With the swings in the stock market and panic in the air it has been difficult to gauge, even for us, whether we are in a free fall, a cycle, or something never before experienced. On the other hand, when you step back a little, this appears similar to the savings & loan crisis of the mid 1970's followed by the real blowout that began in 1987 and did not totally disappear until 1994.  If you remember, the savings and loan crisis was not limited to just savings & loans.  Many big banks disappeared at that time as well, e.g. Bank of New England, Shawmut and Boston Five.  In the end, thousands of savings and loan institutions disappeared and more than $100 billion dollars of taxpayer money was lost.  After the collapse, we had one of our largest wealth creation cycles beginning in 1994 and ending with the dot-com bust of 2000. 

What we do we have here and what do we see?  Just as the savings & loan institution has almost disappeared from America after the crisis, we have a similar phenomenon occurring with national investment banks.  For all intents and purposes, Lehman Brothers and Bear Stearns have vanished and Merrill Lynch is now owned by Bank America.  We are only left with two national investment banks, Goldman Sachs and Morgan Stanley, and it is uncertain whether either will survive. 

From the latest readings, the original sub-prime meltdown with its approximately $430 billion in losses has matched pretty closely to the current bailouts of Freddie Mac, Fannie Mae and American International Group (AIG).  In today's paper, it states that the latest loan of $85 billion for an 80 percent interest in AIG brings total taxpayer funds at risk to $400 billion.  Since the crisis has been ongoing and worsening, there is somewhere between $100 and $200 billion more to be written off.  That is why there is fear around Goldman Sachs and Morgan Stanley.  It is our opinion that Washington Mutual will go bankrupt or be bought out as well as many other smaller players in the mortgage market.  Also, the sub-prime sector will be absent for a while. 

How this plays out is pretty predictable.  The market will drop until all the losses and then some have been recognized and the banks are either bought out or recapitalized.  Today, as expected, a great deal of assets are being converted to cash.  We would not be surprised if this is in reaction to the raising of capital by hedge funds, banks and insurance companies in an attempt to quickly deal with the losses and clean up their balance sheets before the end of this quarter (September 30th).   With the issues at hand, and assuming Congress does not change the homeownership/mortgage rules, we can easily expect real estate to be weak for several years. 

Overall, with the large write-offs in the last couple of weeks, we appear to be more than halfway through the mess, but I don't like betting against the stupidity of our government leaders.  As investors, our approach to minimize investment in the financial and consumer markets has been very well rewarded as has the investments in downside protection of your portfolios where possible.  These actions have given you much smaller losses (many multiples) than the market as a whole.  So for the moment, we are sitting on the sidelines waiting for the worst to be over. 

Just to put things in perspective, Alan Greenspan first used exuberance to describe the over value in stocks during the dot-com era in 1996.  The markets peaked about four years later before crashing.  We can expect the markets to overreact on the downside too.  Using this perspective, however, what we are witnessing has a similar pattern to what we have seen before, including the panic of professionals and the media.  As a result of what we mentioned before, we view this as a cycle that we have seen before and as such are not panicked but yet, we too feel the anxiety.