The Corner

The Current Stock Market Decline…

…should not freak you out, at least in and of itself. This is a ferocious bear market, but, so far, it is an almost exact repeat of what happened after the collapse of the .com bubble about 5 years ago. In fact, if we were to repeat that experience, we would see further declines from where we are today:

There were, in the grand scheme of things, pretty limited consequences of that equity bubble popping for most people in America. Partly, of course, this is because both the Fed and the Chinese government decided to make credit very easily available to U.S. consumers, and therefore many people who got a lot “poorer” in their 401K statements, suddenly got a lot “richer” in home equity. A ton of this increase and decrease in wealth was illusory. I agreed to say your house was $10 million if you agreed to say mine was worth $9 million, and suddenly we were both richer. It’s great until many people try to convert this wealth into other kinds of goods at once. In this way it was a lot like the .com bubble. My guess (and it’s only a guess) is that these two events will come to be seen as two sequential manifestations of the same underlying imbalances in the financial system.

What should concern you deeply, however, is the ever-growing TED Spread, as per a prior post. It is now well over 400 basis points, or about 50% above its historical peak at the time of the 1987 stock market crash, and about 10 times its “normal” level. It has continued to rise every week throughout the past month, indicating further worsening of the credit crisis, and rising perceived risk of contagion. We’ve injected so much debt into the system over the past decade that not only can’t we borrow our way out of the consequences of the real estate bubble popping, but we’re going to have to start paying off a lot of the existing debt in the face of a poor economy. What Paulson and Bernanke are doing is to make this adjustment only painful instead of catastrophic.

Jim Manzi is CEO of Applied Predictive Technologies (APT), an applied artificial intelligence software company.

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