| Millennium starts with negative returns and two major crashes |
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Since the blast of the "Internet bubble" in March 2000 (by September 10, 2001, the Nasdaq had declined roughly 34% for the year, while the S&P index had sunk 18%) a series of ‘Parmalat-style' and ‘Enron-style' defaults in diverse economic sectors have occurred in the US and the EU alike. Profits at U.S. banks declined from$35.2 to $5.8 billion (-83.5%) during the fourth quarter of 2007 versus the prior year, due to provisions for loan losses. As of August 2008 sub-prime-related and other credit losses or write downs by global financial institutions stood at about 500 billion dollars. The Federal Deposit Insurance Corporation (FDIC)'s watch list of troubled banks has grown to 117 banks by the end of August 2008, and is expected to increase further. The largest commercial bank failure thus far is that of IndiMac, a commercial bank with US$ 19 billion in deposits and taken over by the FDIC in July 2008. The most notable failures so far, however, have been those of three major U.S. Investment banks: Bear Stearns, Lehman Brothers, and Merrill Lynch. Bear Stearns collapsed on March 16, 2007, after facing major liquidity problems, and was sold to JP Morgan after Federal Reserve Bank of New York agreed to take over Bear Stearns' US$ 30 billion portfolio of mortgage-back securities. Lehman Brothers filed for Chapter 11 bankruptcy protection on September 14th, 2008, after failed attempts to sell the bank to private parties. Merrill Lynch was acquired by Bank of America on September 15th, 2008. Another significant event has been the placement under conservatorship of Fannie Mae and Freddie Mac, the two largest US housing government sponsored entities (GSEs). As part of the plan announced on September 7, 2008, the Federal Housing Finance Authority (FHFA) was granted direct oversight of the GSEs, the US Treasury was given authority to inject capital into the GSEs in the form of senior preferred shares and warrants (while dividends on existing common and preferred stock have been suspended), and senior management and the boards of directors at both enterprises were dismissed. Effectively, this entails a nationalization of the two entities. The 2008 ‘October Surprise' materialized in the default of critical investment and commercial banks in the US and the EU. Notably, also the world largest re-insurer company, AIG, avoided bankruptcy thank to a government loan of $85 million that has reportedly not yet sorted out its difficulties. In concrete terms since Jan. 2008 to date the decline in returns of S&P500 has been more than 30% while the Dow Jones index lost over 40%. The responsibility for this unprecedented series of market crashes lies with the Federal Reserve System over which Greenspan was the chairman (1987-until the end of January 2006). The "irrational exuberance" in the market place, as Greenspan called it during the boom years that have now ended, grew with the financial markets awash in Fed-created money, credit-worthy standards were lowered, and "inventive" financing introduced to make it possible for the credit-unworthy to obtain home loans, and for others to have access to large sums of money for speculative buying at low margins. Moreover, regulatory holes and doubtful bankers' conduct have permitted spectacular speculative growth and returns for the few. "We're not smart enough as people", Greenspan said. "We just cannot see events that far in advance." During the recent Congressional hearings, the one thing he did not admit was that it was his own monetary policy when he was at the helm of America's central bank that created the boom that has now resulted in a crash. The 2008 financial crisis has entrenched into everyday life (like in the 1930s and more than in the 1970s). Media and analysts effortlessly report and comment on the financial data. Western governments have been rushing unprecedented monetary measures to re-establish ‘sovereignty' in the financial market and to ‘secure' the private banking system from bankruptcy and predators' takeovers. Albeit these decision the banking system does not seem to recover yet. In September/October 2008 the governments and treasuries have injected more than 3 trillion USD in the financial system (Europe 2 trillion Euro - Germany alone more than 500 billion Euro; and the US 700 billion dollars). Recession, economic slow down and looming hyperinflation have become common vocabulary. People's perception of the crisis is now translating into fear for the future, for employment stability, pensions and daily life needs. Therefore consuming constraints further depress the demand. Many industrial sectors are warning on "missed targets" though forcing to reduce production plants capacities. Car makers industries have already been hit forcing ‘temporary' shut down of production plants (Mercedes-Benz announced its monthly sales were down 34.3% for October 2008; the sharp decline of stocks for the "Big Three" US car makers is putting them in the hands of investment funds). But the list of troubled corporations is growing daily also touching consumer goods and service industries. The crisis is evolving with breakneck speed. The debate about why it happened and how it will unfold is still very much ongoing, as Felton, A. and C. Reinhart, 2008, wrote in "The First Global Financial Crisis of the 21st Century": "Our preliminary analysis based on partial correlations indicates that some resolution measures are more effective than others in restoring the banking system to health and containing the fallout on the real economy. Above all, speed appears of the essence. As soon as a large part of the financial system is deemed insolvent and has reached systemic crisis proportions, bank losses should be recognized, the scale of the problem should be established, and steps should be taken to ensure that financial institutions are adequately capitalized. A successful bank recapitalization program tends to be selective in its financial assistance to banks, specifies clear quantifiable rules that limit access to preferred stock assistance, and enacts capital regulation that establishes meaningful standards for risk-based capital. Government-owned asset management companies appear largely ineffective in distressed assets, largely due to political and legal constraints. Next, the adverse impact of the stress on the real economy needs to be contained. To relief indebted corporations and households from financial stress and restore their balance sheets to health, intervention in the form of targeted debt relief programs to distressed borrowers and corporate restructuring programs appear most successful. Such programs will typically require public funds, and tend to be most successful when they are well-targeted with adequate safeguards attached". The world crisis is still looming at the horizon. This crisis is not a typical economic cycle downturn. by Dr. Paolo Raffone , The CIPI Foundation Published on November 14, 2008 |