2008 Year in Review: Where We Are and Where We're Going
"A year has passed since I wrote my note. I should have known this right from the start."
--The Police
2008 has been unlike anything ever witnessed in the storied history of Wall Street.
Martial Law was declared on the capital market construct, a multitude of institutions were laid to rest or forced to merge and the government socialized markets and nationalized industries in a desperate attempt to combat the cumulative imbalances that have built through the years.
In the coming weeks, we’ll offer fresh foresight as we cast our eyes towards 2009. In the interim, it's time for some honest reflection as we revisit our 2008 themes with hopes that mistakes morph into lessons as we together find our way.
Theme 1: Hedge Funds Buying Brokers
January thought: The critical issue facing financial institutions after years of engineering and risk recreation is the solvency of their balance sheets, particularly if they're forced to move Level III assets back onto their books.
Look for large, well-capitalized hedge funds to take selective stakes in troubled brokers as the financial continuum comes full circle.
Update: The solvency of financial institutions has been the single biggest story in a year full of front-page financial news. The combination of toxic off-balance sheet positions, interwoven derivative exposure, complex counter-party risk and the dearth of regulatory oversight brought Wall Street to its knees and threatened the very existence of the finance-based global economy.
While we’ve seen selective investment attempts by private equity and hedge funds—the $7 billion stake in Washington Mutual (WM) by TPG comes to mind—the credit cancer that consumed the hunted hampered would-be hunters who might otherwise have added capacity into the downturn. Once socialist agendas began to manifest, the motivation to assume incremental risk abated in kind.
Theme 2: Migration Toward a Middle-Class Mindset
January thought: As Kevin Depew wrote on Minyanville, "If the '90s were about wealth, accumulation and consumption, 2008 will continue the mean reversion toward something altogether more austere, if not more sensible. Debt reduction and the rejection of (and guilt projection toward) materialism will continue what began in 2006 and 2007 as meditations on not just doing more with less, but doing less... period."
Update: It’s long been my belief that a stealth recession has existed for many years, masked by the lower dollar and skewed by the spending habits of a slimming margin of society. That created a de-facto two-class society of "haves" and "have nots" that persisted until the age of austerity arrived this year.
The combination of involuntary thrift (when people can’t afford basic necessities) and voluntary thrift (when folks with money choose not to spend) created a perfect storm for the consumer and industries dependent on them.
The conspicuous consumption that once defined our immediate gratification society has passed as flashy rides and outrageous lifestyles now serve as hollow reminders of misplaced priorities.
Theme 3: Return of the Dollar
January thought: While risk remains -- for instance, if OPEC decides to denominate crude in Euros -- it's important to remember that the dollar "crash" already occurred. The greenback is off 37% since 2002 and spending power is down 97% since 1913. Factor in the widespread negativity of money managers, rappers and supermodels, and a counter-trend bounce doesn't seem so strange.
Update: After losing 8% the first half of the year, the dollar sprinted 24% higher from the middle of July to the end of November before pulling back last week.
Our longstanding view has been that all roads lead to deflation (as a byproduct of debt destruction) and the greenback would appreciate as asset classes deflated in sync. That natural progression played through until the U.S. government changed the rules of engagement. 
We’re now at fork in the road, with watershed deflation on one side and hyperinflation on the other. We must respect the possibility that capital preservation could conceivably mean capital conversion into alternative currencies such as the Japanese yen, Australian dollar or gold, at least until such time that it's confiscated.
Theme 4: Relative Performance of Pharmaceuticals and Consumer Non-Durables
January thought: I foresee the energy sector reassuming the top weighting in the S&P (as first shared in 2003). As our financial destination isn't as important as the path that we take to get there, however, defensive sectors such as pharmaceuticals and consumer non-durables will likely outperform on a relative basis as global slowdown fears permeate.
Update: Two tidbits warrant a mention as we tie together 2008. The first is that the energy sector did, in fact, leap-frog the financial complex for a brief spell—both behind information technology—before the devil of deflation arrived and demand destruction snuffed out those hiding spots.
The second derivative was that the consumer non-durables would benefit from said deflation by not passing along input cost savings to the consumer. That proved true as General Mills (GIS), Johnson & Johnson (JNJ) and Campbell Soup (CPB) tickled 52-week highs this summer despite double-digit declines in the mainstay averages.
