Eric Von Schmidt used to sing a traditional song about the Galveston Flood of 1900.
Wasn’t that a mighty storm
Wasn’t that a mighty storm in the morning, well
Wasn’t that a mighty storm
That blew all the people away
I thought about those lyrics this morning while on a phone call with a friend who had just spent a few hours with one of our country’s most successful hedge fund managers. Though the TV images of yesterday’s Galveston hurricane damage played silently in the background, the words of my friend were bringing to mind not a hurricane but a financial storm of epic proportions.
The hedge fund manager believes we are now past the point that we could ever have a “soft landing” for the economy and that we are maybe only 40% into the crash that is slowly unfolding. He believes that the bill for the writedowns of mortgage backed securities will be more than a trillion and that at least 50% of the more than $400 billion in mortgage bonds will default. He also thinks there is a high probability that more than 40% of the securitization of credit card loans will default. Lehman Brothers and Washington Mutual are “dead men walking”, but can perhaps be acquired at bargain basement prices.
Overall we are entering a period of profound contraction and consolidation. In nine months there will be many fewer banks and the small hedge funds that levered their $2 billion of capital to $30 billion in securities will be gone, because if you lose 10% with that kind of leverage, you’re out of the game. The notion that there is any decoupling between the world’s economies is dead. Instead, countries are in a “global race to the bottom”, to complete the process of creative destruction and delevering. In some ways the U.S. is leading the pack and may finish the gut-wrenching process sooner than China, Germany or the U.K. But make no mistake, the recession/depression will be global.
Ironically what is part of the disruption is weekends like this. The manager said there have been “six weekend interventions” by the Fed or the Treasury this year (bailouts, emergency rate changes, etc) and so managers leave work on Fridays never knowing if the world may change over the weekend. The market hates uncertainty, so this is adding to volatility. Of course the big hedge funds are creating self-fulfilling prophesies by shorting stocks like Lehman and WaMu.
Early in the year I wrote a post called “Savage Capitalism” and wondered if the deregulatory fervor that seized our government in 1980 had not unleashed a cancer that could consume the very system the Laissez Faire crowd was trying to support. I’ve been saying the storm is coming for a long time here, but now we better start thinking about how we want to rebuild when the storm finally clears.