Ted Forstmann.The Credit Crisis is Going to Get Worse

[Elliott]

7/5/08 WSJ,

The Credit Crisis Is Going to Get Worse

“Twenty years ago, Ted Forstmann contributed a scathing--and prescient--op ed to this newspapers warning that the junk-bond craze was about to end badly: “Today’s financial age has become a period of unbridled excess with accepted risk soaring out of proportion to possible reward,” he wrote in October 1988.

....

But after 9/11 [2001], the Fed opened the spigot. Short term interest rates went to zero in real terms and then into negative territory. When real interest rates are negative, borrowing money is effectively free...

“They could not find enough appropriate uses for the money,” Mr. Frostmann says. “The money just kept coming and coming and coming and coming. What are you going to do with it? IBM only needs so much. .... I don’t know when the money was ever this inexpensive in the history of this country.”

“Buffett once told me there are three I’s in every cycle. The ‘innovator’ that the first ‘I’, After the innovator comes the ‘imitator.’ And after the imitator in the cycles comes the idiot. In other words, “”In order to fix what’s going on in the US there’s going to have to be a certain amount of pain. The market’s going to have to clear somehow....and its hard for me to believe that it gets fixed without upheaval in the financial system, the economy and the country as a whole. Things are going to fail. Enterprises are going to fail. The economy is going to slow.”

 

[Mike Seward]

Buffet's three "I's" make a lot of sense, but let me paraphrase an article from the Washington Post written a few months ago.

Time Honored Story

"The mortgage meltdown in the financial markets in 2007 mirrows the story of the junk bond market inn the 1980's.

In chapter one, a new financial instrument makes capital available to a new class of borrowers. The result is profit for the innovator along with gains for consumers.

In chapter two, a group of investors misunderstands the novel instrument and bids its price up too enthusiasticaly. When the bust follows, the new innovation is denounced as inherantly dangerous.


Then, in chapter three, the complaints blow over. The investors learn their lesson and the new instrument stabalizes.

During the 80's, the value of junk bonds in circulation went from zero to $200 billion. Then, in the early 90's, one in ten junk borrowers defaultednd junk bonds were widely denounced.
But, that period ended quickly, and by 2000, the value of the junk bond market has soared to $600 billion."

I think that right now, we're in chapter two. Wall Street has taken their cards off the table. We don't have a liquidity problem. We have a creditability problem.

Hopefully, chapter three is just around the corner.

 

[Couch Potato]

Elliott, I think that sums it up quite well. Thanks for the post. To bad our country doesn't suffer from a shortage of idiots.