It should be noted that, as discussed at the time, I tempered my enthusiasm on the consumer non-durables when the government unleashed the monetary spigots and the specter of higher input prices (as an unintended consequence of their efforts) began to crystallize.
I will also note that the DRG (drug index) is down 20% to date, or about half as much as the general market. You can’t spend relative performance, we know, but it’s worthy of a mention as we revisit our themes. 
Theme 5: The Other Side of Zero-Percent Financing
January thought: While subprime was the first domino to fall, more ominous issues loom. The other side of zero-percent financing will manifest through credit-card delinquencies, auto loans and other forms of consumer-credit deterioration.
Update: After years of bellying up to the "consume now and pay later" bar, the cumulative bill came due in 2008. Corporate America, the bartender in this analogy, hoped patrons would pay up before passing out.
What became clear this year is that the burden was simply too much to bear. The government spread that risk to the taxpayer, attempting to buy the cancer and avoid a credit car crash. What we’ve witnessed is an unhealthy dose of both.
In my humble view, the only true solution for what ails us is the medicine of time and price. Protect savers by backing deposits and assign culpability for those who digressed, from consumers who over-extended on credit to institutions responsible for financial engineering and policy makers complicit by acceptance.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
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I'm dumbfounded to hear people (CNBC talking heads, reporters, etc) still talking about how things will eventually get back to normal.
Please explain to me what "normal" is and exactly how we will get back to "it."
In one massive (world) government intervention, the world has changed as we know it. It's most certainly not going back to what it was. Humpty Dumpty will not be put back together again.
Now that's change we can believe in.
I know what I will be preaching to my grandkids.
Does anyone TRUST the SEC to get any better at policing Wall Street? After all they have had 20 years to clean up their act and here we are again. And what hidden Ponzi scheme don't we know about? I read an article about how the SEC computers were loaded up with Porn which implies the auditors spent more time cruising porn sites then work. I don't want to believe that is true but given what has happened lately! How is it that Bernie is out on bail living the life of luxury in his pent house apartment using stolen money as bail? How can you trust a system like this?
The Food and Drug Administration is again caught enforcing safety after the fact with Heparin, Melamine, and lead from China. Their oversight after the fact has cost the lives of many and the health of millions. We would be safer without their implied safety net.
Americans are bombarded with drug ads that are supposedly cure alls but for most the effects of those drugs are worse then the illness they were supposed to cure. Drugs approved by the FDA.
Wall Street is burning! The thieves of Wall Street know it and are grabbing everything they can before if all collapses. As bad as the markets are they continue to pay themselves lavish bonus packages, dividends, stock options and retirements. TRUST! How can you trust the Bankers, Brokers, annalist and Pundits when a lifetime of savings disappeared in months or days? Trust your banker? After he loaned you money to buy a home knowing that the home was overvalued by 50% or more. I think not!
Trust your Politicians! Whatever!
Trust. Something we had too much of and it's going to cost us dearly. Faith! Too many preachers have shot holes in that concept. Santa! He is coming to town. You better watch out! His bag is empty and he is pissed off!
Merry Christmas?
JPM
The part left out of your qoute from the head of the IMF was that civil unrest in developed countries would develop BECAUSE those elites "who looted the economy" in acts of financial terrorism (my words) are not being held to account.
A positive outlook and doing good for others is great, and why I highly value Minyanville. But the elites can't be left to get away with holding only the poor responsible for their own actions. At Minyanville I challenged JPM and Citi to sue me for caliing them bankrupt, and to reveal their level three assets in open court. I now call for the jailing of Robert Rubin for his role in the Enron embezzelment and for the forfeiture of illegally obtained gains in the form of bonuses paid out over the past seven years to the Wall Street Criminal Syndicate and the jailing of the guilty.
While this justice is being dispensed, we can move forward toward building a more balanced system.
Especially since the banks "took out" the only maniacal crusader- Elliot Spitzer- who saw a path to power through prosecuting, (or rather, allowing criminal bankers to make large monetary settlements while never admitting guilt) crooked bankers. Where are the politically ambitious prosecuters? Where is Teddy Roosevelt?
