-08 Financial Crisis In Review
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What Causes A Currency Crisis?
Top 5 Signs Of A Credit Crisis

When the Wall Street evangelists started preaching "no bailout for you" before the collapse of British bank Northern Rock, they hardly knew that history would ultimately have the last laugh. With the onset of the global credit crunch and the fall of Northern Rock, August 2007 turned out to be just the starting point for big financial landslides. Since then, we have seen many big names rise, fall, and fall even more. In this article, we'll recap how the financial crisis of 2007-08 unfolded. (For further reading, see Who Is To Blame For The Subprime Crisis?, The Bright Side Of The Credit Crisis and How Will The Subprime Mess Impact You?)

Before the Beginning

Like all previous cycles of booms and busts, the seeds of the subprime meltdown were sown during unusual times. In 2001, the U.S. economy experienced a mild, short-lived recession. Although the economy nicely withstood terrorist attacks, the bust of the dotcom bubble, and accounting scandals, the fear of recession really preoccupied everybody's minds. (Keep learning about bubbles in Why Housing Market Bubbles Pop and Economic Meltdowns: Let Them Burn Or Stamp Them Out?)

To keep recession away, the Federal Reserve lowered the Federal funds rate 11 times - from 6.5% in May 2000 to 1.75% in December 2001 - creating a flood of liquidity in the economy. Cheap money, once out of the bottle, always looks to be taken for a ride. It found easy prey in restless bankers - and even more restless borrowers who had no income, no job and no assets. These subprime borrowers wanted to realize their life's dream of acquiring a home. For them, holding the hands of a willing banker was a new ray of hope. More home loans, more home buyers, more appreciation in home prices. It wasn't long before things started to move just as the cheap money wanted them to.

This environment of easy credit and the upward spiral of home prices made investments in higher yielding subprime mortgages look like a new rush for gold. The Fed continued slashing interest rates, emboldened, perhaps, by continued low inflation despite lower interest rates. In June 2003, the Fed lowered interest rates to 1%, the lowest rate in 45 years. The whole financial market started resembling a candy shop where everything was selling at a huge discount and without any down payment. "Lick your candy now and pay for it later" - the entire subprime mortgage market seemed to encourage those with a sweet tooth for have-it-now investments. Unfortunately, no one was there to warn about the tummy aches that would follow. (For more reading on the subprime mortgage market, see our Subprime Mortgages special feature.)

But the bankers thought that it just wasn't enough to lend the candies lying on their shelves. They decided to repackage candy loans into collateralized debt obligations (CDOs) and pass on the debt to another candy shop. Hurrah! Soon a big secondary market for originating and distributing subprime loans developed. To make things merrier, in October 2004, the Securities Exchange Commission (SEC) relaxed the net capital requirement for five investment banks - Goldman Sachs (NYSE:GS), Merrill Lynch (NYSE:MER), Lehman Brothers, Bear Stearns and Morgan Stanley (NYSE:MS) - which freed them to leverage up to 30-times or even 40-times their initial investment. Everybody was on a sugar high, feeling as if the cavities were never going to come.

The Beginning of the End

But, every good item has a bad side, and several of these factors started to emerge alongside one another. The trouble started when the interest rates started rising and home ownership reached a saturation point. From June 30, 2004, onward, the Fed started raising rates so much that by June 2006, the Federal funds rate had reached 5.25% (which remained unchanged until August 2007).

Declines Begin
There were early signs of distress: by 2004, U.S. homeownership had peaked at 70%; no one was interested in buying or eating more candy. Then, during the last quarter of 2005, home prices started to fall, which led to a 40% decline in the U.S. Home Construction Index during 2006. Not only were new homes being affected, but many subprime borrowers now could not withstand the higher interest rates and they started defaulting on their loans.

This caused 2007 to start with bad news from multiple sources. Every month, one subprime lender or another was filing for bankruptcy. During February and March 2007, more than 25 subprime lenders filed for bankruptcy, which was enough to start the tide. In April, well-known New Century Financial also filed for bankruptcy.

Investments and the Public
Problems in the subprime market began hitting the news, raising more people's curiosity. Horror stories started to leak out.

According to 2007 news reports, financial firms and hedge funds owned more than $1 trillion in securities backed by these now-failing subprime mortgages - enough to start a global financial tsunami if more subprime borrowers started defaulting. By June, Bear Stearns stopped redemptions in two of its hedge funds and Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds. But even this large move was only a small affair in comparison to what was to happen in the months ahead.

August 2007: The Landslide Begins

It became apparent in August 2007 that the financial market could not solve the subprime crisis on its own and the problems spread beyond the United State's borders. The interbank market froze completely, largely due to prevailing fear of the unknown amidst banks. Northern Rock, a British bank, had to approach the Bank of England for emergency funding due to a liquidity problem. By that time, central banks and governments around the world had started coming together to prevent further financial catastrophe.

