|
|
|
Investment Outlook — White Paper February 2008
|
|
|
 |
Re: The Financial Crisis
The End in Sight?
Most financial crises appear to go through distinct phases of a boom and bust cycle -- the current one is no different. The phases of the current housing situation are a good example of this cycle:
Individuals become aware of profit opportunities such as owning a house that goes up in value without putting up much equity. The more adventuresome buy additional properties for profit not shelter. As these profit opportunities become more popular (e.g. television shows like “Flip this House”) more individuals buy into the housing profit phenomenon. Specific states, such as Arizona or Florida, attract the most attention, and a herd of speculators starts to form.
Financial institutions and other lenders realize they can juice their profitability in a booming real estate market through aggressive mortgage products and the purchasing, bundling and selling of mortgages to investors. Cheap credit flows, fees and profits abound.
As asset prices accelerate more speculators enter the market and place deposits on real estate with the intention of selling before the project is even completed. In essence, they are taking options on further appreciation. Remember the European tourists who put down deposits on condos in Orlando during their visits to Disney World?
Builders go for the brass ring as well. They buy up large tracts of land in Arizona and California; developments spring up like desert flowers and before long supply meets demand. Price increases slow, then level off. Incredibly, prices start to weaken as speculators realize too many buyers are priced out of the market. Lookout below.
Larger speculators, such as hedge funds and banks, suddenly announce losses in arcane mortgage securities. These sophisticated institutions were actually more leveraged than some of the house flippers. Mortgage brokers go out of business, banks suffer massive write-offs and lending is curtailed.
Now the problems start to affect the broader economy. The ability to borrow becomes more difficult as lenders tighten standards and seek to repair balance sheets with new capital. The economy slows.
At some point, but not quite yet, confidence is restored as institutions, such as the Federal Reserve, step in, lowering interest rates and injecting funds into the capital starved lending institutions.
We are beginning to see indications that we may be in the final phases of this crisis. Institutions are stepping up to the plate. The UK government is absorbing their largest, most important problematic lender, Northern Rock. Foreign governments and investment entities have surfaced to inject capital into the likes of Citigroup and the large Swiss bank, UBS. Berkshire Hathaway has come forward with an offer to back municipal insurers. As 2008 unfolds, more well capitalized entities will emerge to help clean up the mess.
It is important to remind ourselves that these financial maladies are always remedied -- it is only a question of time. In most circumstances we have found ourselves back on track within a year, though sometimes it takes longer. We are confident that housing prices will decline to a level that will induce buyers with solid credit and sufficient equity to reduce the inventory overhanging the market. Mortgage delinquencies and defaults will eventually peak and the securities that have afflicted Wall Street and their humbled investors will stop having to be marked down. Balance sheets will slowly improve and lending will pick up again. No doubt some will predict a much longer timeframe -- until 2010 -- before we see a resolution; others will worry about additional shocks to the system. We are not sure how long it will take. Our perspective is that US stocks will withstand the current crisis and are outstanding values. We have seen this before, or at least a close duplicate.
February 27, 2008
|
|
|
< Previous 1 I 2 I 3
Next >
|
|
|
|
News
Investment Outlook