Pisani's Trader Talk: Taking Lessons from Former Crises

CNBC's Bob Pisani reports on what traders are telling him:

Bob Pisani on the floor of the NYSE.
Bob Pisani on the floor of the NYSE.



The real estate collapse of 1989-1990




The lessons learned:


This action, which seemed extreme at the time, greatly accelerated the real estate recovery. Many were predicting the damage was so bad that real estate would not recover for a decade; but the market began recovering in the mid-1990s.

2) Contrast this with what happened in Japan, where real estate also collapsed in the late 1980s; but rather than mark down the damaged goods and dispose of them, Japanese banks held them on their books. The result was a painfully slow recovery in the Japanese real estate market.

The 1997 Asian crisis

Southeast Asian economies maintained very high interest rates to bring in foreign investors in the mid-1990s. As a result, growth rates increased dramatically in countries such as the Phillipines, Thailand, and Malaysia.

In the early part of 1997, interest rates in the U.S. began rising, and the dollar strengthened. This made U.S. investments more attractive investment relative to SE Asia. Many SE Asian countries had their currencies pegged to the U.S. dollar, so when the dollar strengthened, it made their exports more expensive and less competitive.


What we learned:

--Like the present crisis, the Asian crisis provoked a "flight to quality," but it was a flight into "safer" U.S. stocks and bonds. That year, the S&P 500 was up 31%.

--Investing in emerging market stocks was a relatively new trading strategy in 1997; because there wasn't a large global base of investors (many investors were U.S. hedge funds), many attempted to get out all at once.

1998 Russian-LTCM crisis

In August 1998, Russia devalued the ruble and declared a moratorium on its Treasury debt. Like today, there was a "flight to quality," but this time investors fled emerging markets in particular and into government bonds. Specifically, many traders sold Japanese and European bonds and bought U.S. bonds.

This dramatically impacted a hedge fund called Long Term Capital Management (LTCM). The fund specialized in finding securities around the world (mostly bonds) that were mispriced relative to each other. Simply put, they went long cheap securities and shorted those believed to be expensive. Like many hedge funds today, they also used an enormous amount of leverage in order to make significant profits.


What we learned:

--A bailout worked. Ultimately, the Federal Reserve organized a bailout by the major creditors. Like the creation of the Resolution Trust Corporation, a government bailout--particularly of a hedge fund--was controversial, but the fear was that once the company started liquidating its portfolio to cover its debt, it would lead to a vicious cycle that would force other companies to liquidate.


The Stock Market: (posted earlier today)

The sector to watch is the U.S. banks. Big commercial banks like Citi, JP Morgan and Bank of America have extensive retail banking operations and are far more diversified and better at laying off risk (often to foreign banks) than investment banks like Goldman, Merrill, Bear Stearns, and Lehman.

No one has even remotely raised the possibility that a major bank might be in big trouble. At the same time, no one on the Street I have talked to today said they would be shocked if a brokerage firm got bought out somewhere in the next couple months.


That's why banks are outperforming brokers. Today the Bank Index is up fractionally, brokers are down 1.8% again. The bank index is down about 6% in the last month, the broker index is down 18%.


The Credit Crunch:

1) Although stock traders would prefer the Fed lower rates to provide a psychological boost to the market, those with a "broader" view agree that it would do little to get liquidity to the players who need it most--mortgage lenders.

2) Calls for the Congress to get involved in the mortgage market are being met with dread on the Street. Proposals that have been floated include:

a) mandate forebearance for borrowers

b) allow losses to pass through to buyers of mortgage backed securities

c) raise the conforming loan limits above $417,000 to allow Fannie Mae and Freddie Mac to expand their mortgage portfolio

d) allow Fannie and Freddie to simply hold more mortgages in their portfolio below $417,000

The Fannie and Freddie proposals are likely nonstarters; their regulators are already opposed to it. First, most subprime loans are below $417,000, so raising the conforming loan limit is no help. Allowing them to hold more mortgages? Fannie and Freddie are working through accounting problems already, and may have unrecognized losses. This morning Fannie said higher risk mortgage loans in their portfolios that were originated in the market between 2003 and 2006 increased significantly through 2006.

Yen Rallies; Countrywide Tumbles (posted earlier today)

The rally in the yen we saw at the end of yesterday continued today--not just against the dollar (one year high against the dollar)--but against many other currencies where there was a notable carry trade, particularly the Australian dollar; New Zealand as well.

Another down morning for Countrywide as it announced it was drawing on all its $11.5 billion credit facility.

Traders are disappointed with Bill Poole's comments in a Bloomberg interview that it is unlikely there would be an interim rate cut from the Fed unless there was a "calamity."

Most traders agree that this is not a liquidity problem, it is a credit problem. There is plenty of money around--it is just not getting to the players who need it, like the mortgage companies.


Still, traders like Charles Campbell at Miller Tabak has pointed out that this is a psychological Bear market--and in these kinds of markets a Fed cut--stock traders hope--will have the psychological effect of freeing up money to the players who need it.

Maybe. What is really needed is for major financial players, a strategic player (like Fannie Maeor Freddie Mac), or foreign players, to step in and make the market function normally. Expanding Fannie and Freddie's role--allowing them to buy more mortgages--is widely advocated, but generally opposed by their regulators.

Even if the Fed cuts rates, the mortgage companies have instituted tighter lending standards. And with home prices down in several key markets, many will still have trouble qualifying for mortgages.

Here's the bottom line: banks are raising cash, and squeezing everyone else. They are unlevering the financial economy. They will shut down some mortgage lenders, even some non-bank lenders, and then they'll start lending again.

The long-term risk comes a few months from now: what happens when a major corporation goes to the well to issue new corporate paper for expansion, and the major players are not willing to buy?