It's Just a Cycle

The panic of 1819 was the first major economic crisis of our young country's history. Sure, there had been swings in prices before but this was a true disaster for our economy. Debt from the War of 1812, bank excesses, a devastated Europe from the Napoleonic Wars buying only grain from us, frenzied land speculation in the Western United States ending in a burst of the bubble and a contraction of available credit brought on the panic. The following year began a six-year depression. Unbridled speculation, banking woes, no available credit and panic. Very interesting.

In reality, there were eight major crashes in the 19th century that with a few variations, were caused in large part by the same elements. The bank Crises of 1901 and 1907 were again the story of wild speculation surrounding Railroads / Copper respectively, and then: (plug in the above cycle). You'd think we'd learn. Learn what, exactly? What causes such catastrophes in our free market economy? Free enterprise is cyclical. No kidding? Whether you invoke the wisdom of Keynes, Minsky or your rich Uncle Floyd, there is a central theme to the capitalist boom to bust phenomenon.

Keynes called it Strategic Complementarity. I call it Herd Instinct. Once the panic sets in, no one wants to be the last one in the herd - face it, that's where most of the predators are. Or, let's call it Economic "Musical Chairs". No one wants to be left standing when the music stops. In the rush to liquidate / exit, the result becomes a self-fulfilling prophecy of sorts. You know the advice from those around you: "if people would just keep from panicking this would all work out". (Whispering, hand over telephone) "Hold on a minute, I'm talking to my broker". (Yelling into the telephone now) "Sell, you idiot, Sell!"

In America today, there is no available credit, this occurring in a consumer-driven economy. Well, it may not matter today- no one is buying anything, anyway. The Fed is now having to enter uncharted waters in offering to buy short-term (typically 90 days or less) commercial paper because the risk premiums being sought by the few lenders offering to buy that paper makes it too expensive to borrow the money. If corporations can't meet payroll, how are they going to [want to] invest in capital equipment? Individuals with credit scores near 800 can't get money individually. Why?

Basically, all of the speculation in this particular boom cycle has resulted in a bubble bursting so loudly that the "POP" is being heard around the globe, to wit, the herds overseas are running for cover. Without a central bank, things are getting pretty ugly across the pond. Even here, we all know that bankers are basically cowards. They take your money and loan it back to you, never taking any of the kinds of risks you do when you start a business or invest in America. They then, like little lemmings, follow each other wherever the others are darting at any given time. The mortgage crises had them all trying to out-dart each other off the proverbial sub-prime cliff, trusting Mother Fed to bail them out if it all went sour. Cowards, but certainly not stupid. That's why they're not loaning your money back to you at the moment. You've got to love that.

Ahh, safe havens....

Municipal Bonds, exceeded in safety only by U. S. Treasuries, have been a popular investment of the more affluent for many moons. No problem, there right now, eh? Uh, Uncle Floyd, you may need to sit down for a minute (said with the same gravity as when you told him that you had just run over his pet cat in the driveway). State and local governments, broadly called Municipalities, have seen their revenues fall. This, due to lower property taxes from defaulting mortgages, lowering sales tax revenues from a lack of consumer demand and reduction in fees that spring from real estate, building and development.

At the same time, money has gotten too expensive to borrow for everyone. Refinancing their debt or borrowing for new projects that have been approved. As municipalities get more strapped for funds, another self-fulfilling prophecy, the rating agencies lower the government's rating, making it harder and more expensive to borrow. Bond referendums are being cancelled or postponed. Even Ambac, the insurer of municipal bonds, has been downgraded and risks having to double its capital reserves at a time when there is no money available.

Little Finance Lesson (please skip paragraph if you're already nodding off): In the bond market, if current rates go up to attract available capital, that nasty old inverse relationship of a bond's principal value to its effective yield occurs, dropping the underlying value of existing bonds to get them to a discounted price that "marks them to the market" so that they "yield" the same as current bonds of equal quality. The bondholder then has an unrecognized loss of principal in their bond portofolio. The tax-free income is still there, thank goodness!

IS THERE ANY GOOD NEWS?

The Good News? This is only one of many cycles we have endured in our country. It will settle down out there when the panic ceases and hopefully, the resulting damage will be contained enough to avoid anything more serious than a severe recession. If not, call Uncle Floyd.