Multidimensional Problems

The subprime crisis's unique issues called for both conventional and unconventional methods, which were employed by governments worldwide. In a unanimous move, central banks of several countries resorted to coordinated action to provide liquidity support to financial institutions. The idea was to put the interbank market back on its feet.

The Fed started slashing the discount rate as well as the funds rate, but bad news continued to pour in from all sides. Lehman Brothers filed for bankruptcy, Indymac bank collapsed, Bear Stearns was acquired by JP Morgan Chase (NYSE:JPM), Merrill Lynch was sold to Bank of America, and Fannie Mae and Freddie Mac were put under the control of the U.S. federal government.

By October 2008, the Federal funds rate and the discount rate were reduced to 1% and 1.75%, respectively. Central banks in England, China, Canada, Sweden, Switzerland and the European Central Bank (ECB) also resorted to rate cuts to aid the world economy. But rate cuts and liquidity support in itself were not enough to stop such a widespread financial meltdown.

The U.S. government then came out with National Economic Stabilization Act of 2008, which created a corpus of $700 billion to purchase distressed assets, especially mortgage-backed securities. Different governments came out with their own versions of bailout packages, government guarantees and outright nationalization.

Crisis of Confidence After All

The financial crisis of 2007-08 has taught us that the confidence of the financial market, once shattered, can't be quickly restored. In an interconnected world, a seeming liquidity crisis can very quickly turn into a solvency crisis for financial institutions, a balance of payment crisis for sovereign countries and a full-blown crisis of confidence for the entire world. But the silver lining is that, after every crisis in the past, markets have come out strong to forge new beginnings.

To read more about other recessions and crises, see A Review Of Past Recessions.

by Manoj Singh, (Contact Author Biography)
Manoj Singh is a central banker and a freelance writer. Apart from writing for Investopedia, he and his spouse write a weekly column on economics and finance for a financial daily.http://www.investopedia.com/articles/economics/09/financial-crisis-review.asp

http://www.investopedia.com/articles/economics/09/financial-crisis-review.asp

The Survival of the Longest

10/17/2008 Safehaven The Survival of the Longest…


October 14, 2008
The Survival of the Longest
by Thomas Tan

What a week! What a month! S&P 500 started around $1,250 a month ago, was as high as $1,200 at some point two weeks ago, no one had ever imagined it could drop below $850 last Friday. I gave out $800 target in August last year at one of my old articles, which S&P 500 is on its way to test now. It was an easy target to give since it was the low of the 2001-2003 bear market. Even the market is quite oversold, and due to for a dead cat bouncing, I doubt now $800 will be the bottom for the bear market, and there is no support whatsoever in sight once $800 is decisively broken, until around $4-500.

After the 1987 crash, government has implemented the so-called circuit breaker system which they hope would prevent a one-day crash of 20%. However, people are always smarter than the system and will always find a way to get around it. Instead of dropping 20% in one day, let us do it 5% a day on average, and easily beat the 20% record in 1987 by a wide margin last week. The next thing government can try is market holiday(s) and eventually bank holidays like in 1930s.

Early this year, Jeremy Grantham of GMO predicted at his interview with Barron's that S&P 500 would drop to $1,100 by 2010. A lot of people just laughed at him, was this crazy old man out of his mind? Now it is like Hamlet's last line 'all rest is silence'. We always should listen to an old man who has experienced the nifty-fifty losing 80% of their market value in 1970s, and has studied extensively the great depression of 1930s. He probably regrets now that his $1,100 target given was too conservative. Actually now $1,100 becomes an important resistance point for the upcoming dead cat bouncing or bear market rally.

Jeremy derived his $1,100 target with a more normalized P/E of 11-12 as a norm for a very long term capital market. If I use the more representative bear market P/E value of 6-7, I would come up with a target of around $600-$700 range. At the extreme of this bear market a few years down the road, S&P 500 might very well overshoot and drop all the way to the $400 level, which is the launch pad for last leg of the past bull market after early 1990s recession. Everything is back to square one and 20 year's return of bull market turns out to be in vain.

How long will this bear market last? Well, 1930s great depression caused a bear market lasting over 2 decades, from 1929 to 1952. It was only until 1958 that market came back to the old 1929 peak, 3 decades later. And 1970s was not much better, lasting 14-16 years from 1966 or 1968 to 1982. Even bear market ended quicker for 1970s, it was until 1992 or 24 years later to reach 1968 peak. My most optimistic forecast is it will last another 4-5 years from now, or about 12 years if we count year 2000 as the starting point. If we use the commodity super-cycle by Jim Rogers, which usually runs opposite to the general equity market and lasts until 2020 as Jim predicts, it will be also a 2 decade
bear market for equities, consistent with both 1970s and 1930s. When will S&P 500 be back to last October peak? At least 24 years from 2000, or 2024. A few chart technicians today think Dow can drop all the way to $1,000, back to the 1982 level. Even it is possible, but I think it might bottom at one of the lower Fibonacci level between $14,000 and $1,000. Which one of them is yet to be seen in future years but my guess is around $4-5,000.

