While prognosticating about the current situation and state of the market, I started thinking more about the roaring 20's. What a fine time it was, markets doing well, people generally happy and the sentiment was that it was going to go on forever. Not too unlike the last couple of years, and if you listen to some economist, they are saying the party will continue (I disagree).
So looking back at the 1920's, the biggest reason the markets melted down was an over-extension of credit and leverage on equities, I believe it was 10:1 at the time. So a small snowball came rolling down the hill and became an avalance under the weight of leveraged magnification and we all know the end.
Looking at what has recently transpired, one can only (or should) be very concerned by this lesson in history. Not only are we in a grossly over-extended credit situation, but the leverage within the system is mind boggling. For example, the two Bear Stearns funds that imploded early on in this story were levered 20:1 and 30:1 (I can't recall the exact ratio, but I believe these to be close if not correct). This leverage is embeded throughout the system, and is one reason why everything is freezing up. Like reading your rearview mirror, the risk is much larger than it appears.
What is really disturbing is the fact that we have become desensitized at the monetary amounts being thrown around here. We hear of multi-billion dollar writedowns and losses now on a daily basis, and judging the broad market action and sentiment, seem to completely ignore the severity of the situation here. Long Term Capital Management almost caused a systemic failure less than 10 years ago, and that was on roughly 2 billion!
Today Paulson spoke about systemic market failure and the job of the government to try to avoid this. The government is scared to death and you should be too.
So looking back at the 1920's, the biggest reason the markets melted down was an over-extension of credit and leverage on equities, I believe it was 10:1 at the time. So a small snowball came rolling down the hill and became an avalance under the weight of leveraged magnification and we all know the end.
Looking at what has recently transpired, one can only (or should) be very concerned by this lesson in history. Not only are we in a grossly over-extended credit situation, but the leverage within the system is mind boggling. For example, the two Bear Stearns funds that imploded early on in this story were levered 20:1 and 30:1 (I can't recall the exact ratio, but I believe these to be close if not correct). This leverage is embeded throughout the system, and is one reason why everything is freezing up. Like reading your rearview mirror, the risk is much larger than it appears.
What is really disturbing is the fact that we have become desensitized at the monetary amounts being thrown around here. We hear of multi-billion dollar writedowns and losses now on a daily basis, and judging the broad market action and sentiment, seem to completely ignore the severity of the situation here. Long Term Capital Management almost caused a systemic failure less than 10 years ago, and that was on roughly 2 billion!
Today Paulson spoke about systemic market failure and the job of the government to try to avoid this. The government is scared to death and you should be too.
