Everyday I hear worse and worse news... and I heard one of the associates saying that the subprime crisis is the worst in 20 some years.
That got me thinking, how does the current crisis compare to previous events (e.g. Asian IMF, Tech bubble etc...) Would appreciate it if any veterans can shed light on the issue.
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I think it's still too early to say.
One thing that is certain (short of armageddon) is that there are cycles - there will always be a recovery, followed by a boom, then a crash, then a recovery, etc.
But how it occurs, why it occurs, how long it lasts and who it hurts the most will differ. Of course everyone gets screwed to some degree, but different segments will get screwed more than others.
Let's work backwards in time.
Tech bubble 99-01: Netscape in '95 was the seed that planted it all. In hindsight, this wasn't as bad as it seemed back then (9/11 was unrelated, but it was the last cruel kick in the crotch when the markets were already down from the March '01 highs) to remind everyone that we were in a recession). The folks who got screwed the most were white collar workers in tech and professional services (banks, consulting, advertising, legal, etc.). These were the ones who benefitted the most from the run up, and got impacted the most. Outsourcing was born out of this, which only further screwed the cubicle dweller. Call it a "cubicle dweller" recession. It was also an "equity" recession - since the run up was primarily equity-driven.
Asian crisis 97-99: this caused some headaches outside of Asia, some bankers got screwed, etc. but it was middle class Asians and Asian industry that got screwed the most. This downturn was characterized by VOLATILITY to the max. I still remember back then in banking when I was in Asia -- you get back from lunch, and some of the Asian currencies DOUBLED in depreciation since the morning! (which would cause a huge stampede to the malls to buy Nikes for the US$ equivalent of like $30). It was a credit crisis that was caused by sudden wild swings in the currency markets, causing many companies to have their debt obligations (denominated in US$) balloon overnight. It's like a really harsh but quick storm that destroys the neighborhood - and then spending the rest of the two years trying to rebuild. In hindsight, in spite of the doom and gloom about "Asia's time in the sun being over" -- it was just getting started. It was just a blip, because you had this huge country called China which continued to grow and grow and grow...
Early 90s recession: started with the '87 crash, but really took hold after '89. A severe hangover from the largesse of the 80s in the equity market, debt (junk bonds), real estate, and the savings and loans crisis. Unlike the Asian crisis or the tech bubble, this one did hurt people across the board. Yuppies and wall streeters lost their jobs, but so did a lot of the blue collar/union guys in manufacturing as it was a broad-based downturn (remember Japan and Germany were still in a huge boom, and there was the whole "Japan is gonna take over the world" fear as they became the manufacturing powerhouse).
Interest rate mess 1982: don't know much about this, other than recalling that people freaked out about 22% interest rates on their mortgages. People lost their homes, but it also hit the manufacturing sector particularly hard -- it was a working class recession and really widened the gap between rich and poor which continues to this day.
Oil shock early 1970s: the US got off the gold standard in '71 as did other countries, causing the US$ to depreciate significantly. OPEC which used to peg oil in US$, realized they were getting less money for oil. So OPEC pegged it to gold. Oil prices shoot through the roof. Everyone's pissed.
1950 - 1970: this was really a golden era. Don't recall hearing about any real major economic downturns in the US. There certainly was social unrest with the civil rights movement, Vietnam, counterculture, etc. but the US economy really had a period of stable prosperity during this long period.
Great Depression: this is the big one. I don't think we'll ever see this (at least I hope not) in the US. Unlike the other ones I've mentioned above, the Great Depression didn't happen suddenly, but was more a slow death that started with the stock market crash in '29, and arguably ended with the US starting its war machine by supplying Europe's fight against the Nazis from 1939 onwards (and then officially sending men in 1942). Back to the Depression -- a credit crisis causing massive bank failures, the dustbowl in the midwest (severe drought causing food shortages), and massive unemployment as industry slowed to a crawl (around 25-30% not for a few months, but for a few years, and remember that this was a 10-year depression!). In every other downturn since, unemployment never hit more than 10% (I believe the early 80s did, but if you look at any downturn, none has hit close to even 10%). This was also the time of Prohibition with the puritanical mentality at its height (kinda like the jesus freaks of today).