Yet being part of the solution means that now I get to be ripped to shreds by the government as those who took the biggest risks that didn't pay off - Wall Street and overextended borrowers - get the bulk of government support. Me? I get a middle finger from the government, and the likelyhood that my taxes will increase DESPITE wonder boy's promises.
Yet I remain optimistic, because it is an innate trait of people like me, who always try to do things the right way, to be optimistic. We do things the right way because we see the best in people, in the economy, and in our lives. That means living right, and doing right.
In the end, however, we always get the shaft. But we persevere. I believe that, as Ayn Rand always said, doing things the right way is its own reward and that those people who engage proper behavior ultimately come out ahead.
As far as I can tell, 2009 will be a FAR BETTER year for me than 2008. As I refinance my mortgage, I'll be able to reduce the term and lower payments - I expect to be able to do this within 3/6 months. Lower gas/oil prices have given me a $200-300 extra per month...quite a nice tax break.
I'm sure this trend will continue in 2009 for me, and many others, and this current situation will ease.
The one thing I wish would stop is the negative journalism. Nothing makes thing worse than a bleak outlook that is constantly hammered home and constantly reminding people how bad things are and how they will get worse. I simply refuse to believe this, not because I'm blind and ignore information, but because I believe in the basic good instincts of the American people, and in their amazing innovative behavior.
The US has never been brought low, either from external influence or internal flaws. We are resilient, intelligent, and creative. We will rebound and be better than before.
And your analysis of why we can't trust all these positions of authority is exactly why we're in the boat we're in - because trust is eroded. People would borrow and spend if they TRUSTED that others were doing the right thing. But nobody trusts right now.
Reestablishing this trust is important. And it won't come through politics, the basis of politics is lying, coercion, and scandal. So don't look there.
It isn't on Wall Street. It isn't at the large banks.
It's between you and me, our friends and family. It's between me and my local banker, who unlike 1929 is in far better shape than the big banks because he didn't leverage himself to the hilt. These small areas of trust are always the core, and the core is still intact.
Why is it that idiots like Jim Cramer are still garnering ratings from half wits when he screams "SELL SELL SELL" one week after shilling for all his friends to buy their crappy stock? Why do we listen to people who weren't just misguided, but spectacularly wrong? We refuse to assign credibility because we invested so much trust into these resources that when they failed, we felt that it wasn't THEM who failed, but something else...the "system", the "government"...anything but THEM.
Fact is, the system is fine. But the trust is gone, and it must be regained, and it can't be regained through bailouts. That's like trying to fix a problem by throwing money at it (a typically American solution). We all know that never works.
Panics are natural reactions to the elimination of trust and uncertainty. Some people may take issue with my use of uncertainty, and say "certainty" is better. But markets are never certain, which is what makes them profitable. Uncertainty is what causes us to invest - the uncertainty of the risk benefit. We BELIEVE we will profit, and if we're good, we will.
But when uncertainty is replaced with confusion, the first reaction is flight from risk. We are confused, we are wondering where we are going.
Where we are going is the same place we were going 2 years ago - to a better future. But in the near term, we've taken a detour. Clearing up the confusing detour signs is the first order of business.
Show me the political will to make these changes. Show me how you will remove the gun from the hand of the intruder without getting yourself shot.
The fact is that until "we the people" decide that the pain of remaining where we are is greater than the imagined pain of the needed changes, we won't demand it and it won't happen.
As long as each and every one of us feels that things may be bad for others but we're OK, the "better future" will not come. In fact, as things get worse, more fear enters the minds of "we the people." Like a deer frozen in the headlights of the oncoming vehicle, frightened people are frozen people.
In fact, this is happening now. We are begging the same people who got us into this mess to get us out. We are frozen into thinking that our tormentors are our saviors. Sounds like battered spouse syndrome to me.
This change won't happen until the majority of "we the people" demand change. When members of the local social clubs take to the streets, the movement will have begun. Until then, it's all words. The powers that be know this and use it against us.
Take the red pill and wake up to the reality. While it may be comforting to think we live in a free country (and it may be somewhat "freer" than others) we are herded around like a bunch of shorn sheep. And we "freely" participate.
