Mar 15

The Greatest Deleveraging in the History of the World

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At our recent Insurer Investment Forum VIII, each attendee probably had a few key ideas that they gleaned from the conference.  In my case, one idea came when I was preparing my brief opening remarks, and the other came from listening to Allan Sloan, Fortune Magazine, address us at lunch.

The first idea is that we are witnessing the Greatest Deleveraging in the History of the World.

When you think about it, that is not as forceful a statement as it seems on the surface, since we have just witnessed over the last few years (until about August, 2007), the Greatest Leveraging in the History of the World.  The largest single country economy ever used expanding leverage to grow in excess of the rate it would if it did not so use as much leverage.  As we all know, leverage is a two sided sword:  great when things are going well, and dangerous when they are not.  We are now in the dangerous stage.

Perhaps the Fed, by working with JP Morgan and salvaging Bear Stearns,will control the impacts of this deleveraging today.  And, perhaps there will be other large institutions (‘too big to fail’) for which the Fed or other government agency will have to do the same.

And that brings me to the second idea from our conference.  Mr. Sloan was quite entertaining and witty, as he is within his column in Fortune.  However, he said that this was only the second time he can remember that a break down in the financial system is impacting the ‘real economy’ towards what looks like a recession.  (Usually, it is the ‘real economy’ that has problems that cause a recession that then impacts the financial system to some degree.)  The other time Mr. Sloan could remember that the financial system caused problems for the ‘real economy’ and not vice versa:  the great depression.

If credit continues to contract and if market liquidity continues to be under assault, the problem in the U.S. will be falling, not rising prices.  And, therein lies a truly problemmatical scenario.  In that case, when would those helicopters aluded to by Chairman Bernanke start dropping suitcases full of cash?

In May, 2007, Chairman Bernanke said he did not expect ‘significant spillovers’ from the subprime market to the rest of the economy or financial system.  The Fed’s latest moves, including significant rate cuts, opening up the discount window, setting auction market lending facilities and now working on a Bear of a problem proves that not only does he ‘get it’, but he is quite concerned about the Greatest Deleveraging in the History of the World.

There are still many other monetary and fiscal policy solutions that can and probably will be used to tackle this deleveraging.  Unlike during the depression, we have those tools at our disposal.  In addition, the occassionally maligned Mr. Bernanke could be the most educated person on this topic.

Our conference was really quite positive in many ways, but those two rather interesting and troubling ideas were my personal ‘take aways’.

We’ll have more on what this means for insurer investment strategies in future blog entries and in client communications.

And, as always, you can comment by signing onto the Insurer Investment Forum Online.