The current market crash is not like 1987, which recovered in a relatively short time since the fundamental was strong, stock was in an uptrend and it didn't have the economic bloodline of credit cut off then. There is another fundamental factor now supporting a long lasting bear market than 1970s. This time, it is demographic. Setting aside the whole investment banking sector being wiped out and OTC derivatives, for the public, the more important factor is that baby boomers are not comfortable with this market turmoil since last year, and want to lock in their nest eggs and to cash out, which has caused more baby boomers to do the same. They don't want to take the risk of sitting through this credit crisis and bear market, since no one knows how long it will last. What happens if it lasts as long as 2 decades? Time is not on their side. How can we blame them? With the real estate market at free-fall and no sight of its bottom, it is only natural for them to protect their only remaining nest eggs. And they will never get back into the stock market again after cashing out, due to growing risk adverse profile with increasing age. All the concern is to protect their cash. This is why you see US treasuries reaching so high these days with yield at 0%, the so-called safe haven vehicle. Maybe stocks in the future will be "undervalued" at 50% of book value, 70% of intrinsic value, P/E at 6, PEG less than 1, but who cares. Yes, inflation is gradually eating their money away, well, let us worry about that later when inflation reaches double digit.

The above discussion about baby boomers is not new, as early as 2001, Wharton professors of Andrew Abel and Jeremy Siegel have voiced concern about the herd behavior of baby boomer generation and their cashing out simultaneously will cause a stock market meltdown around 2010. What an accurate prediction that is, only miss by 2 years. At the same time, who wants to be the last one to cash out in 2010 at the lowest price by holding the bag anyway? I think 2010 bottom prediction by professors is still one of the valid bottoms, and probably the most important one in this bear market, reaching $4-500 target discussed earlier after the upcoming dead cat bouncing rally.

Here is a brief discussion on Warren Buffett's investment in both GE and Goldman Sachs. Investment in perpetual preferred stocks is usually a good way to invest in good business as long as the firms survive, and obviously Buffett thinks both will. I tend to agree too. However, even both GE and Goldman survive, not many people realize these investments are at the large expense of the existing common shareholders. In GE's case, GE is using Buffett's name and investment to raise $12 billion in a separate public offering to dilute their common shares, not counting on the $3 billion of GE warrants, causing potential more dilution. Almost all GE industrial units are doing fine since they are usually #1 or #2 in the sector and have some monopoly price power. The biggest risk for GE is their GE capital unit, which never reveals their portfolio based on illiquid asset securitization and OTC derivatives, similar to highly leverage investment banks. And unfortunately it accounts for half of the GE earning power. If GE Capital is in the same trouble, GE will likely have to shut down this division, write down large losses of their portfolio and lose half of their earning power but as a conglomerate, they will still survive. The problem is in an economic depression with decreasing revenue and much worse profit margin, GE's earning will be depressed substantially, but still has to honor the large interest payment to Buffett on the new preferreds before common shareholders see their dividends. In Goldman's case, it is even more so and a much risky investment than GE. The largest expense for investment banks is compensation, and they always issue many new shares to retain talents besides cash bonuses every year. That is typical and part of their incentive program. In an economic depression, there is likely no banking deals, not much trading activities, especially no more highly profitable structured products like before. Goldman's net income could be running less than $1 billion at its worst years (like Morgan Stanley today). However, they have to pay Buffett $500 million, 10% interest of his $5 billion investment every year. What is left for common shareholders with their shares
diluting heavily each year? The incentive program becomes a demoralized program. Both deals are really very negative to common shareholders, taking a large piece of the net income pie and shifting from commons to preferreds.

From where the stock price and credit derivative swap are trading at for Morgan Stanley, it is pointing them to be another Lehman. The original tentative discussion with Mitsubishi UFJ Financial Group by investing $9 billion for 21% stake then can buy the whole Company last Friday. No wonder people are questioning whether this deal makes any
financial sense at all. What is also interesting is that there has been a very popular blog in China, discussing in detail a high level special interest group inside China SWF and banking system, using their relationship with top managers of Morgan Stanley and Blackstone for alleged corruptions, kickbacks, abusing power, questionable investments going sour, luxurious life style, etc. Usually Chinese government would have ordered the removal of such kind of "un-harmonized" blogs right away, but not in this case. There is wide speculation of anger by some government officials toward the China SWF fund investing in Morgan Stanley, Blackstone and all the US home mortgages and derivatives, for the purpose of nurturing their own personal relationship and self-interest but letting the whole country down. It is always a bad thing to make your investors angry by losing their money, especially this time it is their boss, the Chinese government which now realizes that they would never get any return and worse at the edge of getting wiped out on their investments. There are also many angry investors in this country too, causing the House to defeat the$700 billion bail out plan initially. If without Wall St.'s creativity on structured products, subprime crisis could be easily contained, even with widespread abusive lending practices.

