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History Repeats Itself
10/09/2008 12:00 pm EST
John Dessauer, editor of John Dessauer’s Investor’s World, finds striking parallels between today’s crisis and the Panic of 1907.
Every new era has an “unprecedented” element. But last year, authors Robert Bruner and Sean Carr found some eerie parallels in The Panic of 1907: Lessons Learned from the Market’s Perfect Storm.
Today, the words “Perfect Storm” apply again, just as they did in 1907. To be sure, there are differences. But the core issues in 1907 were liquidity and confidence, just as they are today.
There was no Internet, TV, radio, or other rapid mass communication media in 1907. Rumors could take hold and grow with no effective response. In New York, cash was in short supply. Depositors began to withdraw cash from banks and hide it at home. A crisis of confidence developed and grew to such proportions that leading bankers feared the collapse of the entire US financial system.
There was no Federal Reserve in 1907, and the Treasury was hampered by the gold standard. During the crisis, the Treasury withdrew liquidity at the wrong times, making the situation worse. In effect, J.P. Morgan became the de facto Federal Reserve director, deciding which banks to save and which to let fail. Morgan convened a coalition of leading bankers and businessmen to put out one fire after another, hoping each would be the last.
The Panic of 1907 teaches us several important lessons about today’s panic. First and foremost, that panic was quelled, not by some grand overall strategy, but by persistent leadership and patience.
The goal, then and now, is to restore confidence in the financial system. Treasury Secretary Hank Paulson is today’s J.P. Morgan, with advantages that Morgan could not even imagine. We also have the Federal Deposit Insurance Corp., the Federal Reserve Board, all sorts of bank regulators, and the benefit of lessons learned the hard way in past crises, like 1907.
What we need most is a real market for distressed mortgage-backed securities. I see the Paulson plan as a brilliant first step, a way to create a market where none existed. Right now, there is still no market for mortgage-backed securities because investors are terrified of the risk. There are no buyers. This is what has frozen credit markets and threatened the entire economy.
The Treasury is likely to end up acting not only as a buyer and market maker, but as a clearing house for mortgage-backed securities. J.P. Morgan created just such a clearing house in 1907, screening good banks from bad. Today, the odds on restarting the market for mortgage-backed securities goes way up if a qualified team can go to work separating good loans from bad.
The Treasury won’t be a permanent presence in the private market. The new authority expires two years from the date of enactment, which is enough time for the rating agencies, bankers, and mortgage brokers to get their act straightened out. The end game would be a return to a normal free market.
But to get there, we need confidence that banks will no longer make high-risk mortgages and confidence that the housing market has stabilized. All these elements are necessary for a return to a functioning free market for mortgage-backed securities.
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