Saturday, December 20, 2008

Money cycle

This month's Monocle magazine describes the six stages of a financial crisis cycle:

Stage 1:  Displacement - an innovation creates new profitable opportunities.
Stage 2:  Euphoria - optimistic expectations lead to rapid rises in asset prices and the belief that "this time its different"
Stage 3:  Mania - the prospect of easy money draws in investors and prices soar
Stage 4: Distress - market sentiments shifts from greed to fear and insiders retrench
Stage 5: Panic - as asset prices fall, investors stampede to sell, accelerating the crash
Stage 6: Revulsion - public hostility to financial excess - until the next euphoria

My career as a lawyer has seen the development of this entire cycle; I started practicing law as the fury of the Asian Financial Crisis waned and as the love for the sale of securitized assets and its derivatives began to pick up. 

I saw the "Euphoria" phase, when a partner in the first law firm I worked for placed me in a team devoted to the repackaging and selling off of non-profitable assets of banks and other companies, and establishing, for this purpose, Special Asset Vehicles which offered "participations" and on the back of these, other "security type instruments" derived from such participations.

I saw the "Mania" phase, and in fact was schooled in it thoroughly - as derivative transactions grew I went to school and studied it (sort of), and law school actually became business school. I also worked in Singapore and Hong Kong when the Mania phase was still hot - as a finance lawyer I helped multinational financial institutions lend huge sums of money to multinational corporations, often in order to invest in derivative transactions, and with interest payments and principal repayment tied to the performance of the derivatives.

When the "Distress" phase started I saw it too, and all the transactions coming across my table related to refinancings or hedge funds lending at crazy rates.

I saw "Panic", and I painfully saw transactions I just finished working on unravel quickly after the companies tell the banks, "We've defaulted and we can't pay."

I left my job in Hong Kong and transferred to the Netherlands before "Revulsion" set in. But I don't need to be in an office somewhere to see how it is. 

The cycle ends when the new "Euphoria" stage commences, and then another financial crisis is in the horizon. Can we get out of the cycle, or is the cycle innate to capitalism?

I think two great sages have the answer:  Puppies!

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