The Audacity of Stock Market Hope

Tom Stevenson writes in the Daily Telegraph that "hope will only emerge when we're utterly submerged in bad news." Most regular readers here will agree. And I didn't know that the word "crisis" comes from the Greek word for "turning point."

I'm not sure I go for Stevenson's view that we've had a 30-year experiment with free markets. In fact, I know I don't. Western countries (he's in the UK, I'm in the US) have mixed economies and the problem isn't lack of regulation, but regulations and government entities -- see Fannie Mae and Freddie Mac -- that distort events and markets. And that's entirely apart from the corruption of so-called "public servants" lining their pockets at taxpayer expense.

Look folks, I'm old enough to remember the 1970s. And anyone who says government wasn't largely "the problem" is kidding themselves. I'm all for government regulations that enforce the honoring of voluntary contracts, throw the book at drunk drivers, and perhaps even have rules limiting the amount of leverage used by financial institutions. Yet just as Sarbanes-Oxley has been, on balance, a negative, we can expect Sarbanes-Oxley on steroids in the future.

But let's get back to Stevenson's piece. He says something I hope people across the spectrum can find beneficial:

The stock market cycle is always the same. It moves from optimism through excitement to euphoria before turning down via anxiety, denial, fear, desperation, panic and capitulation to a low point of despondency and depression. Only when this point of utter revulsion is reached can investors look out at a new dawn of hope.

The timing and duration of each phase is unpredictable. What always holds true, however, is that when investing seems most scary it is likely to be most profitable.

An audacious sentiment for some, no doubt.

Comments

[Sivaram Velauthapillai]

I have to disagree with some of what you said. I hope you don't mind me challenging your views... it's just one man's opinion...

I would agree with you that the problem in the 70's were largely due to government actions. Price controls, oil embargoes, and so forth, were largely responsible for the inflation.

However, I don't see how you can claim it was government interference that led to the current problems. Yes, they were responsible for some issues but most of the causes lie with the private sector and private citizens. (The Federal Reserve keeping rates at 1% was clearly a big mistake but I'm talking about the other government agencies here. The FedRes move was justifiable at that time due to deflation threats.)

It was not government regulations that led to banks and brokers to buy, secrutize, and sell any of these mortgages. It was also not regulations that led to banks to using off-balance-sheet entities like SIVs. Nor was it regulations that led to investment banks taking on greater leverage. The government also did not force the insurers--bond insurers, AIG, etc--to insure mortgage bonds. It should also be noted that another potential bomb in the background--the derivatives market--is largely undertaken by private actors in a free market and has nothing to do with regulation (if anything, derivatives attempt to circumvent regulated markets.)

It was also not government regulation that led to investors buying up any of these mortgage securities. If anything, investors were encouraging all the players to continue their questionable business schemes. Let's also not forget that it was investors who approved of, what seems like very high given the outcome, compensation for all the executives, further endorsing the activities undertaken by management.

It seems somewhat fashionable to bash Fannie and Freddie but very few of the problems have anything to do with them. For instance, the core problem was with subprime mortgages and that has nothing to do with the GSEs. They are not conformant with GSE requirements so neither the GSEs nor anyone relying on the GSEs had anything to do with subprime. Alt-A and other types of mortgages, some of which were accepted and promoted by the GSEs, are also a problem but I really wonder how bad they really are. The market is treating them similar to subprime (in terms of everything fall apart; fradulent mortgages; etc) which seems quite simplistic to me. As far as I'm concerned, it was a huge mistake by Paulson to seize Fannie and Freddie from shareholders, when they were still able to raise money from private investors and by standard accounting they were still solvent. Not only did this make it difficult for any other business involved in mortgages to raise capital (since govt indicated that it would seize companies without them being insolvent,) it also introduced further doubt into the market. If Fannie and Freddie, who were in better shape than many other banks, were insolvent according to the government, well, then so are a whole lot of other banks. I know I'm in the minority but I still think that Fannie and Freddie would have recovered and survived if they were left alone.

You are right in saying that there is going to be greater regulation in the future. I hate to say it but I also think that you are right in saying that the regulation would be excessive and likely will create some new (minor) problems. Many reading this probably won't agree but I would say that this is one of the few crises that was largely created by the private sector and the (largely unregulated) free market. If the housing market or banks were more strongly regulated--as is the case in Canada, where zero-down, negative-amortization, NINJA (no income no job and asset) loans, either aren't permitted or are severely curtailed--I suspect it wouldn't be this bad.

[John]

Sivaram: Of course I don't mind you challenging my views. Believe me, I'm challenged in more ways than I can count! ;-)

I know my post mentioned Fannie Mae and Freddie Mac, and I guess that gave the impression I was focusing on the current crisis. I didn't mean to. I'm talking more broadly, in that I've seen several press stories and op-ed columns talking about some grand experiment with free markets over time (usually dating to about the time Thatcher and Reagan came to power). I've even seen press reports calling the American system lassez-faire capitalism. It isn't and hasn't been.

But I think you and I may be talking past each other. I think the leverage financial firms employed is a huge factor. And I'm tempted to just let them fail. Yet, even though I'm a libertarian, I'm a realist who thinks that if we (taxpayers) are going to come to the rescue, then there should be some regulations.

I may disagree with you on one thing: I don't know if the unintended consequences of the coming over-regulation will only be small. Let's hope so.