Back in the 2008 financial crisis, the big risk was ugly mortgages on bank balance sheets and the kinky derivatives that became “financial weapons of mass destruction.” But that problem of bad debt alone wasn’t the reason for a market catastrophe and the bankruptcy of Lehman Brothers. Rather, it was the systemic risk caused a crisis of confidence and a resultant credit freeze.
“Crisis of confidence” pretty much sums up the last few weeks in Europe. The difference this time is the losses are at governments, not banks, and the cause for the budget issues is decades of irresponsible spending instead of irresponsible lending. But the bottom line for nations like Greece, Italy and Spain is the same — no more money to spend, and no willing lenders to help you pay your bills.
What’s the big difference this time? Well, after Lehman went under, the U.S. Treasury and Federal Reserve pulled out all the stops to prevent a breakdown of the whole financial system. On Oct. 3, 2008, President George W. Bush signed into a law a $700 billion Troubled Asset Relief Program meant to offset debt troubles and get the credit markets functioning again.
The market responded by dropping 18% in the next five trading days. It was down 27% six weeks after the announcement, and down 37% five months after TARP was revealed.
This time, we are seeing a strong rally surrounding the bailout news in Europe. The broader market is up about 14% since Oct. 4, a mere three weeks’ time, and today’s surge in the Dow brought it to its highest levels since the go-go days of July before U.S. and euro zone debt issues seized Wall Street’s attention.
You have to wonder how long it will last.
True, the original Emergency Economic Stabilization Act of 2008 failed in late September that sparked the declines in 2008. But again there are parallels with the early stumbling in the EU a few weeks ago that caused uncertainty.
And granted, the European situation is materially different than the bank bailout. Euro zone governments propping up member states is much more palatable than Uncle Sam bailing out investment banks. But read any of the commentary about the European Union bailout and you will see that there are very real concerns over the measure:
Here they are in a growing succession of alarm:
- “Although the summit takes important steps towards addressing the large scale of the crisis confronting the euro area, the devil is in the details and the final form of the support is not going to be known until next month.” — Barclays Capital analysts
- “Any deal was better than no deal on the night — but now critics are asking why China would want to bankroll European debt.” — London’s The Guardian newspaper in a blog headline
- “The plans announced by euro-zone policy makers overnight look more like a pea shooter than the ‘bazooka’ previously promised to tackle the region’s problems.” — Jonathan Loynes, chief European economist at Capital Economics
- “A malevolent mixture of monetary rigidity, uncontrollable debt and banking insolvency seems to doom any potential solution to irrelevance.” — a post in The Daily Bell blog run by The Foundation for the Advancement of Free-Market Thinking
Some of those fears might be overstated. But some might be understated. Whatever the case, the reality is that there are many out there who are skeptical the big agreement will solve Europe’s debt woes.
That leads us back to TARP in 2008. One can legitimately argue many of the details in hindsight, including whether banks just took the cash as a giant windfall with no intention of ever lending and whether the government just bankrolled a spate of bigger banks buying up little one. But at the time, the move was part of a multifaceted effort to do something to prop up a battered global financial system.
It didn’t matter. Investors were focused on the doomsday scenario and barely even blinked Oct. 3 as the market continued its steady downward spiral.
So what’s with all the optimism over the euro zone debt deal, vague as it is? And more disturbing, what’s with the rally in anticipation of the deal from early October through today?
It just doesn’t add up.
One reason for the rally could be that the markets new TARP was too late or too small or too unfocused to soften the impact of the 2008 financial crisis, and now the markets are thrilled with a deft and comprehensive solution to the euro zone debt crisis.
If you believe that, then by all means continue to buy this rally — but as for me, I’m going short.
Jeff Reeves is the editor of InvestorPlace.com. Write him at firstname.lastname@example.org, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.