“The future is a lot like the present, only longer.”
– Woody Allen
The financial crisis is in the headlines again; one of the most frequent questions I get is, “How much longer will this last?” Yesterday, the stock market dropped two percent on news of more loan write-offs at Citigroup. And the general fear is that the malaise in financial firms and housing will spread to other sectors of the U.S. economy and to other countries. Back in August, the conventional wisdom was that this subprime loan mess was a temporary inconvenience. Sam Stovall of S&P was more sober:
“Since 1950 we have had 48 pullbacks – meaning declines of 5 – 10%. We’ve had 18 corrections – meaning 10- 20%, and 8 bear markets. At the worst on average we end up getting back to normal in about 3 1/2 years. But people just don’t want to wait that long and they let fear overtake their emotions.”
He listed a range of possible scenarios: pullback, correction, bear market and “the worst,” by which he probably meant a full financial crisis. By now, we know more about the gravity of the situation.
The correct answer to the question is that I don’t know and I don’t think anyone else does either. However, based on an understanding of previous financial crises, I don’t think that we are close to the inflection point at which the good times resume. Studies ((Lowenstein, Roger, 2004. The Origins of the Crash: The Great Bubble and Its Undoing. New York, NY: Penguin Press. Silber, William L., 2006. When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy Princeton: Princeton University Press. Sobel, Robert. Panic on Wall Street; A Classic History of America’s Financial Disasters — with a New Explanation of the Crash of 1987. 1968. Reprint. New York: E.P. Dutton, Truman Talley Books, 1988. Wicker, Elmus. Banking Panics of the Gilded Age. New York: Cambridge University Press, 2000. Kindleberger, Charles . 1978. Manias, Panics, and Crashes: A History of Financial Crises. New York: Basic Books. I’ll also mention my favorite: Bruner, Robert and Sean Carr, 2007, The Panic of 1907: Lessons from the Market’s Perfect Storm, John Wiley & Sons.)) of past financial crises yield many insights, the chief of which is the systemic nature of crises—trouble breaks out somewhere and spreads rapidly because of complexity in markets and the absence of adequate shock absorbers. The trouble stops when there are no more losses to be taken, mainly because there are no more assets or institutions at risk (that is, the worst have been dissolved and the others have the capacity to withstand the crisis).
The contagion of crisis ordinarily lasts many months—and this is usually followed by a recession. The end of a crisis might be gauged at two points: (a) “the bottom” or the inflection point at which conditions turn for the better; (b) the point at which the cycle returns to a level of economic activity prevailing before the onset of the crisis. In the Panic of 1907, point (a) occurred in June, 1908, 18 to 26 months after the start of the financial crisis (depending on when you date the onset, either April or December 1906.) And point (b) occurred in mid-1910, about four years after the onset. The crisis of today began (we suppose) some six to 12 months ago.
Studies of recent crises add more doubts. Richard Bookstaber (see his Demon of Our Own Design) argues that the instruments, institutions, and trading strategies in today’s markets increase the complexity dramatically and therefore lower our ability to make sound assessments. Paul Blustein’s The Chastening, recounts the “Asian Flu” crisis and essentially argues that because of this greater complexity, modern crises are different from those a century ago: they last longer. He determines that the “Tequila Crisis,” “Asian Flu,” and Russian Debt Default were linked and part of the same underlying crisis arising from globalization of markets. Similarly, the short-lived Crash of October 1987, the S&L Crisis of the late 1980s and the recession of 1990-91, could be linked by the turbulence induced by sharply-falling oil and gas prices in the mid-1980s.
How today’s financial crisis turns out will surely differ from previous crises. But they bear points in common. One commonality is that these tend not to be brief episodes. Indeed, the future of this crisis will be like the present, only longer.
My advice to MBA students and applicants is still to pursue your long-term career vision. In the near term, we are probably in for some turbulent flying. Don’t get too picky about employment opportunities. Prepare to engage in some missionary selling, to help employers discover your talent. But also, don’t lose confidence about the longer-term prospects. The World Bank projects 4.9% GNP growth for the world economy next year—this is down a shade from 2007 (5.2%) but remains pretty robust. And growth is expected to rise back to 5.1% in 2009. Many fundamental forces are aligning to sustain that kind of growth: technological change, trade liberalization, liberalization of markets, demographic change, etc. The odds seem strong that a new graduate from a top MBA school will face reasonably good demand for his or her skills over the long run.
Posted by Robert Bruner at 01/16/2008 08:45:26 PM