recession in the air

Some thoughts about the last financial crisis and how Fed chief, Ben Bernanke saved the world.

As of lately it's been hard to ignore the constant talk about the next recession being upon us. I'm not going to chime in, since - and that's actually a much larger dilemma - in this market it's impossible to have any clarity. President Trump opens his mouth and the market moves 2% in either direction (unfortunately it's been mostly South) and that's just the icing on the cake... it's been unpredictable for a while. So, since hindsight is always 20/20, let's do something useful and take a brief look at the last crisis.

Although the following is only indirectly related to our mission, we're interested in everything that concerns investing (that's how you become a savy investor - and how you make relevant software) and I believe the following needed to be said. So, without further ado, elfetica finance & engineering brings you back my thoughts from 2008.

Former Fed chairman Ben Bernanke is a controversial character - loved by a few and hated (con gusto) by many. To me, that appears to be a mainly a consequence ignorance - or, to put it more midly, the unwillingness to face cold hard facts and blame someone else when things go wrong. In a nutshell: we don't realize how incredibly lucky we've been in 2008. And, frankly, that is scary... huge meteorite-impact kind of scary.

Did Ben Bernanke do everything right? Probably not - being human like you and me, that is quite unlikely. But, in the same vein, he didn't do everything wrong - which is pretty much what some people claim. Disregarding extremism, I'll say that I strongly believe that much of what he did during those extraordinary times (which actually boil down to a couple of months... or days) was absolutely crucial in avoiding a complete collapse of our financial system.

If you, like most of us, associate bank-runs with underdeveloped countries, let me tell you that we came incredibly close to having them ourselves (there's much more to be said on that chapter, though unrelated to 2008). (Note: I say we, because regardless of your nationality, if the United States goes down so goes the rest of the world... we've seen as much when the world was less interconnected and the country was Japan!)

Imagine a world were no ATM is working, where your bank account is blocked and inflation running rampant while companies drop dead (go bankrupt) like flies. One of these is ominous enough to raise the hairs on my arms, unfortunately - as we've seen over, and over again - when the weakest link - in the economic chain - fails, the others follow.

Once this cascade of events occurs, the performance of your investment portfolio will be the least of your worries since money itself will be worthless within weeks. I suppose we're all too old to remember, but if you were one of those weird kids who liked stamps, you may have seen - and been impressed - by the 'restamped' German stamps. Inflation was so rampant that there wasn't enough time to reprint them with a new value from scratch. The problem was 'solved' by only re-printing the denomination. Often several times... each time adding a zero (or two). There's no way any person can cope with that sort of financial stress... hence: what stocks you own (or not) won't matter. Even cash under the mattress won't matter... and if you're thinking gold, think again...

Does it sound dire? Do you suddenly feel anxious? If so, good... you're still alive and thinking rationally. What is truly scary is the fact that, either consciously or unconsciously, as a species we never acknowledged this. The Volcker-rule was the only reaction to the 2008-crisis. It was too little, too late and way too much in the wrong places. Why? Because implementing real reforms (real safeguards) would be very painful... perhaps for a generation. That's how rotten our (Western) financial system really is. For what it's worth, I believe we're witnessing the beginning of the end... and I don't mean a little crisis - more like the end of the Roman empire (hopefully it won't happen in my lifetime, but it's a close call).

Although I suspect that people who are reading this are a sophisticated bunch (who know this already), for what follows just keep in mind that the much critized bank-bailout was engineered by the Treasury (at least officially, unoficially we'll never know). Just to give credit (or blame) where credit (or blame) is due. I won't go into the details of the bailout or of the crisis itself - enough has been written already. I won't even go into detail as far as Bernanke is concerned since I'm trying to look at the big picture. I'll simply point out a couple of things that are key to understanding what did or rather, did not happen in 2008.

