Wednesday, March 12, 2008

History Rhymes in Slow Motion

The repeated attempts by the Fed to arrest the credit contraction and prevent equity markets from going into a tailspin look to me like a repeat of what happened in October 1929, albeit in extra-slow motion. As an avid student of market history (... "it rhymes"), I highly recommend the careful reading of Galbraith's The Great Crash of 1929.

Within it are described concerted attempts to forestall the inevitable. As the market swooned in late September and early October 1929, "great men" from Morgan and National City Bank were sent to walk the floor of the New York Stock Exchange. They made a grand show of providing money at the broker call-loan post (margin funds) and supporting a variety of blue chips like Steel and Radio with repeated buy orders.

Their actions cheered speculators, who ramped up prices sharply for a few days. But when conditions worsened once again, the "great men" had to give up in order to protect their own institutions.

This time the "action" is taking weeks rather than days to play out, because:
  • The "great men" have been replaced by the Fed, which has more resources at its disposal and less inhibitions to using them. It has no shareholders or depositors to protect (except for millions of taxpayers, but that's too amorphous a group) and the man at the helm is stubbornly certain he is following the right course.
  • Markets are far more diverse and complex today than the simple stocks, bonds and trusts of 1929. While the overall leverage may in fact be far greater today, there are also more dominoes at play, i.e. more products (e.g. derivatives) and more players (e.g. all sorts of funds). Starting as always with the "bad debt" domino, it takes more time now for the whole series of them to drop before the final "equity" domino is hit a decisive blow.
  • After 25 years of successful Fed action that averted or contained financial crises, its abilities have become an article of faith with most speculators, investors and - most unfortunately - politicians. This past performance has created widespread complacency; time and again I hear the same adage from "sophisticated" market participants: "They won't let it get out of hand". The Greenspan put has morphed into the Bernanke put, even though conditions are far more dangerous now.
To summarize, events are proceeding more or less along the same path as 1929 but with more fits and starts. The experience is akin to watching a football game entirely in slow motion - it may take a while to get to the end, but the outcome won't likely be any different.


  1. H

    I agree with your comment about the importance of reading Galbraith's book - was there ever a more READABLE economist?

    Indeed, I would make it a regulatory requirement that no-one is allowed to enter the financial markets industry - defined widely - without reading at least ten books on the history of financial markets.

    Keep up the good work.

  2. At last you gave your opinion. It is also mine.

    And now what?


    I'll be all around in the dark. I'll be everywhere. Wherever you can look, wherever there's a fight, so hungry people can eat, I'll be there. Wherever there's a cop beatin' up a guy, I'll be there. I'll be in the way guys yell when they're mad. I'll be in the way kids laugh when they're hungry and they know supper's ready, and when people are eatin' the stuff they raise and livin' in the houses they build, I'll be there, too.

    Or that?

    Excuses, I am not very optimistic right now.

    Arnould, France.

  3. great post again!

    One query - I thought the Fed was owned by the banks with people having to own shares to be members of the system.

  4. Congratulations and welcome to the "dark side" of the street. I used to be alone over here, but these days I think you'll find that you're in the company of quite a few old friends.



    John J. Xenakis
    Web site:

  5. agree entirely with what "anonymous wrote about compulsory book reading.

    Almost everything that is unfolding now has happened before in fact the similarities are uncanny.

    On e of the best books I have read is called "Dodging Bullets" which is a history of the leverage mania of the 80's and the subsequent equity boom of the 90's

    Talking about the development of the LBO business and what gave it such impetus ie the adoption of a fee structure which originated in the oil and gas industry the authors wrote ...
    " One way of thinking about the fee structure - a variant on the heads we win,tails you lose- is that it is so attractive to the Street that
    "new" products will come to the market that will require it. And because there really are no new asset classes to be found,familiar assets will reappear packaged with debt to justify the fee structure"
    On the subject of memories and moral hazard they said...

    " a crash averted may be risks forgotten and eventually mistakes repeated"

    Book published by MIT press I have no connection with the authors or publishers but learned so much from reading the book that I am happy to recommend it to anyone else who believes the history of the markets is very very helpful in anticipating how events such as that we are witnessing today will eventually end.

  6. Well, let us just hope that the coming depressing gives the humanity enough time to realize, that the current model of perpetual and accelerating growth cannot continue any longer.

    Maybe even depressions have silver linings?

    At least, this time a new war will not heal the economy - last time it was only WWII that made the economy grow again. But, as said above, we cannot really have any bigger (in material sense) economy.

  7. BTW, you've just been added to FT Alphaville's blogroll after a recommendation :)

  8. Hellasious,

    Do you think that a large swath of the banks could fail as a result of the hedge fund forced selling?

