Monday, February 15, 2010

Financial crisis 2.0

“After all, you only find out who is swimming naked when the tide goes out.”

- Warren Buffett, 2001 letter to Berkshire Hathaway investors

When making the comment Mr. Buffett was speaking about insurance business in post 9/11 world and the very complex chains of reinsurers after reinsurers. “A single weak link can pose trouble for all”, he said. He might as well have been speaking (today) about investment banks or banking system in general.

As pointed out by many, subprime crisis might have been just a “prelude” to a much bigger crisis. As the “tide” is slowly going out more and more entities appear to have been “swimming naked”. Not just banks, but entire countries. Many countries were heavy on debt even before the crisis. Now all eyes are on Greece, but the deficit & debt problem is far more widespread than that.

It is not just so called “PIIGS countries” (Portugal, Ireland, Italy, Greece and Spain) that may in for trouble. Also other European countries, Japan and USA have significant debt levels and budget deficits. Check out this chart.

In his recent article titled ”A Greek crisis is coming to America” Harvard professor Niall Ferguson painted a gloomy picture of a potentially rolling debt crisis. I was compelled to listen to “Moonlight sonata” by Beethoven while reading it. And that masterpiece has some pretty seriously sad and anticipating sound to it.

Basically Mr. Ferguson says that what we might be witnessing is a beginning of fiscal crisis of the whole western world far worse than what followed the subprime tsunami. To me the most striking claim was that the “US will never again run a balanced budget”. So I just had to look it up. And sure enough, CBO projects large deficits throughout 2020. What might make US situation even worse is anticipated second round of mortgage defaults.

Markets are nervous and who knows what might set of the next panic. Hopefully all this goes away as I’m still pretty heavily exposed to stock markets right now. In anticipation of some sort of recovery hiccup I have sold the riskiest assets that gained heavily in 2009 and reinvested to more defensive index funds and stocks.

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