History, including market history, does sometimes seem to repeat itself. Exactly one hundred years ago, the Panic of 1907, whose details are brilliantly recounted by Ken Silber in his feature story “TR vs. JP”, occurred only months after the Dow broke through the symbolic 100 mark. Credit had been easy and stock prices were on the rise. When speculative mining investments boomeranged against financial institutions backing those investments, depositors made a run on banks weakened by the implosion. The crisis would have intensified had J.P. Morgan not stepped in to save the day.
Fast forward a century later and we can see some important parallels to what may come to be called the Panic of 2007, a.k.a. the subprime mortgage meltdown. The very lengthy run-up in the housing market was fueled in part by mortgages that were packaged by investment bankers as collateralized debt obligations and other types of asset-backed securities. But what happens if those assets backing those securities are part of an asset bubble, and when the debtors paying those collateralized obligations weren’t all that creditworthy?
Too many people — particularly mortgage brokers, investment bankers, hedge funds and rating agencies (and let’s not forget individual homebuyers speculating on ever-rising prices) — rode the risky housing-market wave till its crash, leaving widespread economic damage reaching far beyond just real estate. MarketWatch’s David Weidner has even hailed Bank of America CEO Ken Lewis as a modern-day J.P. Morgan for bailing out Countrywide Financial when the subprime crisis was at its peak.
Of course, Lewis’ well-timed move was made for the benefit of B of A shareholders, however salutary an effect it also had on the plunging market. Morgan, in contrast, raised money to provide liquidity to markets at a time when there was no Federal Reserve that could do the same. Which begs the question: Should the Fed be providing credit to wobbly markets, in effect supporting investors who had a hand in building the financial house of cards? Or should the market, including shrewd investors like Ken Lewis, sort out the mess? Alexei Bayer offers his thoughts in his commentary on the Panic of 2007 (“Success or Excess?”).
It’s worth drawing one safe conclusion from the market panics of 1907 and 2007. In each case, the fear followed the greed. That is, people made money while not paying too close attention to the financial worthiness of the investment. The chasm between mortgage borrower and mortgage lender had become quite great, as news reports of the financial condition of borrowers have made embarrassingly clear. As in the dot-com days, investors were buying their dreams even as people with insufficient credit were buying their dream homes. As we sweep up the mess, we’d all do better to try and keep a firm grip on reality.