Update to the Outlook

This piece was written for a customer who deemed it too long for his use. So, since I hate to waste 2000 words–enjoy! Regular readers will note that there is some repetition here for you, but that’s because you’ve already learned this stuff while new clients haven’t.

It’s a hard cruel world out there with much economic turmoil and concern. Since August 9, 2007, the day that the huge French bank BNP Paribas (one of the 10 largest in the world with assets in excess of $1.3 trillion) told owners of shares in three of its mutual funds they could not redeem them “because we own bonds based on U.S. subprime mortgages that we can’t put a value on right now,” financial panic has spread around the world.

Nothing makes an investor madder or more scared than being unable to cash out his or her investment from a fund. This problem has recurred many times throughout history. A comprehensive documentation that is also a most delightful and interesting book to read is Manias, Panics, and Crashes: A History of Financial Crises (5th Edition) by Charles P. Kindleberger and Robert Aliber (ISBN 978-0-471-46714-4). This wonderful book, which has always been a huge hit with my MBA students in the several second-year elective courses when I’ve used it, covers the history of financial panics around the world from Kipper-und-Wipperzeit of 1619-1622 and the Dutch tulip bulb episode in 1636-1637 through the Asian collapse in 1997 as well as the Russian default and the collapse of Long Term Capital Management in 1998 and the corporate scandals of 2001-2003 (Enron, Worldcom and so on).

The Wall Street Journal had a lead editorial on September 16, 2008 (“Surviving the Panic”) referring to the usefulness of this book in understanding the current situation. You’ll feel better if you get a copy of the book and peruse it carefully.

Few people were sorry to see 2008 pass into history at the stroke of midnight on December 31. Many will be happy to see the end of 2009 as well because it has seen the largest decline in global economic output and international trade since the end of World War II.

The International Monetary Fund (IMF) in its October World Economic Outlook expects world output to shrink by 1.1 percent in 2009 after having grown 3.0 percent in 2008. They expect global growth of 3.1 percent in 2010 and for growth to average 4.4 percent a year in the 2011-2014 period. Click here to read the full post and comment (Insights subscribers) »

The Panic of 2007-2009 May Finally Be Ending

The decision of the huge French bank BNP Paribas on August 9, 2007 to suspend sales and redemptions of three of its mutual funds that had major investments in mortgage-backed securities that were based on U.S. subprime mortgages launched the Panic of 2007-2009. It was easy to tell we were in a panic because the spread between the 3-month LIBOR (London Interbank Offer Rate) U.S. dollar rate and the bond-equivalent yield on 3-month U.S. Treasury bills shot up from its long-term range of 5 to 9 basis points to over 200 basis points.

It was only a few months ago that these spreads began to come down out of the stratosphere. Click here to read the full post and comment (Insights subscribers) »

In Defense of Chirpy Forecasts

The March 30 edition of Newsweek had an article by Kenneth Rogoff and Carmen Reinhart entitled, “Don’t Buy the Chirpy Forecasts.” He’s a professor at Harvard and a former, well-regarded chief economist for the IMF. She’s a professor at Maryland. They have a forthcoming book, This Time Is Different: Eight Centuries of Financial Folly, which sounds interesting. Related work can be found on Rogoff’s Harvard faculty contact page.

Here’s their main point: “The recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11-12 percent in 2011.”

As you know, I put a great deal of emphasis on historical precedents. My favorite book on this subject remains Manias, Panics, and Crashes. Reading it should convince you that we’ll only have such a dire outcome if policymakers make mistakes as bad as those their predecessors made after the Panic of 1907 (the Federal Reserve System
wasn’t created until December 1913) or in 1929-1932 (there was no bank deposit insurance, the Fed allowed the money supply to shrink by 1/3, Congress enacted the catastrophic Smoot-Hawley tariff and kept raising taxes as government revenues declined). Click here to read the full post and comment (Insights subscribers) »