Why Excess Adjusts The Marketplace

Lesson number: 
191

The 21st Century has been a great teacher of business cycles and economics thus far. We have witnessed the so called dot.com bubble and burst at the turn of the new century, followed by the housing bubble and burst; which unfortunately caused the present credit bubble which has already begun coming apart at the seams. One may argue that these bubbles and busts were all driven by the vast accumulation of wealth chasing higher returns on capital invested. Or by fiat monetary policies and cheap credit the Federal Reserve has artificially pumped into the market during the last seven years. Yet the exact reason really doesn't matter. Because whatever one does in excess, be it eating, drinking, gambling, or chasing a buck in risky investments, you can be sure that the day of reckoning will surely occur. And when it does, it will level the landscape for many latecomers who participated in the gluttony.

Once you become a numbers oriented person, and study your business and life using statistics and facts rather than emotions, you'll find that life and markets really are quite predictable. There are entire industries built around polls, surveys, actuarial charts and statistics. However, while nothing is ever full proof or certain, statistics play a major part in decision making. And it's the very brave or very foolish who believe that they are the one person or one company who was destined to beat all the odds.

Keeping in mind that the analysts at the largest financial institutions and investment banks rate stocks and investments daily; and have access to the greatest charts; statistics; and data available to mankind; it makes one wonder how they could have created this credit mess in the first place. The endgame we are now witnessing is a rather quick cash meltdown of some major financial institutions which are responsible for safeguarding the assets of tens of millions of investors, both private and institutional.

According to Business Week during the last week of March 2008, Goldman Sachs estimated that U.S. financial institutions could suffer about $460 billion in credit losses. Losses from residential mortgages will represent about half the total, while another 15% to 20% of the damage will come from commercial mortgages, Goldman's Andrew Tilton says. So far, banks have announced about $120 billion in write-offs since the beginning of the credit crisis. However this wringing out of excess is not limited to American soil. UBS AG, Europe's biggest bank by assets wrote down $4.2 billion in subprime assets, yet still has $39 billion remaining on their books. This mess is hitting financial institutions in Germany, France, England, Asia and most industrialized nations.

Even scarier, is the fact that we haven't heard much about the non-banking corporate write-downs yet. The first shoe dropped last Friday when General Electric reported their earnings and the results from their financial division helped their stock lose 12.79% in value for the DAY. GE has been touted as one of the best run companies in the world for the last few decades and even they were not immune to taking part in the game of mistakes. We haven't heard much about write-downs from giant insurance company yet, who invest vast amounts of capital from the premiums collected. Let's hope they don't add to the misery suffered by subprime lending.

I believe it's safe to say that we have more surprises ahead of us as the quarterly reporting season begins during this coming week. As investors, there's no better time than the present, to make sure that you are watching over your investments and dealing with banks or brokerage companies who are truly practicing their fiduciary responsibilities. Don't wait until the horse is out of the barn as illustrated by the shock endured by the employees and investors at Bear Stearns. Don't become complacent and think that some agency of the Federal Government will be there to bail you out of a personal financial crisis. All investments have risk. Just read your contracts and dis-closer forms and you will learn that the burden of loss is your individual responsibility.

The present economic marketplace in general must adjust to the errors and excesses that have taken place during the last five years. Specifically the housing market must adjust to the excess run up in prices. The commodity markets must eventually adjust to prices that end users and consumers of their products could afford. The oil markets must adjust to the excess price runs caused by the same speculators who in 2003 believed that housing prices had no limits. Excess in all forms meet their match at some point. Just make sure that you are not buying into the frenzy at the top of the pyramid. Or you will suffer some harsh financial penalties that could change your life.

In summary, the laws of supply and demand are doing today what they always do in "free markets". They are marking to market the true value of goods and services. These forces always bring prices back to balance and equilibrium. Just stay awake at the wheel and be diligent as you guard your hard earned assets!