This current crisis will be more broad-based than the tech bubble. It's not just a credit crisis, but a combination of things that hit at the same time - namely, the housing crash, energy crisis AND the US's ballooning deficit thanks to Iraq.
The credit crisis will hurt the homeowners who lose their homes (obviously) and the financial institutions that serve them. This isn't just a housing issue, but seems to be a long overdue correction to cheap credit which everyone from homeowners, credit card holders, hedge funds, banks, and foreign investors investing in the US have all gotten into this game. Remember that Greenspan tried as hard as possible to prop up equity markets during the post 9/11 crash with real interest rates approaching zero - by trying to prop up the Dow, he made borrowing money essentially free.
The energy crisis is basically the bell tolling -- reminding us that the period of cheap energy is now over. There are 2 billion Chinese and Indians that have gotten hungry for oil overnight (10 years), and the US/Europe have only continued to guzzle for cheap. Speculators only make it worse - the price should be around $120/bl, not $150. Not to mention Iran stirring up shit like an internet troll. Our economy will adjust to higher energy prices, but it won't happen overnight. This more than the housing crisis will hurt everyone in the medium-term, and is what seems to be driving markets right now. The credit crisis doesn't help, but $150 or even $200 oil means that many industries have to figure out an entirely new business model, from airlines to autos to utilities and just about anything that uses electricity. And yes, joe consumer - it's not just changing prices, but the prices will force consumers to change how they live and behave (not to mention city planning).
When it comes to the credit crisis, it's a solve-able (i.e. bail out those that will cause the dominoes to fall). The Fed and its equivalent institutions around the world will not let the financial markets fail. Even China and the Middle East will step in if they have to because it's a Ring Around the Rosie (we all fall down).
The energy issue is the harder one. First there's oil. Is water next? With one-third of the world's population going from poverty to middle class within just one or two generations, we need to fundamentally change how we consume and produce "stuff". In other words, to fundamentally change our daily lifestyle habits that have been ingrained for generations. It's hard, and it's scary -- because the lingering question is can we make that change in time?
Alex Chu
While I appreciate the effort you have made to answer the OP's question, I have a sneaking suspicion that you are talking out of your ass, especially when you shift from history to current events. I have a couple of questions regarding statements that you assert as fact.
1) How do you derive the fundamental value of Oil as $120 per barrel. I recall a piece in the WSJ a couple of weeks ago talking about the price of oil. They had the lead economists from each of the big banks' energy departments give a price they expect by the end of 2009. The range was remarkable. Some had it near 300, others had it less than 70. Where does your figure of 120 come from, and why are the "evil" speculators to blame for your $30 difference? 2) #1 begs this question: Are you in favor of regulating futures markets? 3) Do you blame the "Jesus Freaks" for our current situation? Do you blame the "puritanical mentality" for the Great Depression?
BlueHorseShoe,
From your posts here, you seem to get angry when you suspect someone disagrees with you. Or you are looking for a fight.
I don't know how my post warranted such an emotional response from you.
'Cause whenever someone disagrees with me on economics, I spew ad hominems for no reason too.
I have family in the oil business. I don't recall exactly where I read it, but do recall OPEC recently saying how oil should be closer to $120. If that very concept makes your nose flare, then I'm sorry you feel so emotional about it.
As for regulating futures markets. I don't know. Never said anything about that. Just pointing out the problem that others are seeing as well.
The puritanical mentality didn't cause the Great Depression, but it was a coping mechanism for suffering, just like the Great Religious Awakening it seems these days. If you are a Jesus Freak, my Jesus salutes your Jesus.
Save your bluster. I'm sorry my long-winded and rather dry post about economics got you so emotional.
