Bottoms Up?

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We’re apparently meant to understand that the worst of the credit crisis is over, or nearly so. Federal Reserve chairman Ben Bernanke says the markets are “far from normal” but reassures us that the smart and caring gentlemen at the Federal Reserve stand ready to increase its auctioned funds. Banks have started to lend to each other at more gentlemanly rates, narrowing the spread between inter-bank lending rates and Treasuries. All of the big wigs on Wall Street—the kind who get invited to luncheons with Bernanke—have said that we’re finally, or nearly, out of the dark woods we entered sometime last year.
What certainly seems to be passing is our very brief age of anxiety. Those who have been predicting national disaster are a bit quieter. Even the worst fears of inflation resulting from the extraordinary rate cuts from the Federal Reserve seem to be receding with the expectation that interest rates will soon enough—perhaps by year’s end—begin climbing once again. Oppenheimer’s Meredith Whitney says there are more losses to be booked by brokerages but, by the logic of contrarian investing, the attention her every pronouncement gets is an indicator that there is little investment value left in shorting these institutions. This morning on Squawk Box even Jim Chanos, the notorious short seller, indicated that he might be backing off short positions in the financials.
There’s something unsettling about how orderly this has all been. How have we passed through what many have described as the worst crisis in American finance in recent memory with so little blood spilled on Wall Street? That question may seem crass to investors in Bear Stearns, to the holders of still frozen auction rate securities, to the legions of laid-off investment bankers. But the layoffs from this crisis have not come close to those we saw when the tech bubble popped. The holders of auction rates and even Bear Stearns shares have not experienced the pain of investors in the dot coms. To paraphrase a former Kansas senator, “Where's the panic?”


We’ve got a theory about this. It’s often said that Wall Street’s memory or risk only stretches back as far as the first crisis its wise men experienced in their careers. For many, we’d venture to say this crisis was the 1990 bear market. That market was shaken by a downturn in the real estate market that triggered a credit crisis but it too failed to result in the kind of great panics that had characterized every prior financial downturn. The market dipped low—but its ebb was far less than previous ebbs—and the bearish period was short lived. The powerful influence of intelligent and empathetic men holding the reigns of monetary policy could be counted on to adroitly pull us away from the abyss. On Wall Street costs were cut, losses booked, but banks that had fallen into credit traps would be able to restart their profit engines through other means, such as securities trading.
This is what Jim Cramer, who might be the paragon of the cohort who came up through that nearly twenty-year-old crisis, meant when he shouted that the men at the Fed “don’t know what they are doing!” For a few moments last summer the Fed seemed unwilling to uphold its end of the bargain in seemed to have made back in the last decade of the last century. The rescue of Bear Stearns put an end to any lingering doubts about that. The bargain—whereby Wall Street is allowed to keep the fruit of its risks but not expected to eat the rotten apples when the orchard turns out to have spoiled—is definitely still on. And its why Wall Street might be preparing to canonize Ben Bernanke, as it Alan Greenspan before him.
It’s tempting to complain about this bargain. Certainly our system privatized profits and subsidized risk is not capitalism—indeed, some have called it socialism for the rich. But that ship has long since sailed. What troubles us is that we’re not sure the map drawn in 1990 is a great guide to the dangerous territory of financial crises. In many ways, the avoidance of the worst parts of the credit and business cycles engineered by the Federal Reserve in the early nineties and again in the early oughts only encouraged—indeed, some would say low interest rates demanded, as investors and banks struggled for yield among low-interest rates—the foolish financing that gave birth to this crisis. Our current crisis is deeper because it was built on the shaky foundations of the anti-recessionary policies adopted in the wake of the last crisis.
Past performance, as they say, is not guarantee of future results. Could the bloodless, short-lived recessions and velvet-rope downturns in the markets of the past have created an undue confidence in a quick recovery this time around? The investment value of the answer to that question is, obviously, beyond our pay-grade. But we’re at least keeping on the lookout for the possibility that the captains of Wall Street may be sailing their ships according to charts drawn for a sea we sailed through years ago, while we may be in new found waters.

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