Wednesday, September 17, 2008

Fear Index Highest in History

Our MarketPsych Fear Index is the highest in its 28 year history (the prior high was in March 2008). See our index page for the graphic.

As I've said in previous blog posts, it's important not to "catch the falling knife" in the markets. Don't buy the stocks that are plummeting until there is some news that addresses the underlying cause of the share price collapse.

Maybe that's why the markets continue to be so spooked. No one is addressing the root causes of the uncertainty. We've heard U.S. government officials say two things:
1. "We'll save you if you're too big to fail, otherwise too bad (example: Lehman)."
2. "We won't save anyone because that's socialism and uses taxpayers' money and these guys on Wall Street are soulless greedy louts anyway" (heard from presidential candidates and Senator Richard Shelby chairman of the U.S. House Banking Committee)

I think #1 doesn't go far enough. All these firms are interdependent, as we're again seeing with the collapse of Goldman and Morgan Stanley shares today.

I fundamentally disagree with #2. I'm a physician by training. When a patient is dying from a myocardial infarction (heart attack) it's not appropriate to teach them a lesson about eating well and exercising. If they survive, with your assistance, then yes you can lecture them after they've recovered, but while they're dying it's considered bad form.

In my opinion, we need to create a "Resolution Trust Corporation" type slush fund to absorb dodgy debt as we did with the S&L crisis. Yes, it will be extremely expensive. Perhaps we can have a special tax on financial companies to help pay for it. I suspect they would agree in order to stop the crisis.

As psychology experts, Frank and I know that the pain will continue as long as no one steps up to the plate and takes charge. Effective focused action is needed to root out the rot and identify the uncertainty. All the bad debt needs to come to light and be segregated from the good stuff.

In many cases the "bad" debt is in a descending positive feedback loop which reduces balance sheet values, which then causes further need for capital, then forced debt (CDS) sales, and again even lower market values due to more fire sales, etc.... If we waited a year or two, the CDS defaults wouldn't be as bad as anticipated. But with quarterly "mark to market" accounting rules, the companies holding this debt in the U.S. are in death spirals. And without real leadership, this has become the hurricane Katrina of the financial industry.

It's sad to see, because a little psychological saavy and leadership could have prevented this. Clear out the bad stuff, set it aside, and charge companies a lot (a dedicated tax) to manage it while markets stabilize.

But no one wanted to suffer the political consequences of being branded a "pinko." Too bad, because the rapid shock we're currently experiencing probably isn't the best for the country (or the world) in the long run. Psychological studies show that "ripping off the band-aid" causes more psychological distress and unhappiness than removing it slowly and gently. High finance has done an enormous service in globalizing and increasing the efficiency of our economy. Sad to see it left to waste in the name of ideology.


1 comment:

Christoph said...

How dare you compare a person dying with a company going bankrupt?? Yes, people are loosing their job, but they made the choice to work for risky highly leveraged companies - AND received high salaries, stock options and benefits for a long time!!

As a psychologist you should be the first to know: to get people to agree on changes in the way they behave it must HURT in people's pocketbooks!!!

When gas prices went up, people drove less - when cigarette prices went up due to taxes, people smoked less - all for the better of the population!

And this is how it will be with the economy: Severe CHANGES are needed in financial behavior, regulation and legislation. This is why it needs to hurt on Wall Street and Main Street!

The bailout in this form was and will stay wrong, because it bailed out the industry that, by opposing regulation, got themselves into trouble! The taxpayer bails them out, and the next industry stands in line behind them: car industry, airlines, ...

Where will it end, don't we have enough debt already?

Let's face it, the American System is broken and we are loosing to that of other Countries!!