• The situation in 2007/2008 was extremely critical to say the least. Case in point, at least one highly regarded (and not very public) bond-expert fully expected widespread bank-runs (and the disastrous cascade that follows) and instructed his wive to withdraw as much as possible from the bank, first thing in the morning. Fortunately, by next morning the Fed had already formulated a very strong (and very credible) reaction that gave investors confidence that the worst-case scenario won't be allowed to happen. Speaking more generally (in quantity and time) it was widely expected that Lehman Brothers was just the first in a long string of major bankruptcies which would drag down the economy. One could say that such a, milder, scenario was almost unavoidable! And, allthough it's a far cry from a bank-run, a string of major bankruptcies would also unleash a vicious circle that is very hard to break. In a nutshell: by the time you are presented with facts it's too late to act. Not only was such a scenario reasonable, you'd have to be foolish to think otherwise. (Thankfully we could count on the rule that financial 'experts' are always wrong.) Unfortunately, as usual, the media did their best to spell out doomsday scenarios while all of this was happening, but they forgot about it awfully fast - never to be mentioned again. And so, the world remained blissfully unaware of the systemic problems that exist in the financial system, leaving me as the only person still beating this 'dead' horse because I think there are lessons to be learned. And also because blaming someone else (Fed, Treasury, President,...) won't prevent it from reoccurring in one form or another. We, the people, have to keep the pressure up and signal that we are willing to make the necessary sacrifices (there are ways to do this which minimize the pain - pretending the problem doesn't exist is not one of them.) In the meanwhile, we have the mighty Gods and the humble Ben Bernanke to thank for living to fight another day (if you feel rightous, you may add the Treasury to the list, since they were willing - and ready - to double down on the Fed's gambit by injecting trillions into the financial system, albeit in a hare-brained fashion).
• The 2008 crisis is now commonly referred to as the "Great Recession of 2008" - that is simply wrong. The crisis of 2008 wasn't a recession (though, admittedly, it ended up sort-of appearing like one). Fundamentally, it was an altogether different beast. The ugly truth is that the last crisis was the making of another depression, possibly even greater than 1929-1939. If that wasn't the case, the combined actions of the Fed and the Treasury would have caused runaway inflation virtually overnight. In hindsight, we should refer to it as "The Small Depression of 2008".
• As you probably know, the difference between a recession and a depression is that during the latter, economic policy (e.g. interest rates) stop working altogether.(I urge you to read-up on the causes if so inclined.) The trillions of cash thrown into the financial system, the 0% interest rates, etc. are all testament to that: they barely managed to prevent a major disaster (because the intervention was both massive and prompt). Had it been slightly later in time, or less agressive, we can be pretty certain it wouldn't have worked. Put differently, the financial instruments at the disposal of the Fed (not that many) are completely ineffective during a depression. Only extraordinary measures can break the self-fulfilling vicious circle. Precisely such extraordinary measures were also instrumental in ending the Great Recession of 1929-1939. I strongly believe that without those extraordinary measures, 2008 would have turned into another 1929 (or, probably, worse). It takes a singular man to act so aggressively (but not recklessly) so quickly. He might be unassuming, but Ben Bernanke is a very bold man!
• Long before 2008, Ben Bernanke was considered to be the foremost (living) expert on the Great Recession. Fate wanted that he was Fed Chairman precisely at the time when a similar set of circumstances presented themselves again almost a century later. I'm not a mathematician, so I can't give you an exact number but it seems the odds of that happening must be pretty slim. That is before we even begin to take into account the probability of said person being bold enough to take the necessary actions, let alone the probability that they will work as intended. Had someone else, say Jerome Powell (who seems as clueless as Greenspan was reckless), been Fed Chief at the time, I probably wouldn't be writing this, and you wouldn't be reading it!

For a cinematographic excursion into what a depression looks like, I can think of no better example than Rainer Werner Fassbinder's 'Berlin Alexanderplatz'. If you aren't scared yet - in knowing that the underlying issues are still there - you will be after watching this mini-series.

Perhaps, the most important takeaway from this article is that we still haven't grasped the basic facts about the last crisis, we are at best ill prepared for the next one. If we, as investors (or, I'm afraid, as a species) are unable to do that much, then at least we shouldn't fault other people for the state of the economy (or the world) when things finally go awry. And if one thing - along with death and taxes - is certain, it's that everything that can go wrong will go wrong (better known as Murphy's law).