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08/23/2007 12:00 am EST
August 23, 2007
I'm going to take a deep, deep breath and say that the worst of this summer's financial panic is over.
That doesn't mean we won't see more blowups in holders of subprime mortgages or fallout among the Wall Street firms that underwrote them. And unexpected losses by hedge funds or units of large banks or investment firms could send the markets reeling again.
But the Federal Reserve's actions last Friday to cut the discount rate it charges major banks was a classic intervention by the ultimate "lender of last resort," which usually signals a crisis is ending. And Monday's run on the Treasury bill market by institutions and retail investors felt a lot like this panic's climax.
What's clear is that the "subprime panic" is developing along the classic historical lines of most panics we've seen over the past couple of hundred years. Like 24-hour viruses, financial panics happen quickly, you feel awful, and then they're over. Unlike bear markets, they're not chronic illnesses that sap the body over months and years. And if you're nimble, they can be great buying opportunities.
Let's first recap what's happened over the past week or so. Since August 8th, equity markets have been on a wild ride. The Dow Jones Industrial Average plunged nearly 800 points in the week before August 16th, when it careened to an intraday low of 12,455.92 before rallying nearly 400 points by the close.
That intraday low marked a full-fledged 12% correction from the Dow's intraday high of 14,121 on July 19. (It's an 8.2% correction from closing high to closing low. The Standard & Poor's 500 has posted similar declines of 12% and 9.4%.)
As I wrote here a couple of weeks ago, that strikes me as just about right-unless like permabears Marc Faber or Bill Fleckenstein, you think the Apocalypse is at hand.
It's no accident last Thursday was so crazy: August 15th was the last day investors could notify hedge funds they wanted to take money out by the end of this quarter. Given the reported losses in hedge funds holding subprime mortgages and those following quantitative strategies (see Thursday's Gurus' Views and Strategies), those redemption requests were likely to be big.
Knowing how much money they'd have to give back, hedge fund managers clearly sold everything that wasn't nailed down last Thursday, until bargain hunters stepped in and drove stock prices back up again.
On Monday the panic hit a crescendo when investors drove treasury-bill rates down by the biggest amount in one day since the Crash of 1987, as yields on the one-month bill plunged below 2%. (The official federal funds rate for overnight money is 5.25%.) That capped a four-day flight to safety when investors poured $42 billion into money market funds, slightly less than the $50 billion they injected in all of July.
"Financial panic is the ill-advised, confused, and uncoordinated scramble by speculators to dump shares quickly," wrote professor Brenda Spotton Visano of Toronto's York University in this paper.
"Unlike [a] mania, however, a clear, identifiable trigger sparks the panic and its hyper-intense life span is short," she continued.
What prevents it from becoming a crash is the intervention of a lender of last resort.
"In panic after panic, crash after crash, crisis after crisis, the authorities or some 'responsible citizens' try to halt the panic by one device after another," wrote Charles Kindleberger in his classic work "Manias, Panics, and Crashes."
Ben Bernanke and the Fed followed that script, when, as in a John Ford western, the cavalry charged in for the rescue last Friday. That's when the Fed announced it was cutting the discount rate by ? percentage point to 5.75%.
By doing so, it clearly built a wide moat between the banks (which are always welcome at the discount window) and the subprime mortgage mess. The Fed was laying down a clear message: This crisis stops at the banking system, and we will not let it become a system-wide contagion.
The Fed's move also laid the groundwork for a cut in the federal funds rate, but probably not before its regular September 18th meeting.
The Fed's coordinated moves with the European Central Bank (ECB) bore the classic mark of an international lender of last resort, as Kindleberger also described. Both the Fed and the ECB had pumped money into the system in the previous weeks.
As long as investors believe central banks will step in when necessary and protect the core financial system, then this crisis of confidence is over. The free market will do the rest as vulture investors and others gradually price distressed assets and liquidate under-water entities like subprime mortgage brokers, hedge funds, what have you.
When will it officially end? We won't know until it's over. Market historian Richard Sylla of New York University says panics usually last six weeks to two months. That would put the end of this one some time in late September.
But if the Fed cuts the federal funds rate in September, we could be off to the races again. (If it doesn't, all bets are off.) Because as I've written many times, the international economy is strong, companies are flush with cash, valuations are reasonable, and interest rates are much lower than they have been during any other financial crisis over the last 25 years.
That's why I'm going to take another deep breath and say this may actually be a good time to put some money to work in the markets-and I mean some money, a small amount that you can afford to lose. The best time to buy is often when things look the scariest. From August 31, 1998, the low point of the Russian ruble crisis that led to the collapse of Long-Term Capital Management, until the end of that year, the S&P 500 surged 28% and the NASDAQ Composite index soared 46%.
I'm not looking for those kinds of returns this time. But remember what banker Nathan Rothschild reportedly said: "Buy on the sound of cannons, sell on the sound of trumpets." Or, in plain old American English, no guts, no glory.
Comments? Please email us at TopProsTopPicks@InterShow.com.
Howard R. Gold is editor-in-chief of MoneyShow.com. The views expressed here are his alone and do not necessarily reflect the opinions of InterShow.
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