Quite a Laundry List - Bubbles

Look at U.S. household debt as a percentage of GDP – a huge rise in just the last ten years.
Look at the incredible decline in the U.S. personal savings rate over the last 20 years.
Look at the acceleration of U.S. housing prices starting in 2000 (existing houses doubled 2000 – 2006).
Globally, from 2002 to 2006 there grew a euphoric feeling that low interest rates, easy credit, vast liquidity and rising house prices would last forever.
It was a classic example of herd mentality, “when everyone is thinking alike, no one is thinking”.
Commodity prices took off, and the private equity and hedge fund industry exploded on cheap money. Borrowing and spending were in vogue and saving was out.
It was obvious the trends on these charts were unsustainable, but where was the tipping point.
A credit bubble is like blowing up a balloon – it gets bigger and bigger and bigger and you never know when it’s going to burst. This bubble could have broken three years ago, or it could have broken two years from now.
But now we know, this bubble broke in the Spring of 07.
(One thing investors should learn about investment bubbles and manias – “it’s much better to leave the party an hour early than two minutes late”.) Every bubble is different, but in many respects every bubble is the same. The difference this time is that we have an all encompassing credit bubble and it’s global. This was a bubble;
1. In housing prices and mortgage debt
2. In consumer debt
3. In new and untested financial products
4. In commodities and
5. A bubble in bank lending, private equity deals and hedge funds

Quite a laundry list.

Twenty-Five Year Credit Bubble

So what sort of mess have we gotten ourselves into this time?
Well, over the past two years we have witnessed the bursting of a twenty-five year credit bubble of monumental proportions.
The epicentre of the bubble, of course, has been in the U.S. sub-prime mortgage market.
Contrary to almost all forecasts, it spread quickly to all sectors of the banking and credit markets and now to the real world economy – main street.
This economic contraction is the first synchronized global downturn since the 1930s.

What is the new risk?

I think that systemic risk in global financial markets has increased quite dramatically.
- What is the long term impact of one to two trillion dollar deficits in the U.S. annually for the next few years?
- Who will purchase all these treasury bonds”?
- Will the Federal Reserve ultimately resort to printing money?
- Will some of these big banks have to be nationalized.
- Do we have now, in effect, a bubble in U.S. treasuries?
- Will all the credit creation lead to major inflation three or four years out?
- Will we have a major crisis in the U.S. dollar over the next year or two?
This is all uncharted water and, no one on the face of the planet knows how it will play out.

Dr. Bernanke explains quantitative easing

Finance deep freeze

We are now in a deep freeze of credit. It is trickling down that it is no longer business as before. There are new rules and it's back to the basics.

So, what does “back to basics” mean for the financial business. To me, it means.
-running a more conservative business across the board
-reining in your growth expectations to more realistic levels.
-reducing leverage
-much less financial innovation and much less financial engineering
-more focus on client business
-more organic growth and fewer grandstanding acquisitions and
-for the world’s biggest financial institutions it means downsizing your business and scraping your plans to rule the world.

Of course, running a more conservative business, with less leverage, will mean somewhat lower profitability than we have been accustomed to in the past. That’s the price of running a more conservative business but at least, over time, you will be in business.