And as for the "better future will never come" - well, would you say we are in a better future today, compared to 10, 15, 20 years ago? Regardless of our current economic condition, we are in a much better place and to say otherwise is to simply be lying to yourself.
We humans are shortsighted and linear animals. We sometimes forget where we've been and what we've seen, and we always think where we are is a funtional part of where we are going. This is not true, unless we choose to make it true.
If we continue down a negative path, with negative views, such as those you espouse, then most definitely worse things are ahead.
We cannot move forward in positive fashion until we know what we do is good and will move us forward.
I know that what I do is positive - do you? If so, then focus on those positive things and share those positive values with others. This will engender trust and a belief in a better future.
If we sit at the pub and complain about how bad things are, guess what? They will most certainly get worse.
Be an agent of positive change, not just an agent of change or an agent of status quo.
Optimism is a force multiplier - those who think they can, will. Those who think they can't, already have chosen not to. We WILL have a better future. Because people like me will work harder to make it positive. Over the years, Italy has had some of the most corrupt and unstable political institutions in the West, yet has managed to continue to participate in prosperity.
WHY?
Because politics in a free society such as ours is secondary to economic behavior. Ignore the politics, do what you do best. The rest takes care of itself.
Please reread my response. I said,
"As long as each and every one of us feels that things may be bad for others but we're OK, the "better future" will not come."
I did not say "never" come. Please don't take my words out of context and don't misquote me to make your point. THis is an example if hearing what you want to hear.
Optimism requires that we feel OK about ourselves, it does not require Pollyanna-type behavior. As such, most optimists will recognize that others may be in difficult shape, but feel good about their own situation because feeling good about oneself is the best way to improve your own situation.
I happen to be actually be in a good position, for a variety of reasons, but I also know others who are not in a good position. However, sharing good viewpoints and ideas helps them to improve their position - doesn't it? Perhaps some may not think so, but the people close to me in difficult straits frequently come to me for advice and opinion, because my uplifting advice makes them feel better, which leads them to improve their attitude, which improves their prospects and helps them make better decisions.
Better times come when we choose to make them come. I happen to be facing a challenging 2009, but a year which will possibly be one of my best in quite some time.
So I'm confused by the nature of your statement. I'm not sure it is accurate. You keep saying that we are lacking in political will, and asking the people who got us into this problem to get us out.
Politically, you're correct. But as I stated, it's misguided. We get out of this WITHOUT politics. I opt to read the papers, watch the news, then ignore what they say because it is misguided and frequently wrong. I don't know how many journalists have economic training (almost none based on the way they write), and the economists who do write often focus on the politics of the situation rather than the real economics of the situation.
The real economics come down to you and me and what we, as individuals, decide to do.
For years, our journalists have complained that the US savings rate is too low and that we are maxed out on credit - probably somewhat true, though there are limitations to this view - and yet when we suddenly reverse course these same journalists complain about how bad things are because now we're not spending....but isn't that the cure they were hoping for?
That is the real problem today - misguided advice from too many poorly informed people. People who have ignored the past, and the lessons of history. History shows better times always come. History is not clear what the catalyst that leads to better times is. One thing is clear - government cannot provide it. Most likely, what will provide it are the entrepreneurial attitudes Schumpeter spent much time discussing.
The one thing government is good at is killing these spirits. Our innovators in the US, however, are utile and inventive. Low interest rates may not have helped Japan, and may not help the US, but I have a different opinion. The one thing I believe is that low interest rates will boost "garage entrepreneurs". When these gains begin to take hold, of course, the Fed will have to tighten - but will it?
In the meantime, I'm refinancing. An extra $1000 a month in my pocket, and shorter term, may not boost bank profits, but it sure will let me get a new car, paint the house, and take a vacation. The extra $200 a month from lower gas prices allowed us to have a slightly better Christmas than we originally thought. The extra $400 from lower heating oil helped, too.
Returning to your point - feeling good about ourselves, but focusing on how bad things are - I'm not sure how bad things are. I see some people struggling, but I've seen far, far worse in 1982 while in college and during the 1970's in general. As recessions go, this isn't the worst I've seen. For my friends who are directly effected, so far they agree despite their situations.
I firmly believe that better times will return but not in the form they have taken in the past nor will they come soon, meaning in the next 3-5 years. To assume that our leaders will do as the people wish is at best naïve. To assume that they will do what's best for the majority is just plain dumb. The corruption runs deep and nothing short of a revolution will uproot it.