The problem is for $1 of subprime mortgages, Wall St. created $10 CDO products, then the math geeks at structured product groups escalated the $10 CDOs by creating another $100 OTC derivatives out of thin air (refer to my previous article "Why Wall St. Needed Credit Default Swaps?"). Now suddenly, a $700 billion default in subprime would cause $7 trillion default in CDOs and $70 trillion losses in CDSs, a crisis 100 times larger than it should be. Now you know why Wall St. is so profitable because in only past 5-10 year's time, they have already sucked the blood and "profit" of not only this generation but the next. If government is serious about bailout, the size will likely be 100 times larger than $700 billions.

Not long ago, with no market for CDOs, Merrill was forced to sell CDOs at 20 cents on the dollar by creating a market. But that was not the most interesting part, Merrill had to self finance 15 cents out of 20 themselves, leaving a suspicion that those CDOs were really only worth 5 cents. This act forced other banks to mark down CDOs in their portfolio further, however, at 20 cents not at 5 cents, helping other banks to shore up the value of their portfolio than they are really worth. Even so, any asset writedown has to be matched by equity. There is really no more equity to write down for many banks, and no way to raise new equity, only heading liquidation. Since debt stays the same, debt to equity ratio, or so-called equity ratio, has to be reduced in the current deleveraging process, not to be increased. As a result, a writedown causes more writedowns, and it becomes a death spiral of no way out situation.

In the summer of 2007 last year (not 2008 this year), Jeremy Grantham also predicted half of the hedge fund will get wiped out, and more than half of the private equity will vanish. Let us just look at private equity sector. In the boom years, they can achieve 50% return easily. Let us look at a hypothetical deal that a PE Firm A with 2+20 fee structure, purchased Company B at $4B with $2B borrowing at 6%, netting $1B in 2 years by IPO, a very typical deal in the good old days. It is 50% return ($1B/$2B investment) for the PE firm. But for you as a PE investor, your share of return is: $1B profit - $0.08B fee (2%*$2B*2 yr) - $0.2B PE profit cut - $0.24B interest ($2B*6%*2 yr) = $0.48B, or 24% return ($0.48B/$2B). Suddenly the same deal seems to achieve 50% return (for them), the real return for clients is only half of it.

Now let us use the same example above but let us say the equity market enters into a couple years of bear market as of now. The same deal now takes 5 years instead of 2 years to spin off in an IPO. What would the return for PE clients be?

The answer is ZERO. It is: $1B profit - $0.2B fee (2%*$2B*5 yr) - $0.2B PE profit cut - $0.6B interest ($2B*6%*5 yr) = zero. 5 years for nothing. The extra 3 years of interest payments and excessive 2+20 fee structure eat all the remaining profit. For all the corporate pension funds, state and local government retirement funds, endowment funds and foundations rushing to invest 10-20% of their investments into private equities, do they realize investing in 5% US treasury per year (27% for 5 years compounding) would actually offer better return and carry no risk at all (except the risk of holding US dollar)?

In the above calculation, I didn't factor in a long recession with a decade of bear market, resulting reduced revenue with deteriorating profit margin, and potentially large loss instead of profit for business they purchased. No need to show more calculations. This is why Jeremy was so confident about his prediction still in the middle of the bull market last year, with margin of safety by predicting only half of them dead. Now with time against them, no credit for any financing, and no equity market for IPO for a decade for them to cash out and dump the risk to the public, the likely scenario is the whole private equity sector will get wiped out in 2 years by 2010, just like the investment bank sector.

For a decade long recession and likely depression, the only firms that will survive are those preserving cash by cutting workforce, stopping capital expenditure, R&D and IT investments, cutting stock dividends including preferred dividends, no more stock buyback even stock prices going to zero. Things will get very nasty, only firms that can still manage to generate net cashflow during depression are survivors, like in 1930s and 1970s. Newer companies with experimental technologies will be vulnerable and regarded as nonessential, and undercapitalized private firms will be in trouble since IPO window will be shut for an unforeseeable future. Venture capital firms will have to hold on to their investments forever, at least another decade, without IPO in sight, until all their cash being burnt out. Many firms relying on bank financing will not survive. The only business will survive are likely the cashflow positive energy firms and mining producers.

