The Berkley Corner continued

The problems we face have evolved since the mid 1990’s when the government began a relaxation of regulations which allowed investment banks and other financial institutions to become more highly leveraged, thus these institutions became less stable, therefore subject to more risk.  As we approached the turn of the century and the technology bubble burst, the Federal Reserve, in order to avert what they perceived as an extremely risky economic environment, flooded the nation’s money supply.  This excess liquidity to a substantial extent flowed to the housing market which created the impetus for rapidly increasing home prices stimulated by an abundance of mortgage money combined with a boom in new home building.   As these funds got used up, new creative financial devices were used to allow the housing market to continue to expand with sub-prime mortgages and an array of other products designed to allow people to buy houses they often times could not comfortably afford.  At the same time, this all looked perfectly safe and sound because housing prices were increasing.  Thus, you could always sell your house to pay off the loan if you no longer could afford the payments.

During the same period, people became extremely confident in the continued expansion of our economy and the belief that all risk could be controlled and managed.  Our regulators developed a false sense of security.  Risk premiums diminished and risk related interest rate spreads became smaller and smaller.  Investors were willing to assume substantial risk for yields that were less than a few percentage points more than a U.S. Treasury Bond.  The world had lost its sense of appropriate risk premiums.

As all this was happening, suddenly real estate prices stopped increasing and as real estate prices ceased to increase, people no longer had a way to deal with sub-prime mortgages when they came due.  They could no longer sell their houses and real estate values began to decline, and mortgage defaults began to increase.  Suddenly banks no longer wanted to make such mortgage loans and the value of these loans which had often been converted into securities started to fall and the snowball of declining values started downhill.  Financial institutions suddenly had losses and needed more capital to continue in business.  All these things came together and have been building over the past 12-18 months.  We have seen a stock market decline this year of almost 50% and the aggregate  loss in wealth between real estate values and stock market value has exceed $20 trillion and while in all likelihood the worst is over, uncertainty about the future still remains.  While investors have cash available no one wants to invest because the future is so unclear.

So one might ask why is it a “Happy Thanksgiving?”  First, we have come through a difficult time and generally speaking, survived.  In fact, while we all have suffered substantial financial losses, compared to virtually almost any place else in the world, we are all doing quite well.  The standard of measure in America is a high standard and while we may not be doing quite as well this year as we have in the past several years, we are OK and while our short-term future has lots of uncertainty, our long-term future is still bright.

This is not the 1930’s.  We have a central bank and regulators who understand what needs to happen.  Individuals and businesses have plenty of liquidity and while markets and prices look incredibly depressed, investors are sitting on the side not waiting for money but waiting for renewed confidence to step forward.

Opportunities from an economic perspective, if you have patience and a long-term view, have never been as great in my lifetime.  Our company is well positioned and we are optimistic that our employees, customers and shareholders will all be rewarded for their long-term commitment to us.  But life is a state of mind.  It is hard to be thankful when the future feels so uncertain.  It is hard to look past the current situation when the period of uncertainty is so undefined.  I am an optimist.  My first outside investor labeled me an “opportunistic pessimist.”  I see all the problems, but I see past them.  This is a moment to look ahead, to work diligently in the present and help to ensure that the long-term future meets our fondest expectations.  America’s success is grounded in that optimistic attitude built on the confidence that hard work and thinking can accomplish anything.

Compared to a Thanksgiving at Plymouth Rock, Valley Forge, Antietam or any of the myriad of battles of World War I or World War II or the subsequent challenges where Americans were called upon to give their lives for our ideals – our current challenges are small.

If we take a moment to appreciate the things we have been given, we will achieve a “Happy Thanksgiving.”  We need to return to the America of our dreams, regain our peaceful state of mind, and once again appreciate the fact that we have taken steps to solve our problems.  We have reasons to be optimistic.

Thank you America.

Happy Thanksgiving
Bill Berkley