Timeline of the US Financial Crisis and Where the Eurozone Stands

As Europe faces its own "tipping point," can it avert some of the same issues the US recently faced? A review of the US timeline of events provides some clues.

Late 2005 -- The US housing market peaks and the hottest real estate markets begin their descent.

January 2006 -- Homebuilders’ stocks peak and begin a steep decline. Subprime loans’ delinquency rates begin to rise as extended borrowers have trouble making payments as housing values decline and adjustable-rate mortgage payments increase with interest rate resets.

April 2007 -- New Century Financial, the largest US subprime lender, files for Chapter 11.

May 2007 -- Federal Reserve Chairman Ben Bernanke says that subprime mortgage woes do not present a serious problem to the US economy. He goes even further, saying its effects on the overall housing market will likely be limited.

June 2007 -- Merrill Lynch seizes $800 million in assets from several Bear Stearns hedge funds as the funds implode.

August 2007 -- “Credit crunch" manifests as investors become aware of the broad exposure of banks and hedge funds globally to subprime mortgage-backed securities. The Federal Reserve injects about $100 billion into the money supply for banks to borrow at a low interest rate. Central banks coordinate efforts to increase liquidity for the first time since the aftermath of the September 11 terrorist attacks.

September 2007 -- Internet banking pioneer NetBank goes bankrupt.

March 2008 -- Bear Stearns is acquired for $2 a share by JPMorgan Chase (JPM) in a fire sale to avoid bankruptcy. The Federal Reserve offers JPMorgan Chase up to $30 billion to cover possible Bear Stearns losses.

July 2008 -- IndyMac becomes the fourth-largest bank failure in US history. Barney Frank characterizes future prospects of Fannie Mae and Freddie Mac as "solid" going forward.

September 2008 -- The director of the Federal Housing Finance Agency places Fannie Mae and Freddie Mac in receivership (which owned or guaranteed about half of the US' $12 trillion mortgage market), effectively nationalizing them. Lehman Brothers files bankruptcy. Bank of America (BAC) buys a crisis-impaired Merrill Lynch. Standard & Poor's and Moody's downgrade AIG (AIG), and the Federal Reserve lends AIG $85 billion to prevent another massive failure. Washington Mutual is seized by the FDIC. Treasury Secretary Henry Paulson and Bernanke meet behind closed doors with leaders of both political parties. They are told that if bold action isn’t taken imminently, the US financial system could collapse and usher in a depression. According to the New York Times, President George W. Bush was heard to say, “If money isn’t loosened up, this sucker could go down,” and the Treasury secretary knelt before the House speaker as he appealed for support to pass the $700 billion Troubled Asset Relief Program.

October 3, 2008 - Bush signs the Emergency Economic Stabilization Act, creating a $700 billion TARP to purchase impaired bank assets.

There are a few points that I want to draw from these few historical highlights of the US financial crisis

1. Problems surfaced in 2005 and leaders first ignored, then hoped, then tried kicking the can down the road, but eventually couldn’t avoid a “tipping point.”    

2. Leaders seemed complacent as the crisis developed, and politicians did very little proactively to address the huge imbalances that had developed. Political leaders did ultimately approve massive government intervention as the crisis evolved to a point where many financial institutions failed, (including Lehman Brothers), many were on the brink of failure, and the stock market experienced a dramatic decline. Contrast that to the recent debt ceiling debate, where very little was accomplished in the absence of “gun-to-head” potentially catastrophic consequences as motivation for political parties to reach a substantial bipartisan agreement.  

3. America has a printing press. (Fiat currency.) There were many respected investors and economists who believed the problem had grown too large to prevent a collapse of the financial system in 2008. To quote Winston Churchill, “You can always count on Americans to do the right thing -- after they've tried everything else.” I don’t know that TARP was necessarily the “right” thing, but our elected officials did do “something” at a critical moment to keep the financial system functioning; and the financial markets have recovered as a result.

Now let’s turn to Europe. 

1. Problems developed in Europe out of the US subprime crisis. In the early stages Europe ignored problems in hopes they would resolve, then conducted “stress tests” on their banks, lent money to troubled countries, intervened in the bond markets in an attempt to keep interest rates low, and attempted temporary fixes that have not kept the problems from escalating. Just in the last few weeks, interest rates in Italy (and now Spain) have risen to critical levels, creating concern that Europe is getting nearer to a “tipping point.”

2. Europe has 17 countries that adopted the euro as a common currency. The politics involved in agreeing on a solution are very complex when you consider 17 parliaments are vying for the interests of their respective countries. Our one Congress has serious trouble rising above politics to act proactively. Europe does understand the problem and the daunting magnitude, but the question is: Can it muster the political will to act decisively without having a “gun-to-head” potentially catastrophic crisis first?

3. The European Central Bank could “create” trillions of euros to recapitalize the European financial infrastructure, much like the Fed has done in the US to prevent severe deflation. 

These are the things that are foremost in our thinking at the moment. First, the problems will not go away, and a tipping point will eventually force action. Second, politics in Europe are multiplex as they span many countries and many interests.   

• If we keep muddling along as we have been, the austerity in Europe and the negative feedback loop from high unemployment and state budget cuts in the US keep deflationary/recessionary risks as our dominant near-term concern.

• If Europe dithers politically and “tips” into a major crisis, we could see a deflationary scare similar to 2008 prior to obtaining the political blessing for the massive intervention that will be necessary.

• If Europe is determined enough to mimic the US response that it overcomes political obstacles and proactively puts together an extensive, credible recapitalization package… Then global equity markets could soar on the announcement of decisive action. 

I wish we had a crystal ball to tell us how, or if, politicians will act prior to a full-blown crisis, but not even they know what they will do. So as investors, we are left with what seems the only prudent course: Maintain an acute level of alertness while executing a patient, steady, disciplined approach with an eye on both inflationary and deflationary risks that have heightened as a result of the global debt bubble.

My firm continues investing in core asset classes like international large-cap value, natural resources, select health care, precious metals, emerging market equities, emerging market bonds, and utilities, which have performed remarkably well through the secular bear market for the S&P 500.

We are also getting interested in US technology as an asset class for the first time in a long while. Many corporations have very healthy balance sheets and have built large cash reserves, at the same time as many banks and countries continue to flounder under unsustainable debt. Along with core positions, we are emphasizing extra caution, dry powder, and patience. If we do get an (unfortunate) European crisis-induced liquidity event, we would welcome the opportunity to buy many sound investments at a fear-induced discount.

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