The Financial Crisis: Here's What's Next

For those of you who are curious as to what will happen after the dust finally settles on the current financial crisis, this is what will transpire:

1. All of the developed nations will agree on uniform laws that prohibit the activities that created the crisis, and their respective legislatures will adopt them as local law. 

2. It no longer will be so easy to become a billionaire. It will still be possible, but you'll have to do it by creating the next Microsoft, not by starting a hedge fund, which uses sophisticated hedging and arbitrage techniques to achieve above average investment returns, because hedge funds will be illegal. Why? The assets under management of a hedge fund can run into many billions of dollars, and this will usually be multiplied by leverage, meaning that their influence over markets is substantial. So enormous selling pressure is being created by hedge funds having to liquidate to pay off nervous investors who are pulling out their money, and prices are collapsing. It's your basic supply and demand theory in action.  Outlaw hedge funds and you eliminate a major destabilizing force of the markets.

3. The year 2008 will be remembered as a pivotal year. The history books will characterize the times before as a "Wild West" in the financial markets, an "anything goes" playground for the financial elite. The post-2008 era will be seen as a more secure and sober time, due to the laws enacted worldwide to eliminate the instability that the pre-2008 unregulated era created.

Of course, there will be one thing that will be overlooked.  The same thing happened after the Great Depression of 1929.  In 1933 the Securities Act of 1933 was put into law to curb speculative stock offerings by requiring strict disclosure of the details of stock offerings.  The Securities Exchange Act of 1934 was adopted the following year to regulate stock markets and public companies, and the Securities and Exchange Commission was created to enforce these new laws and provide oversight of the capital markets.

But as we see today, people found a way around these laws to create unstable capital markets, which is undermining investor confidence, something that this post-Depression legislation was supposed to stop.

So the question is, how will the financial community find a way around the new laws that will be adopted, creating a new financial crisis 75 years from now? That I cannot predict, but I'm pretty sure that they will find a way. 

Postscript: For those of you who doubt the parallels which I am drawing between this era and the Depression era (at least as far as regulation and investor confidence is concerned - it's my belief that the financial consequences will not be nearly as harsh as they were back in the 1930's), please read the following which comes directly from the SEC's website, describing the history of the SEC's creation:

The SEC's foundation was laid in an era that was ripe for reform. Before the Great Crash of 1929, there was little support for federal regulation of the securities markets. This was particularly true during the post-World War I surge of securities activity. Proposals that the federal government require financial disclosure and prevent the fraudulent sale of stock were never seriously pursued.

Tempted by promises of "rags to riches" transformations and easy credit, most investors gave little thought to the systemic risk that arose from widespread abuse of margin financing and unreliable information about the securities in which they were investing. During the 1920s, approximately 20 million large and small shareholders took advantage of post-war prosperity and set out to make their fortunes in the stock market. It is estimated that of the $50 billion in new securities offered during this period, half became worthless.

When the stock market crashed in October 1929, public confidence in the markets plummeted. Investors large and small, as well as the banks who had loaned to them, lost great sums of money in the ensuing Great Depression. There was a consensus that for the economy to recover, the public's faith in the capital markets needed to be restored. Congress held hearings to identify the problems and search for solutions.

Based on the findings in these hearings, Congress — during the peak year of the Depression — passed the Securities Act of 1933. This law, together with the Securities Exchange Act of 1934, which created the SEC, was designed to restore investor confidence in our capital markets by providing investors and the markets with more reliable information and clear rules of honest dealing.

Here we go again.

Technorati Tags: Securities and Exchange Commission, Great Depression, 1929, legislation, Securities Exchange Act of 1934, Securities Act of 1933, financial crisis, investor confidence, prediction

Comments

[Peter]

Nice article.

[Lunch Admin.]

I came to this blog via a NYT blog link, and I have to say WOW.
Very well said!

[Ray]

Never understood hedge funds. I have a business degree with an emphasis on investing.
If I had some dough, I'd put it all on some random ten stocks next week.