Job risk is greater than market risk in this environment,” he adds pithily. In which case, discretion is the better part of valor for traders and portfolio managers.
All of which has accelerated the contraction of credit discussed ad infinitum in this space. And the evaporation of this propellant for the market’s moonshot, to lift Cunningham’s turn of phrase, sent the markets crashing around the globe.
“Equity investors should not ignore the message from the fixed-income markets,” Richard Bernstein, Merrill Lynch’s chief investment strategist, wrote in a note to clients before the market’s open. “The rationing of credit means equity investors should discontinue their speculation regarding takeovers and LBOs.”
As they heeded that advice, the market’s slide recalled the minicrash of Oct. 13, 1989, when financing for UAL’s proposed LBO fell through. That event marked the end of the junk-bond-financed takeover boom of the 1980s.
Cunningham of State Street likens Thursday’s rout to the Long Term Capital Management crisis of 1998, when the collapse of that hedge fund caused the capital markets to seize up, even while the economy was in relatively good shape. At the behest of the Federal Reserve, the major banks and brokers arranged a bailout of LTCM. The Fed helped out by cutting its short-term interest rate target, even as growth was humming along.
The LTCM incident helped burnish the legend of the so-called Greenspan Put, the perceived insurance policy provided by the former Fed chairman to the markets when things got rough. After the crash of October 1987, the Maestro flooded the financial system with liquidity. And after the Tech Bubble burst, he did the same, slashing the overnight federal-funds rate all the way to 1% through 2003 into mid-2004, by which time the bull market and recovery were well along.
That’s had two consequences: The cheap money inflated the housing bubble, which is now deflating with noxious effects. And it increases moral hazard — the tendency of market participants to take on risk with impunity with the knowledge that they won’t suffer the consequences if there’s a bust. The expected Fed easing in reaction to any market setback is their Get Out of Jail Free card.
This episode marks Ben Bernanke’s first test as Fed chairman. “Never mind foreign oil, the U.S. economy is addicted to easy credit, and an easing by the Fed in the current situation will only maintain this addiction, but it still may be necessary in the short term,” asserts Cunningham. “The real test would be how quickly it was reversed, which was likely the mistake Greenspan made following LTCM,” he concludes.
Or Bernanke could show he’s no Gentle Ben and apply some tough love to the adolescents in the markets who don’t know any limits.
So we are looking at a spectrum between Volcker and Greenspan. Who and where is BB on this??
