The mortgage CDO initiated market crash of 2008 has surprising similarities with the rail road induced market crash of 1873. Both are driven by greed induced risk taking in a rapidly changing market, with banks issuing mis-priced securities and bonds on top of risky and faulty assets that resulted in defaults and deflation which in turn triggered a multi-year recession. In the following passage from Ron Chernow’s House of Morgan, if one replaces the railroad concerns (Credit Mobilier, Northern Pacific) with (Freddie, Fannie, AIG), storied banking institutions such as (Jay Cooke) with (Lehman or Merrill) and there you go …
“Financial markets were at first unsettled by the scandal of the Credit Mobilier, builder of the Union Pacific Railroad … then debilitated by the Northern Pacific, the mighty house of Jay Cooke failed on Black Thursday, Sept 18, 1873. The failure ignited a full blown Wall Street panic … Affairs continue unprecedentedly bad. Five thousand commerical firms and fifty-seven stock exchange firms were dragged down …” [Ron Chernow, House of Morgan]
If nothing else, the repeat of history and the trends in between suggests the following:
i) In the non-ending Red Queen race, the financial innovations, technologies and policies will be insufficient to predict and manage the combination of human factors & secular market transformations that beget periodic market crashes.
ii) Due to the acceleration of secular transformations driven partly by globalization and technology, disruptions and market crashes will become more frequent.
Going forward, the ability to manage volatility will be our ally.