As a society, we have been in serious denial about ourselves and our leaders for decades. Thus, we have allowed terrible financial and political deeds to occur. These can't simply be brushed away as "mistakes" but must be acknowledged before any real reform can be accomplished.
Do you think that excess only happened in the financial markets and that other than that, all is OK? In my opinion, the excess of the financial markets were simply a symptom of a much larger social illness. Until this is recognized and treated, we will not heal.
While I agree that optimism is vital, a pasted on smile doesn't fix anything. Americans are beginning to wake up and realize that the big lie is over and the piper must be paid. How we deal with this realization determines when the healing begins and the magnitude of the scar that remains.
As I pointed out earlier, compare that to Italy, however. Despite inept governance and deeprooted corruption, Italy was well engaged in the growth of the last 30 years. Politics can hamper growth, but cannot improve it, and cannot stop it when it is in full on mode.
As for where we are, and when things will improve, optimism is not a "pasted on smile". Optimism is recognizing opportunity and taking advantage of it. I have alot to be optimistic about, as do many people I know, DESPITE difficulties we face. Challenges shouldn't make us negative or slow our determination. Challenges make us better than what we are.
Times are "bad". But its all relative. I've heard a number of politicians proclaiming "as bad as the Depression". Hogwash. Overall spending IS down, true, but not nearly to Depression levels. It depends on what sector you refer to when you can even make comparisons to the early 1980's.
Still, in the last 3 months, I have (as have many others) curtailed spending and saved (or in many cases burnt off debt).
For years we've been told we need to do this. But now we are doing it, and we're being told this is bad. Explain to me why? Economic cycles require this. So bad times cannot be viewed as such - they come and they go.
I have yet to see, personally, the gloom and doom so frequently offered up by politicians and journalists. I am aware of some areas that have faced difficulties, and people who have lost jobs. But even so, we have had close to 28 years of uninterrupted growth - are we so naive as to think it could go on forever? So when it slows, are we so naive as to become chicken little?
Unfortunately, it would seem yes, we are. But I refuse to accept that. My Economics degrees weren't meant for me to follow fools or herds. They were meant for cool headed and subjective analysis and clear vision.
It is possible for things to flatline for 4-5 years. That is true, and certainly we've seen it before. And no amount of government "stimulus" (HA) can assist (it will most definitely extend the pain and further hamper future generations).
But I am willing to say that scenario seems excessive. I believe we are on the cusp of a rebound in 3-6 months. My hope, though I know truth will be otherwise, is that the government will begin to manage itself a bit more properly. Regardless, what they do impacts me little - until they decide to tax me out of existence. Hopefully, in a democracy, we can avoid THAT turn of events.
We can discuss what should be done now, what should have been done before, and what will or will not be done in the future. Wait, that has all been done. What next? Accountability, REAL accountability must happen, heads must roll, real LEADERSHIP must happen.
Then, I will not have to paste a smile on my face.
This time, we are all bewildered by large real numbers. That's all.
As for leadership, good luck with that. It's not coming with the boy wonder, given how snug he was with Fannie Mae and Freddie...
Accountability exists, but we don't apply it. How many people have we let off the hook, as citizens? How many criminals, malcontents, and general idiots have we pushed off the stage, only to allow them on again as "rehabilitated"?
I'm all for rehab. But make it real...most of these people are not real rehabs.
Point is, accountability comes at an individual level. Things like Sarbanes Oxley don't work because they take productive time away from me, a good businessman...to say "yes, I'm legit", but I know I'm legit. Still, if I wanted to lie to SOX, I could...and I could get away with it!
Laws get broken REGARDLESS of the leader or accountability. So that's never going to change. I refuse to look at these recent events as indications of anything political in nature - they aren't. They are purely economic.
As for pasting a smile on your face, for the 1 millionth time that isn't what I've said. But remember - if you think it's bad (or baaaaaad), then it's going to get worse. You've basically accepted a negative view as your mantra.
I refuse to accept this. I can do my part, and I will. Attitude and behavior are everything. If you don't believe that, then you can move to the back of the line with the rest of the naysayers.
