A Look Back and Why is Today’s Market Different
Posted on October 31, 2018
We recently sat down with Trust Company veteran and Director of Research, Timothy Vick, to get his thoughts on the 2008-09 crisis, the lessons learned, and how today’s market is and is not like that of a decade ago.
Tim, how do you view the current activity?
It’s another in a series of corrections, the type that afflict markets every year or so. We will stay focused on the data and on company fundamentals, and make decisions when needed. But rest assured our clients’ financial goals will drive decision-making. Anytime the environment makes you nervous, it’s time to sit down again with your advisor and address your financial plan. You need to make sure that your asset allocation, income needs, growth goals, and risk tolerances are being well communicated and served. Stock market corrections test whether your portfolio is behaving under stress as you expected, and also test your own ability to withstand price fluctuations.
What was it like to be caught in the thick of the Great Recession?
First, I have to commend all my colleagues for the way the team navigated the 2008-09 shock. Like everyone else, we took the initial months of economic decline in stride, and had taken many precautions for clients. But at some point you were sitting at your desk in utter disbelief as to what was unfolding. It was surreal to see storied, 100-year-old companies falling like dominoes – and for reasons no one outside those boardrooms could grasp. Clients felt the same way. Every day, we were being asked “How is this happening,” or “How low can this market go?” – questions we couldn’t answer. It was impossible for us, or anybody in the industry, to connect all the dots and predict a worldwide recession and a 47% stock market plunge.
By early 2008, it was clear to us that the economy was being led downward by a housing and lending slowdown. We were seeing it firsthand in Florida, as people around us were having difficulty selling homes that a year earlier would have sold within days. The market had anticipated the slowdown, too, because stock prices actually peaked a year before the crisis, in September 2007, and had already fallen 20% when the crisis really hit home. The next 27% fall in stock prices, what I call the second phase of the bear market, was pure panic selling. Everybody was selling the headlines because everybody else was selling.
It always helps to understand history. I first became fascinated with the stock market in economics class in late 1977, just as coal miners initiated a nationwide strike and President Carter tried to force them back to work. The Dow Industrials tumbled for about six weeks to a then-ghastly low of 742. When your career begins with a trial by fire you soon learn that dysfunction is the norm in macroeconomics, not the exception. And you learn right away how important it is to assess risks, deal with dysfunction, and to stay calm and rational. So, when future events occurred – the 1987 crash, the Gulf Wars, 9/11, the housing crisis – you stayed sober.
Was there one great cause to the Recession?
Not at all. To pinpoint one company, one bankruptcy, or one piece of legislation as the precise cause may be politically convenient, but ignores the fact there were also housing and lending bubbles in Madrid, Istanbul, London, Dublin, Reykjavik, Hong Kong, and Shanghai. The common thread was low interest rates. Rates were pushed too low around the world after the technology bubble burst in the U.S., and that awoke the beast. Investors became starved for yield in a low-rate climate, and Wall Street obliged by learning to package U.S. mortgages together into products that were yielding 5%-7%. These packages proliferated for years until every major bank and investment house owned, traded, or wrote derivatives contracts on these mortgages.
It became a house of cards built on a single assumption – that home prices in the U.S. would never fall. As long as prices kept rising, which they had for 30 straight years, equity in homes rose and consumers could borrow more. Banks felt increasingly comfortable making more loans — and riskier loans – believing that the collateral was safe. And the banks knew they could sell off the loans anyway to be packaged by someone else. Everyone in the pipeline – loan officers, mortgage brokers, appraisers, ratings agencies, developers, credit investors, derivatives traders, homeowners – was incentivized to create and trade more product and keep the party going.
In stepped the homebuilders, who ramped up production of ever-larger homes and were constructing 2 million homes a year by 2007, well above population growth. At the same time the Federal Reserve had been raising interest rates to cool off spending and borrowing. Eventually, home prices had to buckle due to oversupply and slowing demand. That exposed the entire cottage industry of lending and packaging.
