Thursday, November 10, 2011

Are We Facing A Repeat of 2008?


The crisis in Europe is raising uncomfortable memories among investors.

Several commentators harken back to the latter days of 2007, when it seemed that the subprime mortgage crisis would be limited to just a small segment of the credit markets.

Then, as now, the stock markets kept rallying, eventually reaching new highs in October 2007. At the same time, the credit markets were already showing signs of strains, which eventually manifested itself through the demise of Bear Stearns in early 2008 followed by Lehman Brothers in September 2008.

I don't need to mention that the stock market eventually wound up falling -34% for the calendar year 2008, with most of the decline occurring in the last three months of the year.

I have two thoughts today, one positive and the other negative.

I wish I could be more definitive but I think the situation in Europe is just too fluid - and potentially too catastrophic - to be confident of how this all plays out.

But here's my positive thought: unlike 2008, when the credit markets totally froze, credit today is widely and readily available. Total corporate bond issuance this week, for example, will be well over $30 billion, and most issues have been gobbled up by yield-hungry investors.

Moreover, corporate America is awash in cash. Corporate treasurers have generally positioned their companies' finances to be able to withstand another shutdown of credit availability, at least for a while.

Now for my negative thought: In 2008 and 2009, there was a massive government response in response to the credit crisis. The Fed slashed interest rates, offered guarantees on money market funds, aggressively bought debt in the secondary market - you name, the Fed did it.

The other branch of the federal government did their part also. The Obama administration forced through a fiscal stimulus package of nearly $800 billion. Two years later, it is not clear how much impact this spending actually made on the real economy, but if nothing else it was a huge psychological boost.

I very much doubt this could happen today in the U.S. today, let alone Europe.

Technically the Fed could enact something like QE3 (where it would buy mortgages in the secondary market) but the political reaction would probably be extremely negative. And the talk in Washington is all about cutting spending, not fiscal stimulus.

The most recent proposals from the Europeans basically boil down to cutting spending and tightening credit, which makes no sense to me. When the European Central Bank cut rates earlier this week, they made it clear that they considered it a temporary move. In short, there is almost an Calvinist attitude towards dealing with the debt crisis, which probably means any solutions will not work.

Finally consider this: In 2008, three US government officials - Bernanke, Paulson and Geithner - could sit in a room and come up with solutions. Today, in order to get any resolution in Europe, you essentially have to get 17 different countries to agree,which to date has proven to be nearly impossible.

Several commentators - including one of my favorite columnists Ambrose Evans-Pritchard of the London Telegraph - have suggested that if the US and China joined forces they could end this crisis in the European credit markets*. However, I think this is simply not going to happen.

I am very concerned, to say the least.

*http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100013198/america-and-china-must-crush-germany-into-submission/