    If so, who would be most vulnerable in that situation?

  9. Hellasious san,

    Accepting mortgage backed paper was mind boggling - makes one wonder what possessed the Fed chairman to make such a move.

    If the patient's running a mild fever, why prescribe a transplant?

    Great trouble I sense.

    It does seem that you've been spot on on the spot of trouble that's bugging Ben&Co.

    What strategy would you be adopting to tide over the dark times ahead?


  10. One of the outcomes of the Fed's actions SEEMS like it would be a continued devaluation of the USD.

    Consumers have all kinds of investment options these days. Is it the case I should just stuff UAE dollars (dirhams?)in my mattress?

    If what you say about asset deflation is coming, then what are some reasonable hedges to take as an investment strategy?

  11. Junior Maestro Bernanke's TSLF looks like another version of Hanky Panky's harebrained super-conduit scheme.

    The neon sign says "under new and improved management".

  12. It looks like the primary broker/dealers are all at risk of collapse as a result of hedge fund forced selling. The Fed is making a desperate effort to prevent this from happening.

    The broker/dealers' collective balance sheet is short Treasuries ($100 billion), long Agencies and private-label MBS ($200 billion), and long corporate bonds ($240 billion). This is all shown on the NY Fed Web site.

    As well, they have huge exposure to the entire hedge fund complex, given that they are their prime brokers.

    The broker/dealers effectively own the majority of the perhaps $5 trillion in total hedge fund assets (factoring in leverage). The huge amount of repos on their balance sheet disguise the underlying hedge fund assets that they are really exposed to.

    The big names at risk of collapse are:

    Goldman Sachs
    Merrill Lynch
    Morgan Stanley
    Bear Stearns
    Lehman Brothers
    JP Morgan
    Deutsche Bank
    Credit Suisse

  13. Arnould-

    I think "This" and "Or that" are linked. It seemed Hitler had an easy time recruiting ego-bruised, improverished Germans after the WWI economic destruction.

    Thai, Okielawyer, et al.-

    I keep mulling over the equality subject so I added a comment on the 3/10 post. Its a subject that really interests me and I'd be curious about your ideas.

  14. Market Ticker did a piece yesterday on the long MBS/short treasuries position - rumbunctious stuff as usual, and his conclusion?

    "The Truth is that The Fed pulled the pin on the next credit market grenade today and stuck it between its legs. It is now praying that it can hold the spoon tight and if EITHER long-bond yields rocketshot (that is, a "disorderly" unwind of people who are in them ensues) OR the spreads between them and agency paper blow further, the grenade will go off, destroying the basis in the swaps they engaged in today. In that circumstance either the primary dealers will be directly trashed or The Fed will have to throw them under the bus on purpose to avoid its own destruction."

  15. Thks. vm to Anon. for pointing out the NY Fed data on Treasury/MBS on primary dealers' books.

    I looked up the time series of the positions and as one would expect the pattern in long MBS/short Treasurys, in order to capture the yield spread (carry).

    In the last few weeks, however, GSEs are taking it on the chin, while Treasurys are soaring, making the positions very unprofitable on a mark to market basis.

    Enter the Fed with its technical "fix" trying to get its primary dealers out of a bind. Hmmm...


  16. Your welcome Hellasious,

    Do you think that the collapse of the investment bank would cause the collapse of all the major commercial banks (as a result of counter-party defaults on derivative contracts)?

    Your feedback is much appreciated.

  17. Your welcome Hellasious,

    Do you think that the collapse of the investment banks would cause the collapse of all the major commercial banks (as a result of counter-party defaults on derivative contracts)?

    Your feedback is much appreciated.

  18. Im becoming more and mroe convinced that the entire financial system collapsed in august. We're only now slowly realizing the ugly truth

  19. Galbraith is a very readable economist. I think that is pretty rare.

    I see the similarities between the events leading up to the 1929 crash and today. The one difference is the weak dollar.

    I wonder if Peter Schiff is correct when he purports that talk of deflation is folly and that inflation is the enemy awaiting?

    Are we heading toward a Galbraith-described depression or hyper inflation?

  20. If a major investment bank collapses there will be "hell" to pay ;)

    Counterparty risk would soar and the markets freeze. The problem with commercial banks is that many of them (but not all) have turned themselves into trading operations, instead of plain vanilla deposit/loan institutions.

  21. your post very much captures my "gut" feeling regarding the ongoing financial crisis. Being an economical illiterate I bought Galbraith back in August when the events became apparent for the layman.
    The slowmotion image again captures my own impression, however should the outcome be truely devastating, including social upheaval, major changes in the social fabric, the stand the us has in world affairs, even war, one would on hindsight argue this is a time where one can watch an empire falling apart.
    I also think of the poisoning of this russian Litvinenko. He fell ill and his doctors realized what the cause for his ailings was only a day before he died. But they could not have saved him even had they known from day one that he was poisoned with polonium.

