IN January 2008 the market forecasters gave their usual predictions for the year ahead. The sentiment was almost uniformly bullish. The stock market had a meaningful decline from the October 2007 bull market top, with the DJI declining about 1400 points. The majority view was that this was just a normal market correction; therefore, it was time to buy. They didn’t realize that it was the start of the year that would go down in history as the worst financial disaster and wealth destruction in the history of the world.
There seemed to be no concern about the accelerating defaults of subprime mortgages. In fact, Fed chairman Ben Bernanke had said the prior year that the subprime mortgage market was too small to infect the financial system.
I disagreed strongly with all the optimistic talk by Wall Street analysts. I had just finished my book, PRELUDE TO MELTDOWN. In that book I stated that my reason for writing the book was my view that the coming crisis would still be discussed in books 50 years hence, and writers would ask, “Why didn’t they see this coming?”
In January of 2008 I was just as convinced as I was in 2007 that 2008 would be the year of the most important global financial crisis at least since the 1930s. As early as April 2007, the headline of our Bert Dohmen’s WELLINGTON LETTER was “THE PERFECT FINANCIAL STORM.”
However, after the crisis of late 2008, top governmental officials, Wall Street’s “Masters of the Universe,” and economists told people that “no one could have predicted the crisis,” and “no one saw this coming.” Well, that is totally untrue.
Those who were surprised by the crisis will see in this book how the many warning flags could have been identified. We must learn from history. As the Spanish philosopher George Santayana wrote: “Those who do not remember the past are condemned to repeat it.”
This book is useful in seeing how the crisis developed and how the warning signs were disregarded by almost all the professionals, including the chairman of the Federal Reserve and the Secretary of the Treasury. They were supposed to be the genii, the finest we could find for these very responsible positions. And they totally failed.
There were a few others who had recognized the danger, but those views were ridiculed in the media. When the Crash of 2008 happened, traditional money managers and their clients were decimated. Average portfolio losses were 40%-60%, even for money managers who had good track records for the previous 30 years. They just could not adapt to the new environment. As I wrote in a WELLINGTON LETTER headline: ADAPT OR DIE.
While most investors suffered in spite of paying professionals for their alleged investment expertise, our subscribers were advised how to make substantial profits.
Arthur Schopenhauer (1788 – 1860) was a German philosopher known for his philosophical clarity. He wrote that truth goes through three steps:
1. First, it is ridiculed.
2. Second, it is violently opposed.
3. Finally, it is accepted as self-evident
In this book you will see the clues I used to predict the near-meltdown. I will refer to my long standing “Theory of Liquidity and the Markets,” which has worked so well over 30 years.
You will also see that governmental stimulus programs just do not work. Washington should have learned that during the 1930s Great Depression when one huge program after another did nothing to stimulate, but only served to prevent a genuine economic recovery. Here is how the first economic “stimulus” program by the president worked.
In early 2008, President Bush assembled, along with Congress, a $168 billion economic stimulus plan to help reverse the recession that had just started in December of 2007. The bill included tax rebates, a rescue plan for distressed mortgages, and tax breaks for small businesses. The first checks arrived in homes during the last week of April 2008. Did you get yours? Here is what the President declared at that time:
“These rebates will begin reaching American families in May. And when the money reaches the American people, we expect they will use it to boost consumer spending, and that will spur job creation, as well.”
For a brief period, the bond market sold off (the U.S. 10-year yield jumped 60 basis points) in anticipation of a stronger economy and the stock market took off for about two months (the Dow surged around 1,300 points) — led by the consumer discretionary stocks. The tax cuts were temporary (as opposed to the semi-permanent cut in tax rates in 2003 or the Reagan tax cuts of the mid-1980s). Therefore, households didn’t spend and instead saved the proceeds. As a result, the savings rate went from 2.7% in Q1 to 4.8% in Q2 of 2008, and even as real personal disposable income jumped at a huge 9% annual rate, real consumer spending was flat and real GDP barely expanded (+0.6% at an annual rate).
Washington should have learned from that. Instead, this program was followed by several trillion of other measures over the next several years. The politicians never learn, because the motivation to spend is so much greater than to save. Money creates power.
In this book, I decided to use a chronological approach, citing my observations and forecasts at the time, as written for my firm’s different advisory services at the time. The valuable lessons about how to interpret the markets and the economy contained in this book will be extremely valuable for the reader in his/her own business or investment endeavors. The charts from the actual issues of the WELLINGTON LETTER reveal how charts and indicators gave me the clues for many of my forecasts. These interpretations by themselves can help the reader immensely in interpreting and predicting future events and crises better than many economists and analysts you see in the media.
In fact, this book should be read by every policy maker in Washington, as well as the top executives on Wall Street and corporate America. The future cannot be known with certainty, but using a box full of sophisticated tools, the experienced analysts can get pretty good in giving high value forecasts of what may lie ahead. And these lessons will be especially important in the critical environment ahead.
A hedge fund manager who did predict the housing crisis and profited nicely from it, Andrew Lahde, closed down his hedge fund in September 2008. He wrote a letter to his investors in which he said he hated running the hedge fund. He also expressed some good observations about what he perceives as corruption:
On the issue of the U.S. Government, I would like to make a modest proposal. First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunct institutions.
These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it. Since Thomas Jefferson and Adam Smith passed, I would argue that there has been a dearth of worthy philosophers in this country, at least ones focused on improving government. Capitalism worked for two hundred years, but times change, and systems become corrupt.
Read more: http://www.portfolio.com/views/blogs/daily-brief/2008/10/17/hedge-fund-manager-goodbye-and-f-you#ixzz0n4NCjDHh
Yes, the global crisis was not necessary, but greed and collusion of our regulators with the big financial firms allowed it to happen. In 2010 we did not need another FINANCIAL REFORM law, just a mechanism to enforce the laws that already exist. But most importantly, we need an independent watchdog to make sure the regulators do not get in bed with those they regulate. A 5-year prohibition after leaving government against working for a firm they regulated would go a long way towards resolving the conflicts.