Alex Chu
Then don't write so authoritatively. It's not the concept of $120, it's the fact that you have demonstrated no more than surface level knowledge of current economic trends, yet tried to pass it off as fact.
There is no bluster on my end, merely a desire to stop the spread of misinformation.
Feel free to write extensively on the GMAT; I won't question your knowledge there.
Alex,
That was an excellent post. It is obvious that you’re a very well read individual and I think you hit the nail on the head by saying the energy crisis is by far our greatest concern in the economy today. However, there are a couple points that, if I may, I’d like to add.
First one pertains to your view of a ‘solve-able’ credit crisis. Does not the notion of a government bail out for those who engaged in risky behavior to create the credit crisis in the first place seem a bit flawed? I understand that the consensus of a bailout is that it is an ‘effort to prevent a collapse of the entire financial system’, as in the case with Bear Sterns, but you make no note of a subsequent re-regulatory process after the bailouts ensue. This re-regulatory process, to me, is just as crucial as the bailouts themselves. It is a matter that relates to only being concerned about the short-term (just bail them out, and all will be fine) when we should be thinking about the long-term health of the entire financial system itself (perhaps by implementing new laws that limit the amount of risky behavior a financial institution/individual is allowed to take on?).
Can we continue to keep putting off the problem by decreasing interest rates and increasing bailouts during every credit crunch? With the rise of complex financial products such as credit default swaps and structured investment vehicles, it’s often hard to even gauge how much risk an institution is even taking on nowadays. Either we revamp various areas of the system now or we will again come face-to-face with another credit crisis five or ten years down the line, and another one after that, and so forth. I think you are correct in labeling the energy crisis as THE serious long-term threat to our economy, as well as the world economy. But at the same time, I think it would be a serious mistake to dub the credit crisis as just a short-term ‘adjustment period’.
I’m not trying to stir up a debate here, but rather I just wanted to point out a few crucial points of concern on my part. I do, however, think that policy makers have taken a step in the right direction regarding the recent initiative taken to increase margin requirements in the futures market to crack down on price-influencing speculation. I would however like to see that same initiative taken in re-establishing capitalization requirements for financial and investment houses because I think it’s far to easy to find a loop hole these days around an under-capitalized status. This is just my two cents. But like you said, the energy crisis is by far the biggest concern of our generation and probably many generations to come……..
Of course it is. If you've taken economics you probably remember the concept of "moral hazard" which is precisely what you're talking about.
However, in reality, whether it's right or wrong, whether it's a short-term fix for a long-term habitual problem is not really the issue.
Because right or wrong, the gov't WILL bail out the system. The one time they completely turned their backs was the 1930s before Roosevelt (who formed the FDIC).
We've had credit crises a number of times already, and when the Fed feels that the market may fail to function and collapse, the WILL step in. We can argue all day long whether it makes sense economically long-term for them to do that, but it makes no sense politically for them to not bail them out in the short-term especially when they have an electorate to answer to.
Governments, even institutions that aren't elected by the public (such as the Federal Reserve), respond to the voting public.
Why do you think Greenspan was under tremendous pressure to keep interest rates so absurdly low post 9/11 to prop up equity markets? If he didn't, an economic policy issue would turn into a political issue.
Alex Chu
Alex,
Yes, I have taken my fair share of economics courses and I'm well acquainted with the concept of moral hazard........
Edit by Moderator: this long quote was causing display problems on the page. Therefore needed to be truncated.
Really great posts, probably some of the best I've read on this forum. Appreciate the overview of all that's going on (and in the past). I'm also glad to see people realizing that commodities are going to be the (a) big issue from this point on. The fundementals are there to create higher prices so it doesn't really seem like a bubble or an issue going away any time soon.
