Is It Different This Time? Comparison To 1997

Everyone knows that the four most dangerous words on Wall Street are "this time is different." Many investors have lost money buying the stock of a company that never quite seems to get its act together despite intermittent positive signs and consistently favorable comments from management (think Home Depot during the Nardelli years). We also hear this phrase applied to the macro outlook. Time and time again when faced with similar macro backdrops, people are often heard to say, "Yeah, but this time it's different."

As the debate rages on about what the Fed is doing or might do, I am reminded of the crisis of 1997. As you may recall, in July of 1997, Thailand devalued its currency and this sent a tsunami of equity market weakness that reverberated globally. Shortly thereafter a hedge fund called Long-Term Capital went belly up. It had made leveraged bets that the spreads between two securities could NOT move apart farther. They did. I recall at the time speaking to Richard Bookstaber (see his blog here), who at the time was the risk manager for Salomon Brothers, and he told me that all the models he was looking at suggested that that trade was a good one and this development was very surprising. A lot of people were surprised by this. Just like all the folks were surprised when the quant models all of sudden stopped working this summer.

The collapse of Long-Term Capital had implications far beyond the hedge fund community because many banks had various loans and commitments extended to it. The Fed intervened (cutting the Fed Fedds rate as I recall), not to help out the economy in any way, but to stabilized the banking system and to reassure all investors and market participants that there would not be long-lasting troubles from this one firm's demise.

At that time the economy was doing pretty well and the easier money really helped it to improve. Shortly afterwards the Internet boom took hold and the Y2K-related tech spending helped propel the equity markets to all-time highs. Although it may be hard to measure the precise effect the Fed's actions had on the bull market of the late 1990s, I think most people would agree they were positive factors and may have starting the ball rolling, as it were.

So how does the current situation stack up against 1997? Is it the same? Is it different?

1) The economy is doing well. The expansion may be long in the tooth, but continues to chug along and has been able to absorb higher energy and food prices without significant impact.

2) The Fed Fedeasing (if it is easing) for reasons not tied directly to the current economic environment. IF there is a perceived credit crunch and Fed Fedls compelled to address this by easing, it seems to be similar to 1997. This could be good for the equity market, especially if the Fed Fedomes more accommodative that it feels it needs to be given where the economy is.

As always, I am making no predictions here or giving any advice, but wanted to throw out this observation to stimulate discussion. Any thoughts?

Comments

[WilliamFeader]

I don't see how adding liquidity to an already over liquid economy could ever be considered a good thing.

Perhaps it's time for you American's to take your lumps and deal with the underlying crisis rather than printing more money to temporarily patch up the system.

[emily x]

I don't know that LTCM is necessarily the comparison, tho everyone seems to be making it. What's going on now seems to have much bigger tentacles. Maybe the dot-com bust that started in March 2000 is a better analogy. Then, like now, a lot of people bought a lot of stuff they didn't really know the value of, and used borrowed money to do it. Then, when conditions inevitably change, there's this sudden unmasking of risky investments that many people apparently thought were safe -- or at least that they could get out of in time -- and then the crash. It's like that scene in "Casablanca" -- "I am shocked, shocked! to find gambling going on here!" Bottom line, when times are good and credit is available, people will use it to buy stuff they probably can't afford. If the Fed actually cuts rates this fall, it will help. But still, it looks like we're in for more pain in the months ahead.