In the last two weeks, we have seen the federal government take over Fannie Mae (FNM) and Freddie Mac (FRE) in a move to save the companies from completely going under. We've seen headhunting vultures perched outside of the Lehman Brothers Manhattan offices hours after the iconic firm declared bankruptcy.AIG (AIG) , a major global insurer, pleaded with the Federal Reserve for liquidity assistance. Meanwhile, Merrill Lynch (MER) was taken over by the Bank of America (BAC) powerhouse (who will soon indeed become the bank of America). And finally, the only two remaining powerhouse investment banks, Goldman (GS) and Morgan (MS), hung their investment banking hats up and then became traditional bank holding companies. A bloody September indeed.
The street reaction: on a sunny Monday morning, investors pulled out enough funds from the market to tank the indices over 500 points in one day, or down nearly 5%. The trading days that followed didn't provide much support. The only other thing that could tank the market in this fashion is the day two enormous planes flew into two skyscrapers, permanently affecting the Manhattan skyline (dramatic enough for you?).
What we are dealing with here is a major broad-based price correction in the markets. As serious as this may be, this is nothing more than a gross and long overdue price correction. As the Washington Post described earlier this week, we are in the midst of building a new architecture for the modern financial world. After years of record earnings and creative new methods of financing, the titans and powerhouses of Wall Street have to reckon with the reality that the financial sector they built has grown too large and is unsustainable given the amount of leveraging and debt usage they've incorporated. The economy is in danger due to incessant greed.
The regulators and the financial institutions themselves completely miscalculated the risks they were putting the economy and the country into. When wealth grows beyond sustainable levels - it will correct itself. The timeless mantra of Benjamin Graham and his disciples such as Warren Buffett and Phillip Fisher states that the natural law of time will indeed correct overpriced companies and simultaneously reward and correct underpriced valuations. We are well into correction phase.
When institutions dream up crafty new ways of building wealth in the markets, they are forgetting the fundamental rule of business - offering a quality product or service for the right price to the markets and monitoring competitive threats every step of the way. Instead of offering quality mortgage loans to the buyers/lenders/borrowers, crummy mortgage loans were offered and then repackaged. No matter how many times crummy mortgage loans are repackaged into clever packages (and then offered as bonds to the public), they are still crummy.
When markets need to correct - you generally see it gradually over several years. The good guys end up watching the bad guys suffer as earnings prove unsustainable, and vultures pick up the pieces left by companies falling part. But when there has been a gross and broad-based miscalculation by just about everyone, what we see is a dramatic series of midnight meetings, last minute bailouts, triple digit losses, and what looks like the entire American financial system crumbling in front of your eyes.
But I suggest to my readers - fear not. Keep the cash on the sidelines ready to pounce when the iron is hot. It will be gut wrenching, horrifying, tear jerking, and a bloody nightmare. But this correction does not mean meltdown. It simply is the path necessary to return to normalcy and rationalism.
This too, shall pass.
Disclosure: none.
