Yes, in 1987 it was a similar environment. I was one of the managers of the top-performing fund in the US — possibly globally — at that time. 

Last year we predicted there would be disastrous consequences in the aftermath of the credit frenzy that gripped Wall Street and much of the hedge fund universe and we probably came across as alarmists.  But it is always very hard to get people to move.  When people are on one side of the seesaw, you have to get very far out to the extreme to change their opinion.

We have gone through a long period where access to credit with overly favorable terms drove the financial side of economy.  This drove a lot of growth on the real side of the economy.  As the Fed funds rate was lowered to 1% in the early part of this decade, it forced people to take risk, and at the same time offered ironclad opportunities to speculate by taking advantage of the spread between cost of funds and the yields available.  The whole system turned into a giant carry trade [where investors have borrowed at a low interest rate to invest in assets with higher yields]. That is what is now being unwound.

The housing market has unwound pretty fully, although not yet in New York, Beverly Hills, or London.  Those markets still have a way to go before they reach bottom.  But many homes near the median price or within the conforming price range are probably very near a low point. Housing affordability is near historically high levels in many of the most overbuilt markets, including California, Arizona, Florida, and Nevada.  Prices in these markets are down 30-70%. 

The saga began on the downside with fundamental damage to the primary speculative collateral which centered on single- and multi-family homes and condos, and then progressed to the instruments within the capital markets used to finance the speculation.  This is the normal cycle of impairment, as it spreads from merchant to financier.  In last stage, the problem is in realm of finance.  When it hits assets that are liquid, the change is abrupt, as compared to the gradual erosions that took place in the housing markets over the last 12-18 months.

The seizure of the credit markets is the terminal event.  It is the end of the cycle.

Not everything is rosy, and there is lot of risk in the marketplace.  The main problem is the intransigence of the European Central Bankers (ECB).  They hiked rates three months ago, and would not reverse that decision.  They would not admit that they we were wrong, implying that such an admission would be more distasteful than a collapse of their economies.  They were dragged by their colleagues, who eventually forced a response.  But short-term rates in Europe are still way too high. 

The shape of the yield curve is one of the most important inputs to the profitability of the banking industry.  Until 8am this morning, yield curves were flat or inverted yield curves for most of the countries in the European Union.  [This interview took place on the day the Fed and the ECB lowered rates by 50 basis points.]  This was completely reckless on the part of the ECB, and showed a profound lack of competence.  In a way, this is not a surprise, since the ECB is filled by political appointments.

  European yield curves are punishing the banking system.  Banking is not a good business when the cost of funds is about the same as the returns on safe bonds.  The ECB’s actions – specifically, their rate cuts this morning - may be a step in the right direction, but Europe is really a mess administratively.