Why the Financial Markets Are Melting

After my divorce, I was wiped out financially and had little reason to follow the stack market gyrations (chart above is from the New York Times). Now, with my parents gone and a modest inheritance, I find myself worrying that the herd earned results of my parents labors will be wiped out by the irresponsible behavior of Congress, the White House and Wall Street. The Daily Beast has an article that looks at possible reasons and part of the problem is the lack of structural controls that will act as circuit breakers if you will to control and moderate panics. The supposed reforms of the last go round of supposed regulatory revitalization has in reality done little. As a result, program trading and people acting like lemmings continue to drive the markets towards instability. Here are some highlights:

No one can say precisely when or why this will end. Its triggers we know: a flawed debt deal in the United States, renewed sclerosis in the European Union about peripheral debt issues in Greece and Italy, a downgrade by Standard & Poor’s of U.S. sovereign debt (oh, the irony of S&P downgrading debt leading to a precipitous decline in the S&P index), and then a wave of global selling. No market has been immune; not one.

Since global markets bottomed in March 2009, there has been an uneasy calm, the capitalistic version of the “Phony War” period between the fall of Poland to Germany in September 1939 and the fall of France in May 1940. None of the reforms passed in the wake of the financial crisis create any breakers against synchronous global financial panic. Yes, there is less leverage and more capital in financial institutions, which is a vital difference between now and then and augurs against a repeat of what happened two years ago, but there are no circuit breakers that prevent the rolling flash-crash of the past week.

These moments create ripples of fear that build like tsunami waves until they crash with destructive force against the shoals of investor confidence, institutional balance sheets, and collective investing psyche. And more than ever, they race around the world unimpeded by national boundaries and uncontainable by central banks.

[A]t times, I also watched in fascination as stock after stock sold off without any consideration of the intrinsic strength of the underlying businesses, even discounting for a possible global recession. Even though such a recession seems highly unlikely, stocks sold off well beyond whatever consequences such a global contraction might have.

If we are October 1987, it’s time to buy; if it is December 2008, watch out. We will only know the answer to this in retrospect, but this feels more like a crash than a new trend, and like any flash fire, these burn quickly, intensely, and then they stop. You don’t want to be in these markets when this is happening, but you also don’t want to be out of these markets when they reverse.