It Is Different This Time
Potentially one of the most costly trappings for investors is succumbing to a belief that ‘it is different this time’. For instance, assuming that the economic engine of the United States is permanently broken or we are destined to the Japanese experience of permanent malaise may lead us to make the wrong choices when it comes to investment strategy. Just over a year ago we experienced a ‘financial panic’. It was not the first and it will not be the last. A financial panic is characterized by a ‘run on the banks’. Our recent experience was a ‘run on the system’. What happens in a financial panic is that all financial players move in unison to ‘safe assets’ leaving financial institutions without risk capital to operate.
Banker Panic of 1907
While the Great Depression was kicked off with a series of ‘bank runs’, the most similar episode to recent Panic of 2008 was the Banker’s Panic of 1907. The stock market peaked in 1906 and fell 40% over the next year during a time of recession. In the fall of 1907, with the economy and financial markets already on shaky ground, a number of financial institutions extended money to a group of investors (think subprime lenders) making big one-way bets. When the investor bets soured (think housing bust) it led to the collapse of a prominent broker dealer in New York City (think Lehman) that caused another and much larger financial institution to fail (think AIG). As news spread, depositors across the nation became nervous and began withdrawing their funds from all types of institutions (think of the mass exodus from money market funds after The Reserve Fund, a money market fund with a small position in Lehman, ‘broke the buck’.) From there, the entire system began to unravel.
John Pierpont Morgan, the wealthiest and most prominent banker of the day (before the Federal Reserve Bank existed) stepped into the fray by making capital injections into several prominent banks (think Bernanke/Paulson with their Maiden Lane loans to AIG and the $250 billion TARP injections into the largest U.S. financial institutions.)[i] John D. Rockefeller, the wealthiest person in America at that time, made a large deposit into Citigroup’s predecessor (think Warren Buffet investing in Goldman Sachs and GE Capital). After these initial injections, over the next few weeks, and through some serious banker wrangling, Morgan was able to pony up enough bankers and money prevent the total implosion of the financial system (think of the $500 billion in the 2nd round TARP, as well as the TALF, CPFF, PPIP).[ii]
Past Performance Does Not Predict Future Performance
The economy did shrink in 1908, but it grew again until it was stymied by the outbreak of World War I in 1914. And in the aftermath of the 1974 ‘Great Bear Market’, the economy grew until 1980 despite double-digit interest rates and double-digit inflation during that time period. It is hard to say if the Panic of 2008 was any worse than the Panic of 1907. Or the economy of 1975 was more resilient or in better shape than the economy of 2009. Whatever the case, unprecedented is not a word I would use to describe the events of the last year or so.
Looking forward, a belief that America is permanently broken, or on the wrong path, or is an empire in decline is generally a bad bet in my view. In 1989, the Nikkei would peak at 38,000. Japan was on a roll. It had a vibrant economy, great manufacturing acumen, they were buying up the most precious real estate in America, and everybody wanted a Sony Walkman. In America, our financial system was in shambles as we shuttered thousands of S&Ls, Citigroup fell to less than a $1, Michael Moore made his first movie about a dying U.S. auto industry, and Apple’s first portable computer was a piece of crap.[iii] Over the course of the next decade, the Nikkei would lose 66% of it value and U.S. stock market would rise 450%. Do you think most pundits were betting on Japan or America in 1989? Perhaps I am wrong, but I caution those that think it is different this time.
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