2008: Year of failing dangerously

Business Times - 01 Jan 2009

What stands out is not inflation, deflation or recession but the collective failure of regulators, brokers, bankers and analysts. R SIVANITHY takes a look at the year past

WHAT was the central theme in 2008 when the Straits Times Index lost 49.2 per cent over the 12 months? Inflation? For the first six months, yes. But not once the oil and commodity bubble burst in July. And certainly not heading into 2009.

Deflation? That's still a real possibility. But it's probably too early to say definitively that the world economy will suffer deflationary shocks from the US sub-prime fallout and, if so, how bad these will be.

Recession? Yes. But the dreaded "R" word really only started to be uttered in the second half of 2008. And in the US, it was only confirmed in December as having taken root. No, if there is one word that defines 2008, and sets the tone for 2009, it is failure. Not just of US properties, banks, mortgage companies and giant carmakers, but of the entire financial system, investment community and supposedly robust regulatory framework.

Many, quite legitimately, have pointed to former US Federal Reserve chief Alan Greenspan as the prime cause of the entire mess because of his failure to rein in bank lending and his easy money policies after the dotcom recession of 2000.

The US Federal Reserve, US Treasury and the US government failed to take action early enough, preferring instead to believe the hype about how strong the American economy was and how well-regulated the country's banks were.

At the same time, brokers, investment bankers and most research analysts failed to discharge their fiduciary duties properly when they underestimated risk and overestimated their powers of analysis. Most refused to read the writing that appeared on the wall as early as March when Bear Stearns failed. Instead they kept urging clients to buy, demonstrating unforgivable complacency in the face of the worst economic collapse in more than 70 years.

The structured products industry failed when US investment bank Lehman Brothers went bust in September. And although those involved might try to deny it, it's very likely that those who marketed and sold High Notes and Lehman Minibonds to unknowing retail investors failed to adequately apprise their customers of the risks involved.

There's plenty more: Bernard Madoff's shocking US$50 billion Ponzi scandal, which suggests a failure to properly regulate hedge funds; the automakers' failure to convince the US Senate to approve a US$19 billion bailout; the panicstricken liquidity injections by central banks and the interest rate cuts that have so far failed to ease the crisis; and above all, the failure of the free market, disclosure-based model to provide the necessary discipline.

Will 2009 be any different? Let's hope that this time next year we'll be writing about successes - instead of failure after failure.

JANUARY: The old market adage "As goes January, so goes the rest of the year" certainly applied to 2008. Markets everywhere kicked off the New Year on a sombre note with large daily plunges commonplace. In a desperate attempt to prop up a sagging Wall Street, the US Federal Reserve cut its short-term rate by 75 basis points to 3.5 per cent on Jan 22 ahead of its scheduled meeting on Jan 30, and again by 50 points to 3 per cent a week later, citing "risks to growth". It brought some respite but not much.

Despite all the bullish predictions by analysts at the start of the month - one house ventured a target as high as 4,800 for the Straits Times Index - the index plunged 484 points over the course of the month, a 14 per cent loss that was a precursor of worse to come. Index closing: 2,981.

FEBRUARY: US President George Bush signed a US$168 billion rescue package for homeowners which provided some stability to Wall Street and by extension, the rest of the world. Trading throughout the month - and indeed throughout the rest of the year - was volatile, the STI constantly tracking the Hang Seng Index almost on a second-by-second basis as investors sought clarity on where the market might head. The STI flirted with the 3,000-mark almost daily, finally regaining it at month's end. For the month, the index rose 45 points or 1.5 per cent at 3,026.

MARCH: On March 16, the US's fifth-largest investment bank Bear Stearns tottered on the edge of bankruptcy thanks to its exposure to Collateralised Debt Obligations (CDOs), instruments that few investors had heard of beforehand. The acronym CDO would soon take a central place in market nomenclature as investors gained a crash course in how the crashing US housing market was feeding through to the CDO market and, in turn, was sending banks deep into trouble. Bear Stearns was eventually sold to JP Morgan but ominously, rumours surfaced that another venerable Wall Street institution, Lehman Brothers, would be the next. Thanks to the US government-engineered bailout of Bear Stearns and a 75 basis points rate cut to 2.25 per cent, the STI lost just 19 points or 0.63 per cent during the month to end at 3,007. The first quarter's performance was a loss of 458 points or 13.2 per cent.

APRIL: Hope springs eternal. Testifying before the US Senate, Fed chief Ben Bernanke said the US economy "may contract in the first half", clearly unable to see the writing that was on the wall and thus playing a central role in lulling Wall Street into a false sense of complacency.

Nowhere was this better manifested than independent research outfit BCA Research, which said in its secondquarter strategy outlook that the bear market had ended and that investors should start buying immediately.

"Our sense is that monetary reflation may be slowly winning the battle against deflationary pressures coming from the housing meltdown, financial deleveraging and retrenchment in banking activity," said BCA. Meanwhile, an increasingly desperate Fed slashed its interest rate to 2 per cent on April 30, Wall Street did, however, stabilise and so the STI managed a 140-point or 4.7 per cent gain for the month to 3,147. It was to be the STI's best month for 2008.