  22. Off Topic...

    I like Elliot Spitzer, do don't get me wrong...

    He's already got a new job working for The BBB.... T

    This is funny...


  23. OK here it is Sorry I messed up......


  24. Try "Once in Golconda" by John Brooks, ISBN 0471357529. I think it's even better than the Galbraith book.

    There is a rather bigger issue this time around though. During the Great Depression, some banks were saved by the bank officers and shareholders putting up their money to keep the bank solvent. Do you actually expect to see any of that this time around?? I don't.

  25. H.

    excellent post. As always.

    Do I understand it correctly that you forsee a "Great Depression" scenario as the probable outcome of this crisis?

  26. Hell, I just read on Mish's blog that Japan did try something akin to the TAF and TSLF. We all know how successful they were.

    Interesting related issue--a friend of mine (an accountant) audits government books, including the states and Connecticut and California. He told me today his firm is in a big dispute with both states (Connecticut and California) as it seems both they have not been accounting for future retirement plan/healthcare obligations for their employees according to generally accepted accounting standards. Apparantly the disupte has become quite nasty-- his firm is considering dropping both states as clients for liability reasons (I don't want to share which departments they audit as it would be too easy to get back to him). But of course, his firm has financial considerations they must consider, and we all know they governement must be better than ENRON. They have not made a final decision.

    Anyway, here is my question, do you have any idea at what % GDP a country will likely outright default on its debt obligations or otherwise try to deflate them away?

    I have been trying to find the answer to this question via internet searchs without success. I read Argentinian public debt was 120% GDP when they defaulted. I know Japan is nearly 200% and has not yet defaulted-- though their economy contracts every year.

    I also read yesterday debt swaps are pricing US debt as riskier than German debt for the first time in US history... so much for the illusion of the 'risk free' US treasury.

  27. This comment has been removed by the author.

  28. "Anyway, here is my question, do you have any idea at what % GDP a country will likely outright default on its debt obligations or otherwise try to deflate them away?"

    Bearishness has reached such an extreme that we are now talking about US Government defaulting !!! US government is far from being insolvent...and also the decision to default is usually political rather than %GDP issue.

  29. There was a Fed in 1929 too, but it was less activist. And it didn't do the unconventional actions that Bernanke is doing, of nationalizing the problems of the major banks and investment banks.

    In this sense, Bernanke is a greater man than Morgan (except perhaps in 1907, before the Fed). But it costs him far less because he just has the money printed.

  30. Tery you're right. None of the banks is a partnership any more; all the leaders are just employees. They may own an amount of shares that's significant to them, but it's not significant in the scale of the overall ownership of the company. They all just live from one bonus to the next. Once they get that bonus, they're never giving it back to save the ship.

  31. Greenie, The Fed itself has basically said we are likely to default "if we don't change our ways".

    Bush's big mouth slipped the other day.

    You can't make this stuff up

    I don't think talking about default is so unrealistic. I have basically read Brad Stetser suggest as much.

  32. To have YOU say THIS is SCARY.
    Jason B

  33. If one believes that "the US Government will default", what form might that default take?

    For example, it could debase / devalue the currency; it could have a moratorium on paying interest / coupons on its bonds; or it could say that it is never going to return the capital underlying those bonds.

    Of course, it could do all three!!

    Any thoughts?

  34. Niall Ferguson gives in "The cash nexus" a historic overview of ways in which governments default. They are:

    - pay back bondholders with their own money, by levying tax or appropiating property,
    - impose more convenient conditions, by lowering interest rates (or stop paying interest altogether) or extending the duration of loans, sometimes into perpetuity,
    - announce certain debt is not going to be paid back (e.g. unsecured debt paid out of general taxes),
    - inflate the debt away.

    Gouvernments tend to find the last option the least unattractive in the short term. In the long term they find the interest rates they have to pay on new loans skyrockets. It can go up to 30% and more.

    To be fair, he also cites examples of countries who reduce their debt servicing costs by actually paying off a considerable amount of their debt.


  35. Betty, thanks!

    I put Cash Nexus down a few months ago and never got around to picking it back up. However I LOVED everything else I ever read by Ferguson (Colossus, War of The World, House of Rothschild).. you have reminded me to finish the book.

  36. If what you say about asset deflation is coming,...

    Obviously, many people do not want that to happen; it is now being suggested that new accounting rules requiring 'mark to market' be abandoned:

    Paul Craig Roberts: How to End the Subprime Crisis

    Also: AIG urges ‘fair value’ rethink

  37. Hi,

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