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The worst market crisis in 60 years

By George Soros

FT.com Published: January 22 2008 19:57 | Last updated: January 22 2008 19:57

The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years.

However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.

Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available. A bubble starts when people buy houses in the expectation that they can refinance their mortgages at a profit. The recent US housing boom is a case in point. The 60-year super-boom is a more complicated case.

Every time the credit expansion ran into trouble the financial authorities intervened, injecting liquidity and finding other ways to stimulate the economy. That created a system of asymmetric incentives also known as moral hazard, which encouraged ever greater credit expansion. The system was so successful that people came to believe in what former US president Ronald Reagan called the magic of the marketplace and I call market fundamentalism. Fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves. Nevertheless, market fundamentalism emerged as the dominant ideology in the 1980s, when financial markets started to become globalised and the US started to run a current account deficit.

Globalisation allowed the US to suck up the savings of the rest of the world and consume more than it produced. The US current account deficit reached 6.2 per cent of gross national product in 2006. The financial markets encouraged consumers to borrow by introducing ever more sophisticated instruments and more generous terms. The authorities aided and abetted the process by intervening whenever the global financial system was at risk. Since 1980, regulations have been progressively relaxed until they have practically disappeared.

The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.

Everything that could go wrong did. What started with subprime mortgages spread to all collateralised debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi-trillion-dollar credit default swap market. Investment banks' commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The asset-backed commercial paper market came to a standstill and the special investment vehicles set up by banks to get mortgages off their balance sheets could no longer get outside financing. The final blow came when interbank lending, which is at the heart of the financial system, was disrupted because banks had to husband their resources and could not trust their counterparties. The central banks had to inject an unprecedented amount of money and extend credit on an unprecedented range of securities to a broader range of institutions than ever before. That made the crisis more severe than any since the second world war.

Credit expansion must now be followed by a period of contraction, because some of the new credit instruments and practices are unsound and unsustainable. The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves. Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so. With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.

Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.

The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.

The writer is chairman of Soros Fund Management

Also Motorola warned today, along with Apple...market will crash again today...I don't know how do you feel, but I feel so bad that I would like to turn off my pc, close everything and stay away on a beach for some months.

David, as you know,  I chosen the worse period to be under evaluation by a bank....

Soros' staffer could not be more correct. The lending problems and the people/institutions that have created them have just begun to fall apart; a problem that has grown exponentially to  such a degree that its almost impossible for anyone to know "how" large it actually is.
This is the catalyst that will, over the next decade, give the US it's "comeupins"; the term imortalized in Orson Welles' "The Magnificent Ambersons", God only knows we've got it coming....

I say we are going down today more and by Friday, you will see people throwing in their cards. I think Friday will be a day to buy something. Maybe just a cup of coffee, but at least something.

                        m

QuoteHowever, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.

Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available. A bubble starts when people buy houses in the expectation that they can refinance their mortgages at a profit. The recent US housing boom is a case in point. The 60-year super-boom is a more complicated case.

More than 8/10 of the World population never had a credit in their entire lives and they say the credit boom is over. Talk about misconception. When Soros published the book "The Crisis of Global Capitalism" the new global Bull Market started, so this is a good sign

Just my humble opinion.

 David, granted the credit boom isn't over; its just over "here",  at least in the current threads it's wearing. We, Americans, must change "how" we deal with credit to survive this. As for the other people in this world, yes, many have never experienced spending money they don't have but of course we can solve that! All the above noted in the tone of personal credit which, has little to do with what banks and institutions do. That being the 600 lb. gorilla in the dining room...

                                          m

Quote from: anvilring on January 23, 2008, 09:09:40 AM
David, granted the credit boom isn't over; its just over "here",  at least in the current threads it's wearing. We, Americans, must change "how" we deal with credit to survive this. As for the other people in this world, yes, many have never experienced spending money they don't have but of course we can solve that! All the above noted in the tone of personal credit which, has little to do with what banks and institutions do. That being the 600 lb. gorilla in the dining room...

                                          m

Yes, I think Americans will have a tough time ahead and will need to pay back their debts. But one thing is the average American, another is the average S&P 500 company.

Since more than half of the S&P 500 and Nasdaq companies revenue comes from outside of the US, I believe that strong Worldwide growth (mostly driven by imitation of what the US did over the last decades) is more important as a long term investment thesis than a US economic recession, which everybody already knows about anyway.

China, a 1.3 billion people country, is doubling its GDP every 7 years. Isn't this more important for the long term economic outlook than a US recession? Yes, China may also have a big slowdown, but still, that's going to be conjunctural, the structural positive trend in growth will probably continue, because all that is needed to do better is to turn on a computer and see how you, Americans, do/did, things. It wasn't like this just a few years ago, when the World wasn't yet convinced that you had the upper hand (and the internet didn't exist). Now we don't have the Communists (at least not so many) to confuse things  

As I write the market is opening in a "crash mode" again. So probably I'm wrong. I've been wrong before.