MAY: Oil takes centre stage. Markets may have enjoyed some relief from talk of CDOs and sub-prime failures - this despite economic data that showed the US housing market continued to be weak - but attention became focused on oil's relentless rise to an all-time high US$135 a barrel in the third week of the month.

Not surprisingly, discussion turned to inflation as analysts, probably carried away by sharp upward momentum (as they usually are) predicted oil could hit US$300 a barrel within the next five years. Daily movements were dictated by US economic data and movements in Hong Kong's Hang Seng Index. For the month, the STI rose 45 points or 1.4 per cent to 3,192.

JUNE: Oil continued to occupy the minds of investors. distracting attention away from a collapsing US housing market. Still, the phrase "credit crunch" entered the market's lexicon, complementing "CDOs" and "sub-prime crisis" as problems lurking behind the scenes seek to derail markets. The US banking sector started to cave in but a stubborn refusal by local analysts to acknowledge a growing problem meant that banks here held firm. The Fed held its short rate steady at 2 per cent at its June 25 meeting, possibly in order to save ammunition if needed later. It did - but as things turned out, interest rates proved irrelevant in stemming the coming tide.

The STI caved in by 245 points or 7.7 per cent over the month to 2,947. It was the last time in 2008 that the index saw the 3,000-mark. For the second quarter the STI lost 60 points or 2 per cent, which brought its loss for the year to 518 points or 15 per cent.

JULY: "Sell into strength and be careful of buying the dips." This was the advice given repeatedly by BT and it proved spot-on as bear trap after bear trap ensnared hapless investors. Early in the month oil hit an unprecedented US$147 a barrel but soon embarked on an almost non-stop downward spiral as oil fears were replaced by a growing realisation that the US sub-prime woes were far from over. Goldman Sachs hit the nail on the head when it said midmonth that "fundamentals have degraded since late-Q1, which implies upside rebound potential may not be as significant as it was four months ago". Not everyone heeded this advice and propped up by a stillcomplacent Wall Street, the STI fell only 18 points in July to 2,929.

AUGUST: Singapore loses its "defensive" or "safe haven" reputation. Sub-prime concerns kicked into second or third gear and the 2,800 level which chartists had thought unassailable was easily breached and the attrition continued. For the third consecutive month the STI fell, this time by 190 points or 6.5 per cent.

SEPTEMBER: Few retail investors here would have heard of Fannie Mae and Freddie Mac before this month but by the end of the month the government-led US$200 billion bailout of the two giant US mortgage providers meant that everyone would have been familiar with the names. US Treasury Secretary Henry Paulson described the two as being too big to fail, prophetic words that would apply to more failures just around the corner. Oddly enough, there was no similar "rescue" of Lehman Brothers, which went bust on Sept 15. Merrill Lynch in the meantime could have shared the same fate but opted to be sold to Bank of America while AIG, another financial institution, had to be bailed out by the US government to the tune of US$85 billion. The fallout here was immediate - structured products sold by Lehman to local investors were found to be largely worthless and thousands of retail investors found themselves staring at millions of dollars of losses. In tandem with Wall Street and the rest of the world, the STI's collapse gathered pace with the index losing 381 points or 14 per cent at 2,358 during the month.

OCTOBER: It's funny how October seems to be one of the worst months for stock markets in history, the crashes of 1929 and 1987 both occurring in October. The selling kicked into full throttle in October, with the STI crashing 564 points or 24 per cent to 1,794 by the end of the month. Needless to say, fears of more bankruptcies and a worsening economic outlook were the main culprits.

NOVEMBER: Another forgettable month for the bulls as investors found it difficult to find reasons to buy stocks. Gone were the urgings to "buy" as the dawning realisation set in that not only would corporate earnings disappear, many companies could follow in the footsteps of the insurers and banks. Citigroup flirted with bankruptcy, seeing its shares which started the year at US$30 crash to US$3.77 on Nov 21. Thanks again to Uncle Sam's boundless largesse (and creaking printing presses), the bank which was deemed "too large to fail" was bailed out. The STI lost 62 points or 3.5 per cent over the month at 1,732.

DECEMBER: Controversy reigned as the bosses of troubled US car companies General Motors, Ford and Chrysler, who had previously flown to Washington in their private jets to beg for bailout money, had the door slammed in their face by a US Senate who vetoed a US$19 billion package because, of all things, an inability to agree on wage demands by the auto unions. Shock and awe in the meantime reigned when it was revealed that respected Wall Street veteran Bernard Madoff is in all likelihood nothing more than a cheap crook, running a "Ponzi scheme" in which he took money from new subscribers to pay high returns to earlier investors. Still, driven by promises of ever-larger rescue packages by the incoming Democrat administration and window-dressing, Wall Street's indices stabilised this month. The STI ended a net 30 points higher for the month at 1,761.56, a loss of 49.2 per cent for the year.