What measures did The Trust Company take?
The first thing we always do when a see a crisis surfacing is to identify where “ground zero” is, then try to gauge what is causing the crisis and whether its impact could spread. Housing was ground zero in 2007-08, and our response was to eliminate as much cyclical housing and lending exposure as we could. We really didn’t know how deep the crisis would be, or that numerous bankruptcies would later grace the front pages, but we felt it prudent to sell the stocks and bonds of a number of financial companies to ring-fence clients from the worst scenarios.
Our second response was to implement a strategy called “Cash and Courage,” in which we did an assessment of each clients’ risk profile, income and budget needs. We decided to raise two years’ worth of liquidity for vulnerable clients so they could ride out a prolonged bear market while getting all their living needs met. For example, if a client needed $200,000 a year from her portfolio to pay bills, we made sure that she had $400,000 sitting in cash or short-term bond funds. Clients breathed a big sigh when they realized that their bills were covered the next 24 months, no matter what the market did.
It was vital back then to have a point of view, and to base our decisions on that view – rather than stick our heads in the sand. We felt that monetary and banking authorities would step in and “do the right thing” when relief was most needed. Had they not, we could not have been as optimistic, or as willing to keep clients invested for the rebound.
Cash and Courage never left our vocabulary. We still implement it when we encounter clients who have income needs and would be vulnerable to a prolonged market downturn.
Were there preventable mistakes?
The primary mistake, where investors were concerned, was denial. The fundamentals of financial companies started deteriorating in 2007. Yet industry insiders, analysts, and money managers were saying that the crisis was overblown, couldn’t spread, and would only marginally affect their favorite stocks. A number of renowned mutual fund managers lost their reputations riding big positions in homebuilders and financial companies all the way down because they looked cheap on paper. It was the old “relative-value” trap. At the same time, we remember talking with many costal Floridians who couldn’t accept that their home values could fall — after tripling in price in less than a decade.
The second big mistake was panicking. Selling begets selling in our business, and that’s why declines turn into corrections, and corrections sometimes turn into bear markets. Clients who stayed the course and rode out the 2008 decline saw their portfolios eventually triple off the bottom. Those who sold near the bottom tended to wait too long to get back in – and now are years behind their financial plans. I still have an email from a client who wrote me March 9, 2009 (the day the S&P 500 hit bottom) wanting to sell all his stocks. He thought the market could fall another 50%. Around the same time, Warren Buffett was writing an op-ed piece in The New York Times saying that this was the buying opportunity of a lifetime.
What was the fallout from the Recession?
Investors turned conservative and quick on the trigger. It is perfectly normal to try to avoid repeating a bad situation, so people tend to engage in behaviors that can eliminate its reoccurrence. Think back to the last time you got a speeding ticket, or had a fender-bender. Chances are you became a more cautious driver for months after the event. You probably drove at exactly the speed limit on the same stretch of road where you got the ticket.
Since 2009, I have seen the same behavior from investors. No one wants to experience a re-peat, so investors have been on a 10-year lookout for signs of the next bubble – even when no bubble existed. We’ve had a number of turbulent events since 2009 – the European banking crises (plural), Greece, China, Russia, the Ukraine, the Arab Spring, budget sequestrations, Brexit, and the collapse of oil and gas prices – but on a relative scale, none were as remotely damaging to asset values as our housing collapse was. If the Great Recession was a 50-year flood; Greece was a 1-year flood.
So, there are no bubbles developing?
Yes and no. The private sector (which suffered the worst blows in 2008-09) has really constrained itself this decade and has not overreached when it comes to borrowing, lending, and spending. As an example, two years before the Great Recession started, the personal savings rate in America turned negative – that is, the average consumer was actually dipping into savings to buy routine goods at Target or to pay the mortgage. That situation was unprecedented and couldn’t persist. Today, Americans are savings an average of 6% of their incomes, which is very healthy.
