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Investment Outlook — White Paper February 2008
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Re: The Financial Crisis
The US Financial Crisis
As we are all aware, the US financial system is experiencing a crisis -- again. Large banks are reporting massive losses, reducing dividends and employment levels, scaling back lending, and seeking capital from sources around the world to shore up their balance sheets. This critical period for financial institutions is not confined to the United States. Just this week, a bank in the UK which had experienced a run in 2007, was taken over by the government, and a Swiss bank reported a large loss just days after denying any problems existed. In addition to billion dollar bank write-offs, other segments of the financial system have been impaired. Mortgage and municipal bond insurers, student loan lenders, and investment banks have all been engulfed in the mortgage/housing meltdown.
If a financial crisis is defined as an environment of falling prices for stocks, real estate, corporate bonds and/or other assets that result in the bankruptcies of commercial businesses, then the current environment meets that gloomy definition. The fear that important financial institutions will also fail adds to the overall unsteadiness. Would it be fair to amend the old saying that the only certainties in life are death and taxes to also include a financial crisis every decade? After all, most of these fiascos are as much a result of two of the seven deadly sins, greed and envy, as they are of sloppy underwriting and leverage. Without being Pollyannish, we have seen this cycle before -- the good news is that economies recover, markets recover, and financial institutions recover -- eventually.
Two of the more prominent economic historians that have studied financial crises include the late Hyman Minsky and Charles Kindleberger. If our arithmetic is correct, the financial mess we are now experiencing is the 37th major financial crisis since the 1600s. The last two major financial upheavals were the “Asian contagion” of 1998 and the aforementioned S&L crisis of the 1980s. (Some investors might contend that the bear market of 2001 and 2002 was no minor earthquake.) In the 1990s, banks in less visible regions such as Norway and Sweden experienced bank related financial declines that were largely contained to their own economies. The crisis in Switzerland in the early 1990s had many of the same characteristics of the current US situation -- a housing boom and bust, sloppy mortgage lending and weak banking regulation -- but a lot less publicity in our news media. The current crisis has some new wrinkles but it has largely unfolded along the lines the economists Minksy and Kindleberger have outlined in their academic research.
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