The Great Unwinding that Isn’t

Posted by on 08/31/09 in America, Debt, Risk

We made a mistake here at Syntrinsic.

Last fall, we labeled the global economic crisis “The Great Unwinding.” We thought (with the best of intentions) that the dramatic and sudden crash of asset valuations (e.g. commodities, equities, real estate, etc.) was due in significant part to the de-leveraging of the world economy. Banks that had been run as hedge funds and were levered over 30:1 were cleaning up their balance sheets, denying or significantly reducing credit to the hedge funds, private equity and private real estate investors dependent upon cheap financing. Businesses small and large could not maintain or get new lines of credit, home buyers were unable to finance mortgages, and even credit card companies lowered limits and raised rates.

And all that made sense. Intuitively, it was logical for an excess of credit that had been expanding largely unchecked for 20+ years would need to be reined in. It was a bitter pill certainly, but one we thought worth swallowing, for the resulting economy would be more rational, more sustainable, more tied to fundamentals.

Wrong. For it turns out that global citizens and their global political leaders are not so eager to pay the price of reduced leverage. There has been neither the intent nor the will to unwind. In our collective haste to avoid the pain of recalibrated valuations, we have not de-levered. Instead, we have simply nationalized our leverage.

Granted, providing debt has always been a function of the Federal Government. But now, we are taking things to an entirely new level. Rather than independent banks and private capital serving as major sources of economic stimulus, we now have the Treasury financing stimulus directly and indirectly through its significant stake (indeed life preserving stake) in industry and banking institutions. In short, the leverage has shifted from private to public, but it is still there. The knowledge that there likely would be further federal intervention if banks and or significant industries encountered further trouble adds yet another layer to the situation.

And this reality gives many people pause—they are uncertain about the path to recovery, how long it will take, how resilient it will be, because fundamentally we are still dependent on a highly levered economy. And this pause is not partisan, but strikes Republicans, Democrats and independents alike. The concern seems strongest amongst those who recognize the high level of systemic risk still in the system, rather than those who are members of one party or another.

So what do we do about the situation? As you evaluate your personal or business risk, keep in mind that the larger system is still one highly dependent on leverage. Manage your risk accordingly.

And while we have accepted that 2008 will not go down in history as the beginning of “The Great Unwinding,” perhaps there is still a chance that it will be remembered as “The Great Reminding.”