Pretty soon, people will realize holding cash in US dollar is also not right due to quick deterioration of US dollar. The current rise in US dollar is due to short term disappearance of money supply since no bank wants to lend any money out. Once the government socializes the banking industry and flooding the system with worthless paper, people will downgrade US treasuries before rating agencies do, since US government is buying and holding the worst quality mortgages and CDOs dumped by the banks.

In a normal bankruptcy process for investment banks, common stocks, preferreds and subordinated debts would get wiped out, and bondholders would act as cushion and suffer some losses, but usually customers and trade partners are protected. The current bailout plan, and the previous BSC bailout, AIG bailout, are all using taxpayer's money to bail out the bondholders and perferreds which are held mostly by institutions. It is basically to wipe out the individual investors then to use taxpayer's money to protect the large institutions. Individuals have already dumped stocks, institutions have already dumped bonds, derivatives such as CDOs and CDSs, the next thing will happen is that both, especially foreign central banks, will dump US treasuries too by buying the ultimate asset everyone in the world trusts - Gold. The reason is people will realize this is worse than 1930s, at least then, fiat money was backed by gold, now US dollar is only backed by liabilities of over $10 trillion national debt and 10 times larger unfunded obligations and promises if we include Medicare, Medicaid, social securities, pension liabilities, Fan and Fred's trillion mortgages, and the future purchases of the whole defunct banking industry, auto industry, airline industry, etc. etc. Government can't only socialize the money losing sectors, and taxpayers and lawmakers have only so much patience and can't tolerate this forever. Pretty soon, government will need to take over a profit sector, such as energy firms, to offset some of the losses. It is going down the slippery path of socialism quickly. This is going to be a nuclear winter for many years to come. No wonder many years ago, George Soros has correctly predicted that there is going to be the end of globalization, and the death of capitalism. This is the payback time for all the abuses few elites have done to our whole society but the public is now footing their bills. If G7 is serious about bailing out the global economy, the only way to do it is to have double digit hyperinflation to inflate the whole world out of depression at any costs. And they have to do it now.
They can't be half-hearted either, otherwise it will end up to be the worst nightmare of hyperinflation combined with great depression. This means all commodities will skyrocket and the current slump of commodities would provide the best buying opportunity before oil goes to $200 and gold to $2000. When people lose faith in fiat money, next thing to happen is barter like Weimer Republic, where only commodities, especially gold, are treated as money.

In this difficult period, do nothing and hold nothing but gold. Only gold, the ultimate asset that has survived the longest in human history, can save us now. A specter is haunting the world - the specter of gold, while the old fiat money has lost all its powers.




Thomas Z. Tan, CFA, MBA
Those interested in discovering more about me and reading my many other blogs can visit web site at www.vestopia.com/thomast.

Disclaimer: The contents of this article represent the opinion and analysis of Thomas Tan, who cannot accept responsibility for any trading losses you may incur as a result of your reliance on this opinion and analysis and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Do your own due diligence regarding personal investment decisions.
Copyright © 2006-2008 Thomas Z. Tan



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**4 Lessons from the Financial Crisis

Complete Coverage Ask the Expert Retirement questions answered


4 lessons from the financial crisis

By Walter Updegrave, Money Magazine senior editor
November 17, 2008 5:13 pm

If you can learn from the mistakes of others, now is a great time to be an investor.

Question: I’m inexperienced when it comes to investing, but I want to build a more secure financial future. What tips or suggestions do you have for a young investor like me? —Caleb Bond, Denver

Answer: It’s a great time to be starting out as an investor. Yes, I know that might sound odd, given that the market and the economy are in shambles. But the fact that people are so fearful and the outlook is so uncertain can also have its advantages.

For one thing, much of the excess has been wrung out of stock prices over the past year or so. And while this hardly insures a quick rebound, the money you invest today is much more likely to earn a higher return than if you had invested before the meltdown.

Even more important, though, is that you now have a better sense of the real risks of investing. People who gain their investing experience during bull markets can easily be lulled into a false sense of security. They know that severe downturn occur and maybe could occur again, but the possibility of one happening to them seems remote.

Today, however, all you’ve got to do is look around you to see that risk is real, it can be devastating and it must be respected.

That said, there’s also the danger that someone surveying today’s scene might take away the wrong lessons. Already, some people are concluding that stocks, or financial assets in general, are just too risky. When it comes to important goals like retirement, they say, the experience of the last year or so shows you should stick to the most secure investments, FDIC-insured CDs and the like.

But that’s an overreaction. Risk is a natural part of investing, a part of life, for that matter. Eliminate it and you eliminate opportunity. The key is to understand how much risk you’re taking and manage it.

With that in mind, here are four lessons I think beginning investors should take from the financial crisis and apply to their investing decisions now and in the years ahead. Come to think of it, I think experienced investors should consider them as well.

