Friday, October 10, 2008

Bear waste

It must be hard on journalists each day having to measure the last worst similar event. FT defines today as "The worst week for stock markets since the crash of 1987. Or since the 1970s slump? Or even before then, since the 1930s? It has certainly been awful. Some $6,200bn was wiped off the value of the world’s stock markets last week as a Category 5 Credit Cyclone smashed around the globe. Many markets simply battened down the hatches and didn’t open. What has been going on?"
Then having settled the all-time worst list, the next problem is explanation. what, where and why now? The FT again, though could equally well be Reuters, Bloomberg or the WSJ, finding a succinct answer that is not at all simple. "The simplest answer is: distressed selling. Hedge fund redemptions prompted one round of sales. Steep losses in the leveraged loan market, related to Icelandic banks, piled on further pressure. Then there were fears about whether $450bn of credit default swaps taken out to insure Lehman bonds would settle on Friday afternoon. Distress spread from there. Even gold was not immune. Bargains have been spurned – the S&P 500 is now trading on 9 times forward earnings, its cheapest level since 1985. But those deals are going to remain on the table until investors are clearer what the rules are – let alone valuations. In fact it is remarkable that equities stood up so well, for so long?"
Yikes! Then what's to follow next? It is to go back to some starting point of the present downward trajectory, either the origin, take-off or highpoint before falling; in this case the latter,
"The crisis in credit markets began in March, with the collapse of Bear Stearns. Equities have only been hard hit over the past three weeks, since Lehman failed. If history is any guide, it could get worse. For example, from its peak last year to its current levels, the UK’s FTSE All-Share has dropped by 41 per cent and the S&P 500 by much the same. By comparison, between 1972 and 1974, the FTSE All-Share fell by 70 per cent, while the S&P 500 lost ”just” 48 per cent. (The 1987 crash was a relative tiddler: a peak to trough drop in the UK of 25 per cent.) All these falls, though, are dwarfed by the 1930s market collapse. In the space of only 15 months, the S&P 500 lost 86 per cent."
Of course, this means that the authorities took the biggest gambles, had they but known it, in letting such long established brands such as Bear Stearns and later Lehman Brothers go spectacularly under (for long periods highly esteemed firms, hough each having failed and been saved 3 times in their histories) and such firms allowed to crash as the most brutish way to discipline the rest (banks, investment banks especially, and also shadow-banks) - the equivalent of shock & awe tactics (that as we all now know didn't work long term in Iraq).
Arguably, belief in the benefits of short term Darwinism as a learning principle and core virtue of modern capitalism doesn't work either, or at least not as a cure for systemic problems. With the benefit of 20/20 hindsight Bear Stearns collapse and Lehman brothers bankruptcy (to which we can add Fortis and maybe some others, and also conclude that the DNB were totally right in trying to defend the integrity of ABN AMRO) looks like trying to cure depression with electro-shock therapy as a salutory and curative lesson for all the other inmates of the asylum! instead, the patients lost confidence in the psycho-medical professionals and quite sensibly panicked!

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