Just when we thought the markets couldn’t be more volatile along came this week. If this week was a thrill ride at Disney I’m not sure anybody would be in line to take their turn. The swings in emotion were incredible. Panic, fear, optimism, and despair were all exhibited in vast quantities throughout the week sometimes within seconds of each other. So, did we hit bottom? I’m afraid I don’t think so, says the perennial BEAR.
I was speaking to a client on Wednesday and after the huge swings on Tuesday I asked him this question, ”Have we fixed all the problems that were in place last Friday?” The answer is no. We are continuing to gather the detail of what happened first, before we try and fix the problem. What is the problem? In a word “Greed” and unlike the quote from the movie “Wall Street” it is not good. I was amazed at how many times people on CNBC, guest included, would talk about the markets problems, but nobody mentioned the word “Greed” was at fault. One word that was mentioned extensively was “Stupidity”. I agree that a lot of people were stupid, but that stupidity was driven by “Greed”.
Let’s look at one example of how “Greed" and perhaps "Stupidity" together may have destroyed segment of the financial service industry. Financial Guarantee Insurance Companies sometimes referred to as monoline insurance companies were in the single business of insuring municipal bonds issued by states, cities and many other municipal issuers across the United States. By all accounts a boring, but and, I underline profitable business.
For some strange reason some and eventually all of these companies decided that they new how to insure the payments on Collateralized Debt Obligations (CDO) and Credit Default Swaps (CDS). They moved away from their core business and went into a line of business that put their capital to work and at much greater risk than the risk they were taking in insuring muni bonds. Why? That word “Greed”.
Over the last 26 years long-term interest rates have been falling. As interest rates fell companies, and for that matter individuals, had increasing expenses and therefore a need for higher income. Falling Treasuries yields were not providing enough cash/flow to meet obligations. It was difficult if not near impossible to cut expenses so the quest for “more” began.
Investors started by dipping their toe in the waters of higher yield and higher risk and by January 2008 some companies found themselves over their head in the waters of high risk and did not know what to do about their financial problems because they never really understood the business they were in. They never envisioned the risk they could find themselves today, when the started a new direction.They had no clue that they were betting their companies and their careers in making these higher risk decisions for more earnings. Pressure from stockholders to perform, earnings, was also part of the problem. In the past companies made decisions looking out years in advance, now we find the future is 90-days out.
It took 26 years to get us to this point of financial crisis and as typical Americans we want it over and done with overnight. What took 26 years to set up cannot be unwound in a day, a week, or a month. I believe we still do not know the full extent of the problem and in turn the impact on the United States and the rest of the world's economies.
It is true that we live in a global economy that has evolved over time. "Greed" is not limited to the good old USA. As economies have grown and expanded over the last quarter century "Greed" has spread throughout the world and I think the world will have to pay for the mistakes.
As bad as the week was we are still in a correction and a bear market that will take perhaps years to unwind. Think about the NASDAQ market in 1999. This market index was around 5,000 here we are 7 years later at 2,600, will we ever see 5,000 again? Not in my lifetime. We are still paying for the greed of the 90”s.
I have to ask myself if we are still paying for the greed of the NASDAQ how can we expect that everything will be OK in a month or so—this is going to take time and I believe more time that most people are thinking about at the moment. Will Rodgers had a famous quote."Americans should be more concerned about the return of their money than the return on their money." This is going to be a hard lesson to learn.