Reflections on the Financial Crisis
Weighing policy directives with the benefit of hindsight.
Minyanville is a digital community that prides itself on effecting positive change through financial understanding. The following exchange is shared in that vein.
Minyanville reader "Minyan Jon" writes:
I haven't dropped a line in a while but wanted to share a couple of thoughts on my mind.
1. Bad things happen when markets get stretched far enough to the upside that shorts have evaporated, technical conditions are brittle, and the value oriented buyers are too far below to matter or provide cushion. I don't think we are in that situation here, but we have been headed that way.
2. Monetary fuel has been the not-so-invisible hand for asset prices the last four years. It can continue to be, but there will come a point when the trick doesn't work any more because everyone sees behind the curtain. If the Fed bought 61% of last year's Treasury issuance without too many market complaints, it may take close to 100% to raise an alarm.
3. Most important in my mind: Your analogy was choosing cancer over the car crash. The question that will never be answered is: Where would we be now in economic terms if we had accepted the car crash and dealt with our previous bad policy choices?
What if we had gone the route of the 1990s S&L crisis, taking over bad banks, liquidating the bad assets, and wiping out equity and bondholders while protecting the depositors and then putting the cleaned up entity back in stronger private hands?
With four years of healing behind us, how much better off would we be now? What would our outlook be, having cured rather than medicated? Perhaps more importantly, how would we view policy? My concern is that, having chosen cancer and potentially survived, we have made ourselves much weaker and encouraged easy decision making rather than responsible decision making.
Our children will receive the outcome of our cancer choice as they approach adulthood. I imagine they will have some hard questions for us when the time comes.
As always, I enjoy your columns."
Thanks for taking the time to write; some quick thoughts on your above-mentioned vibes.
1. Having fought an artificially extended market in 2003 -- and survived to talk about it, albeit scars and lessons learned -- I know all too well that imbalances can mount and markets can lift for a mighty long time before a cumulative comeuppance arrives.
While I've been trading around the short side for the last month -- and my P&L has been dinged in kind after a stellar start this year, although yesterday served as a step in the right direction -- I respect (but will never defer to) the price action. This is an ever-changing endeavor, which is why we created the Buzz & Banter to update our views dynamically each and every day.
I will again say that I'm extremely bullish looking "through" to the millennial generation; it's the steps between here and there that scrunch my nose. As a trader, the path we take trumps the destination we arrive at, and I continue to employ a stair-step approach to risk management as we navigate our forward path.
2. You touch on a strong point; this is an asterisk rally in The System Formerly Known as Capitalism (note: this is not post-rationalization; we must trade the tape we have rather than the tape we want). We wrote for years about the Invisible Hand -- and many viewed us as conspiracy theorists on a grassy knoll with tinfoil hats -- but the role of central banks has morphed from a defensive buffer (as per their mandate) to an offensive agenda in a finance-based derivative-laced economy.
One thing that hasn't been discussed much -- but is central to "why" the Fed has been more aggressive in their efforts -- is the unintended consequences of the failure of Fannie Mae (FNMAP.OB) and Freddie Mac (FMCC.OB). They were the straws that stirred the velocity of money and with them shadows of their former selves, despite the best efforts of those pulling the strings of these market marionettes, all the liquidity in the world may create a rising tide but it will slosh around in slow-motion, which helps explain why banks sat on the lion's share of their newfound capital these last few years.
3. I wonder about that as well; when we wrote about this in real-time, one of my most trusted sources said to me, "People survive car crashes, and you can bet they'll drive more carefully thereafter." The truth is, we'll never know; at the time, the system was so fragile and intertwined that if the government did nothing, there's a high probability that most of corporate America -- or any company with a finance arm, at least -- would have been sucked into a cataclysmic vortex. Remember, the first phase of the financial crisis wasn't a point, it was a process; the culmination of misguided policy directives and societal largess that took years, if not decades, to build.
TARP "worked" in that it reflated markets and allowed corporate America -- banks, mostly -- to roll their debt (to future years) and issue stock, which resulted in corporate balance sheets now being the strongest they've been in many years (this is clearly bullish). It "failed" in that it didn't destroy these financial obligations, it simply transferred them from one reality (private) to another (public) and exacerbated income disparity (that Minyanville highlighted years ago) and societal acrimony, which continues to manifest.
Peter Atwater said it best at the time; sovereign lifeguards saved corporate America, but who will be left to save the lifeguards? That continues to play out overseas and it will eventually arrive on our shores, and the only viable solution set involves one of three outcomes: austerity measures, upward taxation, and/or debt destruction and/or reorganization (like we saw in Greece). That last outcome is the true medicine, in my view, but I don't foresee that being adopted across Europe, much less globally.
This will take years to sort through as, much like the Great Depression, history will view this stretch as an era rather than an event. That's not a glass-half-empty perspective; quite the contrary, actually. A phoenix will arise, and many of those eggs have already hatched. As I wrote in the midst of the first phase of the crisis, I view the 1930s as a framework for optimism. Most of society worked, great discoveries were made, and formidable franchises were established, and the same will prove true anew.
Those aren't just words; I've actually bet my career on it.
As always, I hope this finds you well.
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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 email@example.com.
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