But if the fundamentals are there, and are as apparent as you (WxOnWallStreet), wouldn't that already be priced into futures and other derivatives? I think a more important question is, when are we going to stop deluding ourselves with corn ethanol? --> The only alternative form of energy I want to hear talk about being implemented is nuclear.
ha
sure they should be priced into derivatives. just like the housing crisis was. and the foreclosures and the subprime debacle and the ridiculous, unsustainable leverage on buyouts.
please. 'finance pros' aren't geniuses. the signs were there. many, many people were shouting at the top of their lungs that this is going to get ugly and it didn't get priced in. it's not like no-one saw this coming. paul krugman was writing about this in 2004. in fact, he practically predicted the trajectory of events a few years in advance. smart people talked, no-one listened. markets are not efficient.
Don't talk to me about Krugman.
Are you telling me that there were just as many people talking about the shaky valuations of CDO's, SIVS and other esoteric securities as there are talking about the inevitable commodity boom?
what exactly is wrong with krugman? he's shrill and a left-wing apologist. but he saw this coming and he spoke loudly about it when no-one else would.
since the values of these derivatives were tied entirely to the real estate market, yes, there were people who saw that coming. warren buffet called the entire financial derivatives market a ticking time bomb.
a lot of people think it's all because of the bad loans and structuring. when in reality, most of the damage has been caused just by the entire, broad-based housing market declining rapidly. that was the important thing to catch -- rents vs. prices relationship out of wack, yoy increases that were unprecedented, enormous growth in housing as percentage of gdp etc. -- and many people did see that coming.
the commodity boom caught many by surprise, but certainly not the oil boom. goldman was predicting oil at a 100 as early as 2005.
to act as if the market is perfectly efficient and everything is priced in is naive. wall street always likes to see things as "once in six sigma!" events. these events happen every so often anyways. we just don't want to admit that our models are imperfect and are based on assumptions that will not always hold true and we don't know when they won't hold true.
Of course the market isn't perfectly efficient, and to think that it is would be as you say "naive". But what might be more naive is to follow your line of thinking:
AFTER a significant run up in the prices of commodities, look around and try and figure out why-> Oh wow, a huge world population that is enjoying higher standards of living-> Increased demand worldwide -> These prices have nowhere to go but up in the future.
That strikes me as particularly naive. Sure, the markets may not be 100% efficient, but I guarantee you, they are efficient enough that if a bunch of internet rainmakers have correctly predicted a commodities boom, the majority of future growth has been priced into the derivatives.
You pretty much nailed my problems with Krugman (particularly his tendency to blame Bush for everything), except he also doesn't believe in supply side.
No one is arguing (at least I'm not) that the cause for a large portion of our current mess was caused by broad housing market declines.
I am arguing with those of you who have recently and conveniently developed theories around energy and commodities.
Let's assume for a moment that you are correct, and that it was widely known that a lot of the structured credit products were significantly flawed. Why then, did the banks keep peddling these products? The answer would be it helped the bottom line at the time.
Consider also the argument that speculation has artificially increased the price of oil. Why would banks do this? Obviously, to keep moving the price higher, and help their bottom line.
THEN, why are you not assuming that these processes have already been started by the banks regarding commodities?
great discussion so far. I am not sure where the price of oil should be right now but I do believe there is a very significant speculator interest/dollar hedgers that have inflated the price of oil. Dont really have the time now to go deep into why I feel that way. My trader instinct says do not fight the trend and try to short this, buy the dips.
"Oh - the ladies ever tell you that you look like a fucking optical illusion?"
sweden and japan had to eventually bail out their banking systems at a huge cost to gdp. so did china.
everyone does it.
I was simply giving my thoughts and opinion. Not pretending to be an authority on anything -- and if I write so well to the point you think it seems authoritative, I take that as a compliment on my writing abilities.
I'm hardly an economics expert, but I'll let my knowledge of the subject (and of history) speak for itself on these posts, just as your posts will speak to your knowledge or lack thereof.
Again, if you don't agree with it, don't read it. But no need to be a jackass about it because you really haven't added much to this discussion other than questioning every poster who seems to hold a contrary view to yours (or who you wish to hold a contrary view to yours in order for you to expunge all that pent up banker frustration).
