The Difference Between a Panic and a Crash

The definitions of terms in financial markets are evolving, to say the least.

The difference between a panic and a crash in the financial markets is an interesting study, and not particularly well defined. Here is our most recent effort.

As a rule of thumb, a correction is a decline in prices of less than 20 per cent. After the declines exceed 20 per cent for at least a two weekly prints on the charts we seem to be in the realm of the panic or a crash.

A panic might best be defined as a sharp decline in prices over a short period of time, usually less than a year, as assumptions and valuations are cast in doubt and corrected, often severly. A panic comes and goes, distorting perhaps the progress of the markets, adding certain safeguards to the regulatory process, but having otherwise relatively small lasting effects to the national economy.

A crash is a watershed event, generational in its scope, always accompanied by an economic slump of greater than a year, often called a depression rather than a recession. Its effects are measured in years. It is a furnace in which the national character is tested and tempered, hammered into something different from what had gone before.

From The Great Crash of 1929 by John Kenneth Galbraith:

"A common feature of all these earlier troubles [panics such as 1907 and 1914] was that having happened they were over. The worst was reasonably recognizable as such.

The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning.

Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune. The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost.

The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. (Not only were a recorded 12,894,650 shares sold on 24 October; precisely the same number were bought.) The bargains then suffered a ruinous fall.

Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or a fourth of the purchase price in the next twenty-four months.

The Coolidge bull market was a remarkable phenomenon. The ruthlessness of its liquidation was, in its own way, equally remarkable."

If the Great Depression had never happened, would the Great Crash of 1929 be remembered as vividly as "the great crash" or as a panic such of that of 1907 and 1987? (Give 1987 a little more historic distance, and it will be just a blip in the generational memory, if it is not one already).

The economic progressive believe that the Great Depression was a policy error by the new Central Bank, and are quite confident that it can never happen again, as we are now smarter and better. With the ascendancy of pure fiat currency and sophisticated financial engineering, are all Crashes extinct, merely the dinosaurs of an age of monetary barbarism?

Are financial markets now a science, freed of the emotions and bondage of human nature? Are we now Icarus, released from the bonds of the earth? There are those who believe that this is the case, and their wills and knowledge are being tested as we speak, if only the public can be kept malleable and docile and deluded enough to allow them time and latitude to work their financial alchemy. What if the Fed makes a different sort of policy error this time? Oops?

"There is no worse mistake in public leadership than to hold out false hopes soon to be swept away. The British people can face peril or misfortune with fortitude and buoyancy, but they bitterly resent being deceived or finding that those responsible for their affairs are themselves dwelling in a fool's paradise." Winston Churchill

Plus ça change, plus c'est la même chose

Fed Adds 84 Day TAF Loan and Extends Emergency Status until 30 January 2009

While the good times are rolling in the equity markets and the insiders are racking up those end of month bonuses, the Fed is quietly breaking out the emergency equipment and getting ready for more bail outs.

If there is nothing else we learn from this, it is that the banks must be restrained from speculation and regulated by incorruptible rules, for the good of the country.

Unless we put strong reforms in place we have done nothing to correct our problem.

Fed to Conduct Liquidity Operations Through January 2009, Introduces 84-Day TAF
07/30/08 08:58 am (EST)
By Erik Kevin Franco

(CEP News) - In addition to the $75 billion 28-day Term Auction Facility (TAF), the Fed will also be conducting a $25 billion 84-day TAF to address the ongoing "fragility" of the financial system.

The Fed also said it would be extending its extraordinary lending to late January 2009.

"In light of continued fragile circumstances in financial markets, the Board has extended the PDCF through January 30, 2009, and the Board and the Federal Open Market Committee (FOMC) have extended the TSLF through that same date," according to a statement from the Fed on Wednesday. "These facilities would be withdrawn should the Board determine that conditions in financial markets are no longer unusual and exigent."

Starting Aug. 11, the Fed will conduct bi-weekly TAF auctions alternating between 28-day and 84-day loans. The Fed currently holds a 28-day TAF every two weeks.

Dealers will also be allowed to access up to $50 billion in treasuries at the Term Securities Lending Facility (TSLF).

The Fed also announced that it was stepping up its international co-operation with the European Central Bank and Swiss National Bank. It will increase its swap line with the ECB to $55 billion from $50 billion while the SNB's line remains at $12 billion.

Both central banks will follow the Fed's TAF auction and offer U.S. dollar loans on their end.

The ECB said the move "is intended to continue the provision of USD liquidity for as long as the Governing Council considers it to be needed in view of the prevailing market conditions."

Corporate Bond Market Says A Tsunami of Debt Default is Coming

Wall Street is throwing an equity party and painting the tape for the end of month bonus calculations.