Financial success isn’t just about investing.

We kind of lost sight of this fact because returns on financial assets had been so good from the early 1980s through the late ‘90s. And even after the dot-com bust we had another five-year bull run in stocks, not to mention heady gains in the real estate market. It became easy to assume that we could achieve financial goals like a secure retirement with a minimum of savings because we could count on the compounding effect of years of high returns.

That was always an unsound strategy, but it’s only now becoming clear how flawed. In fact, as a study by Putnam investments showed a couple of years ago, saving is just as important for building wealth, if not more so. We can’t be sure of the size of the investment gains we’ll earn, and we don’t have nearly as much control over them as we used to think. But we have much more control over how much we save.

And by saving more, we gain two big advantages: we don’t have to invest as aggressively to build a retirement nest egg or reach other financial goals; and, by socking more money away, we’ll have more of a cushion in the event of setbacks in the market.

Simplicity is better than complexity.

If I could ban two words from the vocabulary of investors, it would be these: “sophisticated investing.” I think more harm has been done by investors trying to boost their returns by creating arcane investing strategies or buying complicated investments they don’t understand than all the investment con men and rip-off artists combined.

I don’t want to sound like a Luddite. I’m all for using tools, calculators and software to help you create a retirement plan and an investing strategy. But you’ve also got to maintain a healthy sense of skepticism about how much fancy algorithms and intricate computer simulations can do.
Fact is, the more complicated your investing strategy is, the more things there are that can go wrong, and the harder it will be for you to monitor and maintain it. A simple mix of stock and bond mutual funds may not be the sexiest strategy around. But if you use good common sense in putting that mix together - i.e., you diversify broadly as we recommend in our Asset Allocator tool - it will serve you well over the long term.

Allow for the possibility you may be wrong.

One of the most notable features of the real estate bubble was how sure people felt that prices would continue to go up, up, up. At the peak of the housing mania, I remember getting emails from firms that were inducing individuals to open self-directed IRA accounts so that they could then invest their IRA money in real estate. I wrote a column at the time suggesting that this might be a sign that the real estate market was getting frothy and warning people about staking their retirement on the housing market.

I got a lot of feedback on that column, alas, most of it from people who wanted to know how they could get in touch with those firms that could help them get rental houses into their IRAs. And although I and others pointed out that house prices had gone down in the past and stayed down for quite a while after big run-ups, no one seemed to believe that it could happen again.

Which is why it’s always important when you’re investing to give yourself a reality check. Are your assumptions realistic? Is there something you’re overlooking? Could you be wrong? What would the fallout be if you are? And, perhaps most important, are you interested in this investment because it fits in with your overall strategy or because it’s the investment everyone is talking about? Don’t get too euphoric during upswings or depressed during downturns.

When things are going well and the economy and the markets are on a roll, it’s easy to let the excitement cloud your judgment. After all, everywhere you look - the double-digit gains in the fund listings, the upbeat news in the newspaper’s business section, the cheerful banter on cable TV financial shows - you get positive reinforcement. You almost can’t help but believe that the good times will continue to roll.

So you begin to boost the percentage of stocks in your portfolio and put more money than you should into hot investments that now seem like good bets, such as emerging market stocks. In other words, you begin taking on more risk, although, you probably don’t see it that way. How can investing be risky when it seems the market only goes up?

This process kicks into reverse, of course, when the markets and economy change course and begin falling apart. Then the prevailing gloom and doom dominates your thinking. Everywhere you look - the double-digit losses in the fund listings, the downbeat news in the business section, the somber mood and dire pronouncements on the cable TV financial shows - you get negative reinforcement.

You become convinced that the hard times will get even harder. So you sell out of stocks and move into safe-haven investments you sneered at during boom times - bond funds, money-market funds, stable-value funds, even CDs. And you no doubt see this as a move to reduce risk. After all, aren’t you safer getting out of the market when it only seems to keep going down?
But there’s a risk here too: you may be selling at the worst time and positioning yourself to miss the recovery when it occurs.

These feelings and reactions are natural. We’re human. But it’s no news flash that markets and economies move in cycles. That we go through periods of excess on both the upside and downside. We’ve gone through such episodes before and we will again. So ideally you want to set a strategy that factors in such fluctuations, and then avoid the urge to abandon your strategy when your emotions are screaming you to do so.

I can’t guarantee that steering clear of the euphoria that leads to aggressive investing at market peaks and avoiding the despair that causes you to be too conservative after the market falls apart will assure you’ll earn the highest returns or sidestep big losses. But by doing so, you’ll probably be less vulnerable heading into downturns, and better positioned to take advantage of the upswing when it occurs.