Alex Chu
MBAApply had me until he started putting down the "Jesus freaks" who account for 80 to 100 million Americans.
Let’s please try to keep religion out of this.
My argument about commodities not being a bubble is that the market is reasonably reacting to what appears to be a general consensus on the underlying fundamentals. Take oil for example. It is generally accepted that supply is shorter today than in the last decade and dropping and demand is larger today than in the last decade and growing. Global trends like this are well known and widely accepted truths and that has helped drive this market higher. Basic economics.
It is this consensus that is priced into the market right now and causing prices to go well above where people say they “should” be. Speculators or not, as long as there’s a sufficient number of buyers at 140 to satisfy the sellers, the market price will be 140 and that is where it “should” be.
Now, whether it’s a bubble is a matter of personal opinion. If you believe these fundamentals to be somewhat false and that oil is not running out, then yes this is a bubble and it will burst when the “truth” comes out. However, if you believe these fundamentals to be good science along with ideas like peak oil theory, then fundamentally, it makes sense to have prices be this high and they should continue to go up unless things change i.e. new sources of energy, drastic lifestyle changes both in the US and abroad, etc…
Just my 2 cents. Can’t wait to ripped into a thousand times over.
I must agree with WxOnWallStreet, if you look at both NG and Coal right now, and bull runs they have been on. The fundamentals are there, North America is getting less and less LNG, Storage is lower than previous years.
The speculators may push the price up, but China/India are still willing to pay for it. All the countries with subsidized energy will keep buying to continue to grow.
Completely agree with you, WxOnWallStreet.
When will the market rebound? When will oil prices drop? When Will the housing prices go up? When will the last write-down be? When will the subprime mess be over?
When are we going to see financial stocks such as C, UBS , and Leh gain what they have lost so far of their value ( about 80%)?
When will the airlines crises be over?
There are many questions to be answered....
If you knew the answers to those questions, you would be rich.
The idea that speculation has driven up the price of oil and other commodities is utter fiction. To paraphrase the Economist, arguing that speculation through derivatives contracts (which are settled in cash) impacts the prices of real goods is analogous to arguing that betting on a horse impacts the outcome of the horse race. Empirical examples abound--look at the price history of copper and nickel. Massive rises in speculative trading volumes coinciding with prices that have fallen significantly.
At the end of the day, speculative contracts are just rolled over. Cash settlement occurs and there is no impact to the transactions of real goods that take place. Supply and demand determine the market price. For those of you who are so 'sure' that the fundamental value of oil is less than it's current price, why aren't you selling futures?
That is a common misconception. The spot market for oil was becoming increasingly subject to manipulation, which led oil exporters to turn to the futures market, which was more liquid and hence less subject to games-playing, as the basis for contract pricing.
Instead of using dated Brent (European and African spot market index) as the basis of pricing crude exports, several major oil-producing countries such as Saudi Arabia, Kuwait and Iran rely on the IPE Brent Weighted Average (BWAVE). The BWAVE is the weighted average of all futures price quotations that arise for a given contract of the futures exchange (IPE) during a trading day. The weights are the shares of the relevant volume of transactions on that day. Specifically, this change places the futures market, which is a market for financial contracts, at the heart of the current pricing system.
Long story short, oil prices are determined by the futures market.
Oasising: does this also apply to WTI? I'm asking because of the arguments brought forth in the press last year when Brent went to a premium over WTI after having been at a discount for so long. Most in the market were arguing that WTI should no longer be the benchmark, and that Brent should more accurately reflect world events and WTI prices should be driven more by actual events on the ground at Cushing.
The empirical examples I listed, nickel and copper, contradict your analysis.
the truly devastating event for the world economy will be the obama presidency and the new deal 2.
growth in the third world might help, but they're more likely to collapse.
Where are you all now? Oil not a bubble...and all that noise?
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