The Panic of 2007

Is it possible that we are on the verge of a full blown financial panic? I remember studying about the periodic financial panics that would hit the United States economy every generation or so. They seemed quaint and remote and not something that could happen in the age of deposit insurance, the Federal Reserve and the heavy hand of government intervention.

There have been so many financial panics in our history that they had to name them after the years they occurred. The panics of 1893, 1907, etc. Most of these panics involved banks, but the concept is the same. They are characterized by lack of confidence in our financial system, with a sudden shock to that system being the accelerant that sparks the conflagration or panic. And then a rush for the door, as everyone tries to get their money out first.

Let's look at what is occurring in our financial system:

1) Credit for purchasing residential real estate is drying up. It's no secret that sub prime and Alt A lending is essentially unavailable, but now it is spreading to prime lending and jumbo mortgages. If you think that jumbo mortgages is an issue only for rich people then you should take a look at the average home price in California, where you need a jumbo mortgage to buy a shack. This credit contraction will accelerate and prolong the housing downturn even further. This, of course, will have repercussions in the economy.

2) A money market fund just "broke the buck" or would have, if it let investors redeem their money. This is the first time that I can remember that this happened since Merrill Lynch, Pierce, Fenner and Smith pioneered these in the early 1980's.(Yes, I purposely used the former name to show how old I am.) Most non-professional investors assume that money market funds are "cash," and they are not.

3) We may be on the precipice of major redemptions in hedge funds, which will trigger another leg down in the equity financial markets. Think of all the money that has flowed into hedge funds the last decade, and then consider what would happen if that river reversed. Now if you think this is about a bunch of spoiled hedge fund managers whining because they have to sell their third vacation home, you are wrong. If I remember my numbers correctly, around 40% of Americans are invested in stocks.

4) We have a hyperactive media where every bit of information is available instantly, and then magnified tabloid style. Don't underestimate the effect that the media can have in creating panics. They are at the center of all of them if you look back at your high school history book.

The last recorded financial panic was in 1910, but of course we have had them since then but they stopped calling them "panics" and started using other terms for them. I hope that this doesn't happen in my lifetime, but I wonder sometime what really can be done to stop these events. After all, by definition, they are "panics," implying uncontrollable events.