Looking for an accurate credit crisis forecaster? Look no further than Merrill Lynch's chief investment strategist, Richard Bernstein. I've followed his warnings since 2006 about housing and his track record is pretty stellar. Bernstein is still pretty bearish on the overall economy. He agrees with me that the next phase of the credit crunch will spread to consumer loans.
On September 12, Bernstein posed a way to stem the ongoing credit squeeze. He's calling for the government to legislate a Resolution Trust Corporation (RTC) bailout of troubled U.S. financial companies. Former Fed boss Alan Greenspan served as a board member on the RTC back in 1989 following a series of massive failures tied to the Savings & Loan crisis. Greenspan also advocates a similar policy action.
In today's dollars the cost of RTC bailout runs around US$370 billion. Worldwide, the total sum of all financial sector write-downs is US$530 billion through July.
According to Bernstein, "The catalyst for the sustained out-performance of financials is likely to be when the government forms an entity specifically designed to facilitate the consolidation of the financial sector - like the RTC during the 1989-1991 period."
The government's actions have amounted to attempts to tackle crises at financial institutions as one-off incidents, rather than tackling the broader systemic challenge.
In my opinion, we all might be better off if the government structured a bailout fund once and for all instead of isolating each crisis separately. That's been the trend since March when the Fed organized a bailout of Bear Stearns and engineered a sale to J.P. Morgan Chase. No doubt, other banks will fail before this credit cycle eases.
The latest crisis, now afflicting Lehman Brothers Holdings and AIG, is just another shock to the financial system. Unlike the already infamous Fannie Mae and Freddie Mac bailout, the government refused to bailout Lehman. Instead, the government continues to offer special emergency funding facilities to all troubled banks since last year. Heading into Monday's trading Lehman's stock has crashed 95% from its high.
Cliff Diving at Lehman
As for Lehman Brothers' employees, heavily invested in company stock, the firm's collapse means more people have seen most of their savings wiped-out this morning. That's what happened to Bear Stearns Cos. in March.
At this point I think it's fair to assume that unless the government, possibly in conjunction with stronger financial institutions and private equity funds, fails to organize an RTC-type of vehicle, then we're likely to see more failures. The public's confidence has already been damaged this year with 11 bank failures to-date and wealthier investors pulling money out of bank savings accounts.
Europe, by the way, which is about six to 12 months behind the U.S. credit cycle, will eventually have to create its own version of an RTC bailout fund. This is probably most likely in the United Kingdom, Spain and Ireland - the weakest financial markets in the European Union.
ERIC ROSEMAN, Investment Director
EDITOR'S NOTE: Lehman's failure and AIG's dire straits are just the latest flashes in the pan. Truth be told, we can't be sure yet how many of our storied financial institutions drank the poison, and it doesn't seem like they'll tell us until it's too late. In the meantime, the credit crisis is inching closer to home - your wallet and the consumer debt markets. The Sovereign Society just finished a special report on the next wave of debt crisis. Read our FREE special report here.