Well, I'm going for a walk, see ya

Couple of interesting stat's

Average monthly credit card balance
USA - $8,400.00
Canada - $2400.00

Percentage of people paying off there monthly credit card balance
USA - 44%
UK - 56%
Canada - 73%

uc.

Nice recovery here.  Let's hope it holds, so we can get a least a short term rally.

Volatility index hit 39 today...now dropping.

Stocks don't go straight down....geez.

Yah, some of the numbers have turned from red to green on my sceen.  I almost forgot about that color.

Nice reversal day today.  Like I thought last Friday...the fear of these bond insurance companies possibly not having enough capital to insure bonds and possibly causing a freeze in the credit markets really spooked the markets over the weekend and yesterday.  Obviously if the credit markets froze we would have a drop in the market like we've never seen.  However we got some encouraging news from the New York Insurance Department today that they are aware of the problems with ABK, MBI and PMI...among others.  So obviously governments are aware and actually working on the problem.  ABK up 73%...MBI up 35% and PMI up 12%.

However debt levels will probably continue to way on the markets.  It was encouraging to see banks and financials recover today...so it may very well be the smart money is seeing an end(6-8 months down the road) to this credit market problem.

It looks like we will see a short-term rally and technically, like I mentioned yesterday, the S&P touched a trend-line, going back to 1982, and bounced. There is a "less steep" trendline that could take us down to the level around 1225 going back to 1984.  The "less" steep trendline actually looks like the over-all market trend going back 25 years.   

So I would expect lots of volatility for the next couple of months....but I am encouraged that the financials which created this mess are actually turning positive...

This is more a credit problem than an economy problem...


January 23, 2008 1:57 PM ET
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Associated PressAll Associated Press news

NEW YORK (AP) - Reports that state insurance regulators were meeting with troubled bond insurers fueled hopes that the sector may get a lift from the government, boosting shares in Ambac Financial Group Inc. and MBIA Inc. for a second day Wednesday.

On Tuesday, the New York State Insurance Department said it was working with the bond insurance market to ensure the stability and availability of that insurance. It did not provide specifics. The agency was expected to meet with Ambac Wednesday.

That apparently overshadowed news that the Secretary of the Commonwealth of Massachusetts subpoenaed records from Ambac and MBIA. William Galvin said he wants to determine if the two "informed state communities and investors of the insurers' exposure to highly risky securities," according to press release from his office.

"This office wants to know when and if MBIA and Ambac disclosed to bond issuers - the cities, towns, districts and other public authorities -that their financial condition as an insurer was being severely impacted as a result of their involvement with these highly risky securities," he said.

The secretary issued the requests last week and demanded a response by Feb. 1.

That news came a day after Ambac said it was discussing ways to raise the capital needed to shore up its reserves, giving it the financial clout to regain a top-notch "AAA" rating from Fitch. Ambac reported a loss of $3.26 billion in the fourth quarter after contracts it issued to cover claims plunged in value.

Fitch had cut Ambac to "AA" last week, prompting a sharp sell-off in its shares. Without the top rating, the insurer will have difficulty generating new business, especially with all-important municipalities that account for the bulk of its customers.

MBIA raised $1 billion in the last month to boost its capital

as always the IV update:

Old Fool Notes – 01/23/08
A VERY interesting day.  We had a 106 point day from bottom to top on the Naz and (I think) a 600 point move on the Dow.  What a reversal – will it stick – who knows.  What is clear is that it will be a battle.  The volume today was 3.6 billion (huge) and the ratio was 1.3 to 1 in favor of the bulls.  That is good efficiency for 24 points.  The important factor is the ratio reversed (very rare) from more than 3 to 1 in favor of the bears.

The daily chart made a nice reversal, setting up (yet again) a nice bottoming pattern.  While I am optimistic, we have been disappointed before.  The reversal move was certainly worth adding some long but let's don't get carried away just yet.  Patience and deliberate action required.

The hourly chart looks great but needs continuing support action.  Use those stops.  Trading costs are zip compared to up and down risk/reward.

The ratio chart continues to play ball with the bulls.  And while it looks encouraging, has not made a move to the buy side.  We have noted the slow nature of this chart in the past and it is continuing that tradition.

The weekly improved today but still has a ton of work ahead.  Again, worth a buck or two but no signal to get crazy.

Now, the Wilshire really gets my attention.  Its move up was more than double (in percent terms) the Naz.  As I said last night, I like to see the small fry lead the move.  This is an encouraging chart.

The P&F chart killed the pending Xs with the opening drop.  The reversal adds about 10 Xs pending.  Should look interesting tomorrow.