But the corporate bond markets are signalling serious economic trouble dead ahead, NOT behind us.

Brace for disillusion.


Crumbling bond market sounds distress alarm
Tue Jul 29, 2008 7:25am EDT
By Walden Siew and Dena Aubin

NEW YORK (Reuters) - Corporate bond investors are bracing for growing defaults and record company bankruptcies starting in 2009 as the volume of distressed debt climbs past $184 billion, an all-time high.

More corporate debt is now trading at distressed levels than in 2002, when there was $165 billion of distressed corporate debt following the last bankruptcy boom, according to Moody's Investors Service data.

Nearly one in three junk bonds trade at levels known as "distressed," suggesting a serious risk of default. Even higher-rated corporate bonds have sunk to distressed levels in near-record volumes.

Automakers General Motors Corp and Ford Motor Co lost their investment grade status in 2005 and their bonds have since plummeted to distressed credit levels.

Now bonds of financial firms such as CIT Group Inc, National City Corp, and bond insurers like MBIA Inc are trading as though investors expect them to follow that ignominious path.

"It's the fast deterioration of some of the higher-rated credits that is most alarming," said Jason Brady, a managing director at Thornburg Investment Management. "From a dollar standpoint, we're going to see a record wave of defaults and bankruptcies."

Spokespersons at CIT and National City didn't immediately return phone calls seeking comment about how their debt is trading. MBIA's spokeswoman cited the company's policy of not commenting on its bond market performance.

The total amount of high-yield debt trading at distressed levels is now $147 billion, while investment-grade distressed debt is about $37 billion, according to Moody's credit strategy group.

"The market is pricing in pretty ugly bankruptcy scenarios," said Brady from his Santa Fe, New Mexico, office, where the firm oversees $4 billion in fixed-income assets. "The dramatic bank deterioration is coinciding with the overall level of distress."

A slumping economy, high oil prices and tighter credit conditions are putting a greater squeeze on corporations and impacting their ability to manage and pay off their debt.

Credit crisis fears, especially in the financial sector, have pushed yields on several companies into distressed territory recently, though rating agencies still assign them low default risk.

High-grade companies trading at distressed levels in recent days include Washington Mutual Inc, CIT and Ambac Financial Group, according to MarketAxess.

Ambac's spokeswoman declined to comment, while Washington Mutual didn't immediately return a call.

In all, about 7.5 percent of high-yield and investment-grade debt combined is distressed, the same level seen during the credit downturn of 2000 to 2002, when bankruptcies soared, according to data from research firm Leverage World.

Public company bankruptcy filings climbed to 179 in 2000 and rose to a record 263 in 2001, according to bankruptcy court records.

"Investment-grade bond distress is a new feature of this cycle," according to analyst Christopher Garman, adding, "The largest corporate bankruptcies on record often follow this level of distress."

Some 27.2 percent of high-yield bonds by par value are distressed, or trade at yields of at least 1,000 basis points more than U.S. Treasuries, Garman wrote for Leverage World in a report titled "MegaDefault."

The 7.5 percent distress level points to nearly $97 billion of defaults through 2009, said Garman, a former head of high-yield strategy at Merrill Lynch.

For investment-grade bonds, the distressed level has climbed to 1.8 percent, shy of an all-time high of 2.4 percent. If all the high-grade distressed debt were downgraded, it would increase the volume of high-yield debt by 6 percent.

Both Standard & Poor's and Moody's Investors Service have noticed a sharp increase in junk bonds and credit default swap contracts trading at distressed levels as well.

The overall number of U.S. high-yield bonds trading at distressed levels has soared to about 27 percent, versus 17 percent in April and just 2 percent last year, according to Moody's research group.

More than 20 junk-rated borrowers have credit default swaps trading wider than 1,000 basis points, which implies a 58 percent chance of default over the next five years, according to Credit Derivatives Research.

Much of the distressed debt is in the auto sector, but high-yield opportunities may be growing in the financial sector, said Joe Robison, director of credit research at Allegiant Asset Management.

"As autos go, so does the high-yield market these days," Robison said. "Our area of emphasis is watching the financial companies. We're definitely going to see some financial names go from investment-grade to junk over the next years, and that's where we see opportunities."

There is No Doubt the US is in a Recession - SP 500 Operating Earnings

With the end of month rally in stocks, to provide fatter bonuses for fund managers, the happy-talk is flowing hot and heavy on the financial networks and the internet chatboards.

However, based on the facts there should be little doubt that the US is in an economic recession.

The only question is 'depth and duration?'

Expect the next phase to be the 'bottom-callers' predicting that stocks are starting to rally in expectation that the economy will recover in January 2009, roughly about six months out.