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Generational Dynamics Web Log for 24-Oct-2008
Roubini: The situation is "sheer panic," as hundreds of hedge funds are going bust

Web Log - October, 2008

Roubini: The situation is "sheer panic," as hundreds of hedge funds are going bust

Policy makers may need to close markets for one or two weeks.

I've been sick for the last few days, but that's nothing compared to how sick hedge fund investors must be feeling.

Emmanuel Roman, CEO of GLG, Europe's biggest hedge fund, can't be feeling too well these days. Speaking at a hedge fund conference in London on Thursday, Roman said that 25-30% of the world's 8,000 hedge funds would disappear "in a Darwinian process." He added, "This will go down in the history books as one of the greatest fiascos of banking in 100 years."

Speaking at the same conference, New York University Professor Nouriel Roubini agreed, saying that, "We've reached a situation of sheer panic. There will be massive dumping of assets'' [and] hundreds of hedge funds are going to go bust.

Roubini added, "Systemic risk has become bigger and bigger. We're seeing the beginning of a run on a big chunk of the hedge funds. ... Don't be surprised if policy makers need to close down markets for a week or two in coming days."

This scenario would be the generational panic and crash that Generational Dynamics has been predicting for years. (See "List of major Generational Dynamics predictions" for more information about Generational Dynamics predictions.)

As I've said many, many times, from the point of view of Generational Dynamics, if you go back through history, there are many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

It's now been 79 years since the last generational panic and crash, so we're probably overdue for the next one.

What would one of these look like today? Here's how I've described it in the past:

"A generational crash is an elemental force of nature, like a tsunami.

You'll have millions or even tens of millions of Boomers and Generation-Xers in countries around the world, never having seen anything like this before, not even believing it was possible, and in a state of total mass panic, trying to sell all at once. Computer systems will crash or will be clogged for hours, or perhaps even for a day or two. People who had hoped to get out just as the collapse is occurring will be totally screwed, and will lose everything. Brokers and other institutions will go bankrupt."

This sounds a lot like the kind of thing that Roubini is predicting.

A lot of investors don't realize this, but my expectation for a major "panic event" is similar to mainstream predictions of a "capitulation event."

Art Cashin is a very well known (and, I'm told, well beloved) analyst, working on the floor of the stock exchange. He appears frequently on TV, and on Thursday morning he appeared on CNBC before the market opened.

Art Cashin is a major proponent of the "capitulation" theory, and in this interview, he gave details about what he expects:

Art Cashin, on floor of NY Stock exchange. <font face=Arial size=-2>(Source: CNBC)</font>

Art Cashin, on floor of NY Stock exchange. (Source: CNBC)

"Q: We're feeling the bottom again, Art. What's going to happen?

Cashin: I would love for a little bit of an up move today - maybe go up to 8750 or 8800 -- that would be a textbook Elliott Wave move -- and then you'd get that big washout / selloff. I was hoping for it by the end of this week, guess it's going to be pushed into next week. A dramatic climax looks like it's very near at hand here.

Q: Yikes! That could be scary. I guess if it was early November, that's not much different than making a low in October, is it Art?

Cashin: Well, in 1929, you made the low on November 4. I prefer to keep them in October. ...

I'm looking for a climactic bottom, down from here obviously, and that could carry through for several months [i.e., lead to a rally for several months], and then maybe in May, we'll get to know the full effect of the recession, and see how things look then. ...

I don't want to scare anybody. You could get an overtrade, You retest the original lows around 7850, you could go to 7400, you could go to 7000, you could even overtrade that. But it will be quick. Get your basket out, and be ready to catch the bargains when they come your way."

As I've pointed out before, this is a major mainstream view, and to a certain extent, it agrees with what I'm expecting (a generational panic and crash, as described above). This is the kind of thing that happened in 1987, and Cashin is expecting it to happen again.

When you drill down into the "capitulation" concept, you get something that's very strange. There's a large, amorphous group of investors who are slowly selling their stocks, bringing the market down. At some point, this amorphous group will become completely discouraged, they'll panic, sell off everything else, and "capitulate." Once this amorphous group of investors have sold everything off, then they won't push the market down any more, and the market will go up again.

The problem is: Who are the investors in this amorphous group? All the investors listen to these arguments on CNBC, so none of them is going to simply give up and capitulate at any time. So who are the pundits talking about with the capitulation message?

I'm trying to imagine what kind of person would see the market fall, and would say, "I'm not going to take a chance on losing any more money, so I'm going to get out of the market."

Generally speaking, the only person who might say that is someone from the Silent generation (the generation that grew up during the Great Depression). They were running things in 1987, and this is exactly what happened. These Silent top-level managers simply decided to get out of the market, all at one time, at a time when the market was underpriced, and they ended up losing out in the rally.

But you can see where I'm going next -- the Silents are gone. I can't imagine a Boomer or Gen-Xer saying, "I'm not going to take a chance on losing any more money, so I'm going to get out of the market." (The exception, of course, is Boomers and Gen-Xers who read this web site.)

So this explains why there's a capitulation concept at all, why it applied in 1987, and why it doesn't apply at all today.

And so, getting back to what Cashin said, he and I are expecting roughly the same thing, a "panic event," but the differences in our views have to do with the aftermath:

The Silent Generation led the selloff in 1987, and managed it very carefully, based on their memories of the Great Depression, so there really was no major emotional panic.
The Boomers and Gen-Xers today will be quite different, since they have no previous experience. They'll experience total panic, completely unlike the Silents in 1987.

Although a relief rally at some point is possible, the long-term trend of the market will be to continue downward, for the next 3-4 years.

It's interesting that if you take all three people -- Nouriel Roubini, Art Cashin, and myself -- we're all expecting some major, cataclysmic event, but we all differ on the reasons for it, and what will happen afterwards. And although I would be reluctant to name a specific date for this event, it's clear that Roubini thinks it's coming very soon, and Cashin expects it within the next week.

From the point of view of Generational Dynamics, this will be one of the major events in history. From Tulipomania in the 1600s to the 1929 crash, there have been a series of five generational panics and crashes that will never be forgotten. We're now very close to the sixth one.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (24-Oct-2008) Permanent Link
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Generational Dynamics Web Log for 24-Oct-2008 Roubini: The situation is "sheer panic," as hundreds of hedge funds are going bust

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Generational Dynamics Web Log for 24-Oct-2008
Roubini: The situation is "sheer panic," as hundreds of hedge funds are going bust