Filed under Uncategorized22 Comments Add a Comment

I just want to caution everyone that before jumping back into the market that everyone has their credit cards paid off. Too quickly we forget that one of the lessons out of all of this is that we cannot live beyond our means.
Posted By Matt Malinowski, Lethbridge AB: November 19, 2008 12:04 am

Why would anyone advise someone to invest in the stock market now. In 1929 there was a major down turn in the market. And in the end the stock market DOW dropped over 80%. We are in a worst crisis than in 1929. The dollar is about to slide over a cliff. And the tax base is being eroded away so the government won’t be able to pay the interest on our loans. Next year we won’t be able to have foreigners buy our bonds. Because the feel they would be too risky because of all our debt. The credit rating of the US will be downgraded. With all the spending we are looking at a hyperinflation senario similar to Wienmar Germany. The article is dreamland. Tell the kid to invest in silver/gold. In the depression you could buy a house for a couple of ounces of gold and in Wienmar germany you could buy a house for one quarter ounce of gold.
Posted By Kevin Rathdrum, Idaho: November 18, 2008 11:18 pm

Save at least 10% of everything you earn. Like Buffett says, be greedy when others are fearful and fearful when others are greedy. Learn and follow the Elliot Wave Theory. Read and learn about investing. Develop and strictly adhere to a long term investment plan. Learn and apply the dynamics and psychology of market swings and how they work and learn how to make them work for you. In essence, educate yourself and apply your knowledge on a long term basis.
Posted By Ramundo A, Lincoln, Nebraska: November 18, 2008 9:53 pm

I’ll tell you what, its been black friday for a few weeks now and I’m loading up on these bank stocks. In a few years it’l rebound and I believe what I put in it over the next year will at least double my value. at least. its on sale! citi for example is 75% off!
Posted By Anonymous: November 18, 2008 8:02 pm

Nice article. Sad to see all these people near retirement that had more than half of their stash in stocks and real estate. What’s even sadder is considering the moral hazard of the government now helping “too much.”
Stock Market has some interesting features, not widely advertised, like a real return since 1871 less than 2% on price appreciation alone (most people don’t believe this, but take the SP500 data since it started and calculate it yourself). On the other hand, including dividends, real return is 6.4%. Kind of like a bond, to support the argument of another writer to this post (but a bond with a heckuva a lot of volatility).
It also seems to have a 35 year oscillation in peaks and troughs, and the next trough is 2018. Hopefully past performance doesn’t predict future results!
Posted By Dave, Houston, TX: November 18, 2008 7:26 pm

I think what Walter is trying to say is :
Keep it simple to keep it manageable.
Meanwhile:
There has been a phrase bandied about in the press “too big to fail”.
I think that phrase needs to be changed to “too big for their britches” because “Wall Street” has been demanding “more liquidity” from the Federal Government for years.
I think that was a cover-up for “we gambled and made some bad bets so we need to borrow more money even cheaper so when we win a big one we can pay you back but meanwhile we need to pay ourselves several million dollars because we are such darn smart and clever people.”
So when you do your own investing, don’t get too big for your britches thinking you are smarter than “Wall Street” because they have more OPM than you do.
OPM being “Other People’s Money”
Posted By Jason Stoons, Austin TX: November 18, 2008 7:10 pm

One fundamental problem with our economy and Government is the unhealthly focus on the spenders–we bend over backwards to encourage people to go into debt, while at the same time practically eliminate all incentives to save our money (painfully low savings rates)–America’s problems will continue to worsen as long as we continue to spend beyond our means…and I’m talking about both Government and personal spending.
Posted By Nairb Sreoom, Biloxi, MS: November 18, 2008 5:21 pm

The current economics is really a paradigm shift to some basics, that will really develope into a new reality, a new way of looking at things. The promoters of sliced and diced investment “opportunities” have been found out. The repercussions of this failure are yet to be determined. Your article really tells us that it is back to basics, keep your investment strategy simple and understandable. I think the future will be the best time in our history, but only after a lot of lessons are learned and pain obsorbed. If the government bails us out too much, we won’t have learned anything.
Posted By Don Miner, San Francisco,: November 18, 2008 4:41 pm

It’s a shame that there is no TV show about simple, sensible investing principles: keeping costs low, tax efficiency high, diversification high, and allocation appropriate. Although they are the optimal strategy for nearly everyone, can you imagine watching a show that told you to do the same basic thing every week for years on end? LOL They could call it “Don’t just do something, stand there”!
Posted By John, Phila PA: November 18, 2008 3:56 pm

forgetting reality because you are chasing pie in the sky is a tough one. Any reference librarian can help you look up the long term advantage that large cap stocks have delivered over government bonds — it is only about 5%.
Every time you think you’re going to do significantly better than that 5% [before taxes, too] you have to know that you’re chasing pie in the sky.
Can it be done? sure — by experts. Then you have to ask yourself if you’re an expert. something like 99.95% of us are not.
If you’re not an expert, can you hire an expert? Absolutely — if you have millions to invest. However, for the average family, the expert needs to get paid so much that you can’t afford him or her. That means you’ll get average results. period.
Build your plan as if you’ll get average results. Then start becoming an expert and maybe you’ll be able to do better than your plan.
Posted By Spock_rhp, Miami, FL: November 18, 2008 3:10 pm

