This did get me to thinking…….
There were many similarities, 1987 vs. 2008. To understand the dynamics will lead to understanding how a quick recovery is possible this time around.
Both 1987 and 2008 had a period of debt accumulation to enhance investment returns with leverage. Then it was a series of LBO’s. This time the debt was elsewhere but the main point is that part of the market was over-levered.
In 1987 the trigger for the crash was one Dan Rostenkowski, Dem-IL, Chairman of the House Ways and Means Committee, who angered that LBO’s were causing labor reductions to produce gains for the financially privileged introduced a retroactive tax law which would be in effect as of Jan 1 of 1987. This law if enacted would make all the year’s LBO’s uneconomical. It was changing the tax laws after much had occurred. He did the same in 1986 to completely rewrite the tax law as it pertained to tax shelters thus making them no longer as attractive and thus helped kick the S&L’s into a swan dive that resulted in a major bail out because the S&L’s had already closed on deals which now resulted in immediate losses.
The 1987 proposed legislation came out of committee late on Oct 13th, the market began to slide. The slide continued the 14th&15th (Thurs&Fri) but many were as yet unawares of the proposed law. They found out over the weekend as the news spread and a 10 sigma event began in Europe and hit us on Oct 19th with the help of “Portfolio Insurance” which was run by computers, never designed or tested for a massive sell off and in fact multiplied the sell off in the subsequent crash. Only one keen observer, Robert Bartley of the WSJ wrote about this at the time. The rest of the word did not understand what truly happened. A single individual had attempted to change the investment rules over night. Rostenkowski let the legislation die quietly.
The crash of 2008, i.e. what happened in Oct.&Nov., was also the work of one individual changing the playing field in a market already fragile. This was one SEC Chairperson Chris Cox who had eliminated the short sale rule saying he did not have the capacity to monitor the market in June 2007, then decided to ban the only defensive tool HF’s had to limit portfolio volatility w/levered positions of 20:1. He banned short selling. Now the HF’s were forced to sell levered positions outright, banks called margin for fear of losses and the market hit a vacuum. Cox changed the playing field and the participants had to adjust as quickly as possible. Just as in 1987.
Most will not see it this way. Most will point to the build up of debt in HF’s, sub-prime lending, the extraordinary period of Greenspan’s cheap money, the mistakes by certain regulators, the avarice of certain politicians and the mortgage agencies, but this was not an economic collapse. This was an economic slowdown and had begun at the end of 2005 when auto and home sales had peaked.
We were in an economic slow down with financial institutions at risk and we were in an orderly correction when Cox changed the rules and the wild collapse shattered investor confidence.
What we have today is shattered trust. No one knows what the rules are at the moment. It is not that liquidity is not available. It is that liquidity is not moving about the system. People with reasonable credit scores cannot buy cars or houses at the moment because of the fear of the unknown that was inspired by Cox’s single thoughtless decision.
Yes, jobs are being lost not because individuals are over levered, but more because of the fear of lending the copious funds that are available. Ah yes. There is also the issue of the Mark-to-Market rule that was never expected to see an overnight change in value as we have seen. Cox should have suspended this but did not. Mark-to-Market was meant to be a helpful investor tool in an orderly declining market place, something to keep the financial institutions honest. When Mark-to-Market valuations are registering default levels for perfectly healthy securities then you know the rule should be modified.
Much of the value destruction today is the result of accounting rules designed for a functioning market pricing mechanism meeting a frozen market pricing mechanism because one person changed the playing field.
This is not a Depression and does not even have to be a Recession. It is solvable. The rules have to be modified to produce fair valuations and to get pricing mechanisms working again. The head of the SEC can do this. It is quite simple.
Trust is what is missing. We need to revive it.
“Davidson” is the pseudonym for a reader who must remain anonymous…..
Disclosure (“none” means no position):None
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