Financial Firms and Asset Bubbles
As I watch the leaders of several financial companies speak on CNBC this morning regarding the financial meltdown and possible future prevention, I reflect on what happened. I have read numerous articles at length on whose to blame, and when the path to meltdown actually started, but these arguments appear to split somewhat evenly by party line. It seems to me that asset bubbles have always occurred and will continue to occur, no matter who seems to be shouting or heeding any warnings.
Asset bubbles have appeared throughout modern history and are most often predicated by easy money. The ability for almost anyone to receive a mortgage loan, and the lack of foresight of financial institutions not to provide them to anyone, fueled the most recent real estate bubble. The recipe for bubbles is fairly easy. There needs to be an availability of money or credit and you need the basic human trait of greed. The tulip bulb mania in Holland in my opinion is a classic case and an interesting read. It is an enlightening entry into human sociology and the herd mentality we humans seem to so fondly cling to.
Obviously, if a person can determine the next asset bubble to emerge there is much money to be made. Usually, the next bubble is not from the same asset class as the last. Traditionally, banks do well during low interest rate environments as they can borrow money cheap and loan it out for more while making quite a bit of money on the spread. So in the current interest rate environment the banks and financial institutions should be able to produce good profits. However, it is not easy to determine how much their business model has changed with; more government oversight, less leverage, loan defaults, etc., and those effects on the bottom line.
It appears to me we have the foundation in place for another asset bubble. The Federal Reserve, in response to the possibility of financial Armageddon, has lowered interest rates to effectively zero, and is keeping them there. Our political leaders have provided stimulus programs, which have effectively added money into the financial system. Although banks do not appear to be lending which would definitely speed up the amount of money in the system, there are signs of potential asset bubbles. In the midst of the worst recession in recent history prices for food, energy, health care and the like have either stayed constant or sure seem to have increased. In fact, a person could argue that given the state of jobs and the economy that the above mentioned goods prices should have fallen quite a bit.
So, we have excess money and a basic human trait like greed, both of which I do not believe are going away soon. Where will the next asset bubble materialize? That is the six million dollar question. I hear whispers that it is in commodities, government debt, emerging markets etc. Just because prices are going up does not necessarily make it a bubble. Unfortunately, like not being able to see the forest through the trees, it is not very often an easy determination. Like some things in life, you will know it when you see it, or you will know it is a bubble when it crashes and you are left holding the bag, or without a chair to sit on.
Daniel Petrey, CFO, MBA