Good Points. On the whole we forgot about risk. We forgot that trees DO NOT grow forever into the sky. The signs were there for the Dot Com bust and not the housing/sub-prime bust. We forgot to look both ways before crossing the ’street’ and got blind-sided.
I’m 55 years old and have been investing since the early 1980’s and went through the crash of 1987, but this time I see with different eyes. All of my equities will remain fully invested, and will be left alone “to fend” for themselves…hopefully their value will rebound in the next 10 or 20 years. I was 80/20 stock to bonds…that’s now become 70/30 ratio. I plan to continue to save 21% of my income, but these monies are going into a GIC fixed instrument within my company 401(k). The other thing that I am doing differently, is to get back (sold my house in April 2008)into Real Estate, and make it a larger percent of my investments.
Good luck to all!
Posted By BIZ, Dunedin Florida USA: November 18, 2008 2:11 pm

All this advice is great if you have a pension to fall back on in hard times IN ADDITION to your 401K.If you don’t, you can’t save enough for a comfortatble retirement before turning 70 with all this brutal cycling.
Posted By Pat Savu Maplewood, MN: November 18, 2008 2:10 pm

The present meltdown has also shown us how unethical many of the financial corporations are. From the companies that rated AIG “AAA” to the derivatives that were “invented” for fast profits and big bonuses, we have learned that Wall Street lies, cheats and steals, without penalty.
Posted By kate, boston, MA: November 18, 2008 1:50 pm

The author is wrong about “much of the excess wrung out” - PE ratios are still excessive and there’s more downside to come.
Posted By Jack Thomas, Tucson, AZ: November 18, 2008 12:55 pm

It is well written , it truly is the fact , putting the bad to the past ,thought the worst could not be over yet , you could expect another 20 % lower values in the stock market ,look out for the DOWJONES to come to level of 7000 to 7400 to enter the market and stay in the stock of atleast 6 months .to get real returns , if one can stay invested longer , better returns are expected .the market will come back to its original level in 3 years , there could not be a better time to get in to the market if one has the cash liquidity ,
Posted By mansoor ,moradabad ,india: November 18, 2008 12:30 pm

Excellent article
Posted By Anonymous: November 18, 2008 12:29 pm

Great aticle , the only way i can recover capital losses is by jumping back in and yousing my capital gains as tax write offs , it will take some time im not going to miss the rebound ive lost to much .
Posted By Bernie Blyth , Australia: November 18, 2008 12:28 pm

I think these are all good and positive ideas, but if we continue to think that the stock market will again go upwards like it did in the dot com peak and the housing market boom, we may be in for a surprise. With all of these bailouts and the companies not doing what they are supposed to do with taxpayer’s money, big business has learned nothing from this. All they will do is blow it and then turn to the government for help…AGAIN.
Posted By Lee, Shreveport, La: November 18, 2008 11:18 am

My advisor told me,rich,is when you marry it, inherit it or compound interest. Re invest the dividends back into the stocks. I believe him, and that is what I am doing, but only good stocks,like GE,Bristol Myers, and yes Visa is a great buy right now. As long as you have a cash reserve,buying into the good stocks, remember, the stock market has thrown out the “baby” with the wash. Take advantage of the blue chips.
Posted By Ken Wayne, Boca Raton,Fl: November 18, 2008 11:17 am

I agree with article - thanks
Posted By Terrace, Gulf Breeze, FL: November 18, 2008 10:22 am

all these principles are fine to write about but not practical given the current scenario. there can be only one Warren Buffet and one Bill Gates. while your house is burning you cant read or remember fire prevention rules or bye laws you have to act.Moreover today’s situation is s spill over of years of faulty financial expansionary policies & it will take a long time to reassert fundamentals which are neither so distorted nor flimsy
Posted By Aj missassauga ont.: November 18, 2008 10:09 am

Excellent article. Let’s remember that fear builds on fear and that is exactly what we’re seeing on today’s market. The smart investor today will analyze current fear trends and gradually inject back into the market when the underlying causes for concern have been dealt with.
There is always inherent risk in investment, but personally I’m excited about the opportunities that this is bringing. Also, I hope that a new generation of investors will be more atuned to the risks involved with investment and will be more ethically inclined in the future.
Posted By Mitesh Vashee, Dallas TX.: November 18, 2008 10:00 am
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