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Home > Capital Markets Viewpoints > Forecasting the Credit Crunch and Future Market Prospects

Capital Markets Viewpoints

Forecasting the Credit Crunch and Future Market Prospects

by Michael J. Panzner

Introduction

Michael J. Panzner is a 25-year veteran of the global stock, bond, and currency markets who has worked in New York and London for such leading companies as HSBC, Soros Funds, ABN Amro, Dresdner Bank, and J.P. Morgan Chase. He is the author of When Giants Fall: An Economic Roadmap for the End of the American Era (Wiley, 2009), Financial Armageddon: Protecting Your Future from Four Impending Catastrophes (Kaplan, 2007), and The New Laws of the Stock Market Jungle: An Insider’s Guide to Successful Investing in a Changing World (FT Prentice Hall, 2004). He has also been a columnist at TheStreet.com’s RealMoney paid-subscription service and a contributor to AOL’s BloggingStocks.com. In addition, Mr. Panzner is a New York Institute of Finance faculty member specializing in Equities, Trading, Global Capital Markets, and Technical Analysis, and is a graduate of Columbia University.

What brought about the worst financial crisis since the Great Depression?

There are many reasons why we reached this point, but one, in particular, stands out: hubris. By the spring of 2007, for instance, the conventional wisdom on Wall Street was that the financial world had been totally transformed and the business cycle had been repealed. People were confident that reams of research and the lessons of history would prevent policymakers from repeating the mistakes of the past. Powerful technology and rapid innovation would ensure that risk was fully monitored and efficiently managed. Industry consolidation and the globalization of finance would allow any excessive or unwanted exposure to be offset. In sum, the “masters of the universe” thought they had it all figured out—which, of course, they didn’t.

Was it just those who worked in the financial industry who felt this way?

Not really. Insiders and outsiders alike—including central bankers, regulators, and the political establishment—came to believe that markets and economies were virtually bullet-proof, no longer exposed as they once were to the fallout from exogenous shocks and endogenous eruptions. In a sense, the prevailing view was that with all the rules, strategies, and mechanisms that were in place, neither Wall Street nor Main Street would again find themselves taken by surprise, as they were during the Asian financial crisis of 1997–1998, the 1998 meltdown of hedge fund Long Term Capital Management, and on many other occasions before that.

How about the man on the street?

To be sure, confidence about existing conditions and the notion that the good times could carry on indefinitely was widespread. Although there were clear signs that something was amiss, many people drank the bullish Kool-Aid and warmed to the fantasy of a Goldilocks economy. They believed that society no longer had to be a slave to market and other natural forces. In today’s sophisticated and globalized world, people were the masters of their own destiny, economic or otherwise. Not surprisingly, these perspectives spawned widespread complacency. Unhealthy imbalances were permitted to grow and fester. Prudence was seen as highly overrated. Planning for hard times took a back seat to riding the crest of the wave. In the end, of course, those notions proved dangerously misguided.

Are you suggesting that the failure to prepare for the worst ensured that it would happen?

To some extent, yes. In fact, throughout society, many of the mechanisms and backstops that people were counting on for protection in the event that things somehow went awry had unintended negative consequences. Instead of enhancing the resiliency of the system, the latticework of safety measures engendered a false sense of security, leading homeowners, investors, policymakers, business executives, and others to act naively or recklessly. Economists call this the moral hazard effect. Under these circumstances, everyone has an incentive to be on their worst behavior. In hindsight, it’s clear that a lot of people took that message to heart.

So far, at least, the financial system seems to have suffered the most.

That’s not too surprising, given that those who worked on Wall Street and in other financial centers made some of biggest miscalculations, at least in terms of the amounts they were playing around with. Among other things, many supposedly savvy operators failed to grasp that just because risks were being sliced, diced, repackaged, and shifted elsewhere, they weren’t being eliminated. On the contrary, the new financial alchemy meant that all sorts of dangerously unfamiliar combinations were being created and that no one really had a solid handle on overall exposure. Moreover, with risk being shoved into every nook and cranny of the global financial system, it meant that few places on earth would be spared following a major shock to the system, like, for example, a bursting credit bubble.

Presumably, people are looking at things differently now?

There’s no doubt that the events of the past few years are forcing a major rethink in certain quarters. Formerly free-spending Americans, for example, are beginning to cut back on purchases, slash borrowing, and boost the amount of money they have in savings. Yet not everyone grasps what is clearly a sea change. The fact that so many “strategists”—I use that term loosely—failed to see what was coming and were utterly surprised by the breadth and depth of the collapse hasn’t stopped them from offering wrong-footed theories about what may happen next. Many are simply deluding themselves with short memories and wishful thinking. Indeed, ever since the “Great Unraveling” began, there has been no shortage of prognosticators claiming to see a light at the end of the tunnel.

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Further reading

Books:

  • Cohan, William D. House of Cards: A Tale of Hubris and Wretched Excess on Wall Street. New York: Doubleday, 2009.
  • Morris, Charles R. The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash. New York: PublicAffairs, 2008.
  • Phillips. Kevin. Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. New York: Penguin, 2009.
  • Ritholtz, Barry. Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy. Hoboken, NJ: Wiley, 2009.
  • Woods, Thomas E., Jr. Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington, DC: Regnery, 2009.

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