One certain bubble did form and already burst – oil and gas infrastructure spending. Wall Street bent over backwards to fund the construction of pipelines, deep water drilling rigs, storage facilities and liquified natural gas facilities, thinking oil prices would stay above $100 a barrel. Instead, prices crashed to $28. Yet the deep recession in energy in 2015 and 2016 barely spilled over into the rest of the economy.
The bubbles that we believe do exist are in the public sector. Developed governments around the world went on a borrowing binge following the Great Recession to try to stimulate their economies, and bail out their weakest industries. So, while private sectors entrenched and rebuilt balance sheets, public governments filled the gaps, intentionally ripped holes in their own balance sheets, and kept stimulating. Central Banks enabled the debt binge by actively buying and holding the debts of their respective governments when other buyers of the debt backed off.
The Federal Reserve, the Bank of England, the European Central Bank, the Bank of China, and the Bank of Japan collectively hold $17 trillion worth of their own government’s bonds they eventually must sell back to the markets. They hoarded bonds to keep interest rates low in their home countries, and were successful at it. But we have no clue what to expect when these central banks start liquidating, other than that rates will logically rise.
How about housing?
Housing markets have been strong, though recently they seemed to have plateaued. Home prices have escalated in many metropolitan markets, and investors naturally worry that we’re repeating the past. But there are key differences. Back in 2005, home prices were appreciating because of excess lending and liquidity – anyone with a pulse could get financing, which increased demand for homes and gave buyers the capacity to bid higher. Today, the issue is shortage of supply – builders went into hiding for several years and still are not constructing enough homes to keep up with population increases. In the last five years, the industry built an estimated 5.8 million new homes and apartment units, though we realistically needed 7 million units to keep up with the population. Anyone who has tried to repair their home after Hurricane Irma has experienced first-hand the shortage of inventory, labor, and building materials. Correcting this dis-equilibrium won’t lead to another bubble – rather, it means even more economic activity and more jobs.
How is our banking system today?
As healthy as I’ve seen it in 25 years, which is one reason why our economy finally has legs. The banks have been integral to more than half of the booms and busts in America since the early 1800s, so their activities need constant monitoring. Excess, lax lending has put the U.S. in recession more than a dozen times. Each time, new regulations were later written to try to prevent a recurrence. The implementation of “stress tests” on our largest financial institutions starting in 2010 means they all must hold enough excess capital to weather a 30% decline in house prices, as well as 10% unemployment. Similar stress tests have been copied in Asia and Europe for their banks. The testing may prove to be overkill, but another housing bust wouldn’t rip the system apart again. I have seen ample evidence of prudent lending throughout the U.S. banking system since 2009, but there are no guarantees. The next lending bust will look different than 2008 and likely not be housing related.
Can 2008 reoccur?
We’ve had so few episodes of that magnitude in Western history, economists assume that recessions such as 2008 are just remote occurrences. Behavioralists like to think that great bubbles only occur once every 40 to 50 years, because it takes that long for the older generations to forget their pain and for the younger generations to take the same risks all over again. It really took a perfect storm of conditions to build up around the world for years before the housing bubble broke. And it was magnified by the fact that all the large banks were heavily invested in the most speculative areas of the economy – and were trading with and lending to each other. We’ll never be able to stop the type of speculation that lead up to 2008, but the financial system has erected fences so that future problems can’t spread as rapidly.
When it comes to the stock market, however, emotions sometimes reign. There have been numerous examples of markets that fell 20% or more from the peak, even without a financial crisis or a popped bubble. This current correction is perhaps the 28th I’ve experienced. After the first 27, the market eventually recovered and went to an all-time high. Markets tend to correct themselves much faster than economies do. Stocks that fell the most in 2007 and 2008 rose the most in 2009 and 2010.
How do you see the 2008-09 Recession in retrospect?