I have been focusing on adding financials, utilities and tech to the LT port on this sharp down turn and I continued today.  Added all at the open and after lunch.  Needless to say today was a big up day in those sectors and I had a huge green day.  No trades in the TP yet.  I may move there tomorrow but no urgency.  These are the moves that long termers dream about.  Stack up cash on the big up swings and then buy on the washouts.  Been working for 40 years and I expect it will continue to work. Just keep following the ball and nibbling on the downtrodden.

Charts link below.

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID2071209

From Times Online
January 23, 2008
Message from Davos: The recession is coming
Business leaders and economists gave a bleak outlook for the economy which is heading for a 'severe downturn'
Gary Duncan, Economics Editor in Davos

A full-blown, prolonged recession in America is now inescapable, with the rest of the world set to be dragged into a severe global slowdown despite yesterday's emergency US interest rate
The Fed itself also came under heavy fire, along with other central banks.

Top policy-makers, including Larry Summers, the former US Treasury Secretary, joined economic experts in delivering a series of broadsides against the Fed.

A series of experts said that the US central bank not only had been "behind the curve" and "asleep at the switch", but had failed to take necessary, pre-emptive action to curb the emergence of the financial instabilities that triggered the present crisis.

They said that the Fed appeared to have given stock markets an unjustified bailout this week.

Others, including John Snow, Mr Summers's Republican successor, defended the Fed's strategy, however, and applauded yesterday's aggressive rate move.

The ominous assessments of the likely economic fate of the United States this year were led by Nouriel Roubini, the influential economic consultant.

"It's not whether we have a soft landing or a hard landing in the US, but rather how hard a landing it is going to be," he said.

"The recession is going to be deeper and lasting ... at least four quarters ... It's going to be a severe recession."

Professor Roubini said that the Fed's steep rate cut this week was "too little, too late" to stop a consumer-led slump in the US economy because American consumers were "shopped out", laden down with heavy debts, and the financial system was under "severe stress".

He said: "The Fed cannot prevent this recession from occurring."

His bleak prognosis was echoed by Stephen Roach, the former chief economist at Morgan Stanley and now the investment bank's chairman in Asia.

He agreed that with American households under financial pressure from debt burdens that were at record highs and the housing market slump, the US economy faced a sharp retreat by shoppers from the country's Main Street shops and malls.

Mr Roach highlighted how Americans have been spending the equivalent each year of 72 per cent of US national income, far above the 67 per cent average over recent decades.

He gave warning that if spending patterns now fell back to historic levels in a year "it would be the mother of all recessions".

It was likely that consumer spending would fall back in this way, although over several years, and this was a necessary adjustment from behaviour that had been unsustainable, he said:

"We have used the overvalued home like an ATM [cash] machine, and in doing that we have taken debt loads up to record highs," he said.

"None of that is sustainable. So we have got to take the excess out of consumption."

He added that the problem was that Americans were saying, "We do not want to stop excessive consumption", while the rest of the world was saying, "We want you to keep consuming to excess so that we can sell you things you do not need."

"What kind of a world is this?" he asked.

Both Mr Roach and Profession Roubini said that Europe, Asia or emerging markets could escape fallout from a US recession.

"Europe is not going to get a special dispensation from the global slowdown," Mr Roach told delegates.

He added that India and China were "not yet at the stage where they can fill the void that is going to be left by the American consumer".

He said: "I think it is going to be a close call but think we will not actually move into global recession."

In a poll here, Davos delegates voted a US recession the No 1 threat facing the world. But not all the leading economists present saw a worldwide downturn as inevitable.

Fred Bergsten, director of the well-regarded Washington-based Peterson Institute for International Economics, said: "I believe the world economy has in fact largely decoupled from the US ... That means things are much too bleak and pessimistic around here in terms of the outlook.

"My conclusion is that a global recession if inconceivable."

The Fed's rate cut this week left delegates sharply divided over the wisdom of its action, and its broader record in running the US economy.

Mr Snow said: "Have the Fed and other central banks been asleep at the switch? No. The issue of whether the central banks are capable of vigorous action, bold action was answered yesterday."

He said that the Fed's move should ensure any recession was "short and shallow".

His predecessor, Mr Summers, gave a damning view.

He said that it was "hard to give a high grade" to the Fed over its recent policy "when they have been consistently behind the curve".

man I hope that is not the case!

http://www.seekingalpha.com/article/61266-4-prior-market-crashes

I've already liquidated 80% of my equities during the past few sessions and plan on selling the remainder during the inevitable short-lived bounces that are to come. I do think the odds favor a sharp steep decline overall for 2008. I know it's a losers game to try to time the market but I don't see any advantage in allowing red ink to accumulate with no hedge as is the case with the Main portfolio. Being down 'only' 11% YTD in my portfolio is enough pain for now.

On the other hand articles like these doubt a recession is even coming:

http://www.cnbc.com/id/22820241