All recessions are a mixed blessing. They are healthy because they tend to correct excessive economic behavior. The 2008-09 housing crisis caused tremendous pain across our economy in a short period, but it also produced the mother of all buying opportunities. Those who had cash on the sidelines, and had staying power to get through the recession, found everything on sale simultaneously – stocks, homes, commercial real estate, new and used cars, boats, land, furniture, art, private businesses, and so on. We likely won’t see such a fire-sale for American assets again in our lifetimes.
What did our leaders do right 10 years ago?
All of us in the office were skeptical of some of the measures Washington took in 2008 and 2009. It’s still mind-boggling to me what the government did in just a matter of weeks. As examples, the federal government created a fund to buy bad loans on banks’ balance sheets. It later took equity stakes in numerous banks by forcing them to raise more capital, which the government then purchased. It put Fannie Mae and Freddie Mac in receivership and took them over to keep the housing market afloat. It bailed out General Motors and Chrysler, took equity stakes in them, fired GM’s CEO, and forced Chrysler to merge with Fiat. It injected emergency capital into AIG, guaranteed the value of ailing Money Market funds, and negotiated the fire-sale buyouts of Bear Stearns, Washington Mutual, and Merrill Lynch as they were defaulting.
It’s clear now, having read numerous accounts of those times, that Americans owe immense gratitude to Treasury Secretary Hank Paulson, New York Fed Chairman Tim Geithner and Federal Reserve Board Chairman Ben Bernanke for taking these extraordinary steps to save the system. They seemed to grasp, when few did, that our economy was days away from flat-lining and that extraordinary measures were needed – and needed immediately. There literally was no time for white papers, for committee hearings, or for partisan Congressional debates on solutions. The facts were that the largest financial entities in America simultaneously were being bankrupted by bad loans, and that the private sector was in no position to save itself. Only the U.S. government had the wherewithal to inject boatloads of cash immediately into the system to keep banks’ doors open.
Thankfully, we’ll never know how bad it would have gotten. Beneath the surface of the publicized bailouts in New York City, the contagion was spreading fast to companies large and small.
Pure capitalists still cringe at how the crisis was handled, but there was no other way out.
What did they do wrong?
Paulson, Geithner and Bernanke didn’t get Americans to “buy in” to their proposed bailouts and takeovers. Neither did Congressional leaders nor President Bush. It happened too quickly to rally public opinion to their side. Years later, the public still views the events of 2008 and 2009 very cynically. Americans wanted culprits jailed, banks closed, and executives stripped of their bonuses, pensions, and compensation. Trust disintegrated between Main Street and Wall Street and the banking system. By 2014, the economy was expanding again, yet too many consumers, businesses and investors still were hoarding cash and not trusting that the system was mending. It didn’t help that in the midst of the crisis, we had an election and a complete changeover in Washington. So instead of leaders banding together in a united front to raise people’s confidence, they degenerated into endless finger-pointing that was unproductive.
What were the lessons we should take away?
We’re all 10 years older but 50 years wiser. Each strand of grey on our temples has been earned this decade. You can’t NOT take away career lessons from that crisis.
First, you can’t engage in avoidance behavior, because very few investors can hit their financial goals constantly fretting about the future and sitting in cash yielding 2%. Most of you need sufficient income to live off, and you need investments to grow. Just because it’s going to rain today doesn’t mean you don’t go outside. If you watch the news, as we do, you know when to take an umbrella. But you still go outside.
Any other lessons?
In the same vein, pay close attention to whom you listen, and seek consistent advice that is tailored just to you. Your financial advisor should be the chief person you listen to, not someone on television, nor your neighbor or son-in-law. Certainly, now is not the time to begin listening to doom-and-gloom forecasters who are trying to make a name for themselves forecasting another crash. Just because someone “called” the 2008 bubble and shorted housing stocks doesn’t mean they can suddenly see the next bubble, or is an expert in gold or oil. I recall a number of strategists who predicted the 1987 crash, for example, and got a lot of marketing mileage from that prediction for the next 15 years. Most of them never uttered a useful prophecy again.
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