Acquiring Knowledge about History
TD ICAV is committed to gaining an understanding of the historical cause-and-effect links that exist between complex economic ev. The research and decisions made during the crisis enabled our investment team to better understand the market's driving factors and successfully navigate the most severe financial crisis in a generation. We encourage you to examine the research and decisions made during the 2008 events.
A significant amount of time before the events that transpired in 2008, the investment team at TD ICAV had already built the instruments that were required to recognize and analyze economic crises. The following statements are made by key members of the investment team on the ways in which this approach led to extremely important decisions and insights, and the strategies that TD ICAV utilized in order to effectively manage the financial crisis that occurred in 2008. According to the persons who were in charge of guiding TD ICAV through the financial crisis, here is the story of how the company rose through the crisis.
We had a conversation with the founder of TD ICAV and Jim Haskel, a senior portfolio strategist, who elaborated on some of the most important studies we have conducted on debt crises and related them to the current state of the market. The conversation focused on the current state of the market.
Downloadable versions of our book, "Big Debt Crises," are currently available. This book provides a unique framework for understanding the mechanics of debt crises as well as the concepts that may be utilized to effectively handle them. The book bears the title Concepts for Navigating Big Debt Crises. To acquire further information, please download the free PDF.
In this section, we will explore the events that occurred during the financial crisis of 2008 by utilizing the research and recollections of the TD ICAV investing team:
There were three crises: the Great Depression of 1920, Crisis of 2008, the Crisis of 2015
Putting the Scene in Place In the 1930s, the United States had the most recent serious debt crisis that the country has ever experienced. During that period:
- Obligations Due:
- The Rates of Interest:
- Creating new currency:
- The Rates of Interest:
The amount of debt being carried was significant, and the rate of debt increase had surpassed the rate of revenue growth.
During the recession, interest rates approached zero, making it impossible to lower them to a level that would avert a depression.
In an effort to recover from the Great Depression, officials decided to abolish the gold standard. Additionally, they printed money. In 2008, the United States of America's economy faced a similar array of challenges.
A secular decline in interest rates started in the 1980s, coinciding with the later phases of leverage. Since interest rates reached zero in 2008, reducing them effectively to alleviate the burden of the exceptionally high debt currently in circulation has become challenging. The use of quantitative easing, which required the creation of new money, ultimately resolved this situation. This was an essential component of the solution.
The Opening Remarks:
Compared to having to navigate through a storm, handling money during the 2008 financial crisis was challenging in a number of different ways. A deluge of information flooded in, all of which we needed to process to properly communicate our responses to the constantly changing conditions. The event also underscored the importance of having a model to aid us in comprehending the situation. Large financial crises have occurred countless times throughout history, even though the vast majority of people have not experienced them.
Through our investigation of these entities, we were able to gain an understanding of the features they shared, which in turn allowed us to conduct an analysis of the economic and market dynamics within the context of the normal progression of large-scale debt crises. In spite of the fact that there were multiple moments along the voyage in which we were unclear about the next step or made errors in our evaluations, our template served as a map that assisted us in defining the path that we were now following. This approach proved to be highly advantageous for us, as it enabled us to efficiently manage our finances and guarantee the security of the assets belonging to our customers, despite the difficult market conditions that we were facing. The chronology that follows will allow us to revisit our experience of managing the financial crisis through the lens of the research we were conducting at the time. The following will provide you with a peek at the technique that we utilized in order to improve our mental map of the normal course of events that would occur during a crisis of this sort.
As we handled money during the. The following will give you a glimpse into the methodology we employed to enhance our understanding of the typical sequ. We developed this map during our period of managing money. s map will provide you with a sense of how we interpreted the unfolding events, even though it doesn't fully explain the 2008 crisis (a more comprehensive discussion can be found in Section 2 of the book).
We were anxious about the possibility of an economic catastrophe in the United States at the start of the twenty-first century. In the years that followed the collapse of the dot-com boom, there were various signals that the United States was on the verge of entering a depression. In the end, the Federal Reserve was successful in bringing about an economic recovery by lowering interest rates in order to encourage people to borrow money and spend it. However, the economy had been exceedingly slow to react, and interest rates were dangerously near zero. This was a precarious situation. Furthermore, in order to kickstart a recovery, each recession that has occurred since 1980 has required interest rates to be gradually lower than the one that came into effect before it. The ever-lower interest rates caused an increase in debt relative to earnings, making the economy more vulnerable to tightening and less responsive to easing. This was a consequence of the ever-lower interest rates. The ensuing recession posed a serious risk of interest rates approaching zero, rendering traditional monetary policy ineffective. We had witnessed a similar scenario in Japan, where policymakers were still struggling to come to terms with the consequences ten years after the bubble had burst.
In 2002, we conducted research on the following dangers: credit plays an important role in the lives of the vast majority of people, notably in the United States. If credit is affordable and easily accessible, it will be abused. Consequently, historical lessons indicate that reversing a recession is relatively easy, as evidenced by the regular lowering of interest rates prior to any relief. Because the following factors are present, the likelihood of a severe economic downturn occurring during the subsequent recession will be significantly higher than it was during the most recent recession.
- As we approach a zero percent interest rate, the great economic risk will escalate due to the inability to reduce debt service costs and stimulate new consumption;
- the next cyclical low in interest rates is likely to be lower than the most recent cyclical low;
- the Federal funds rate reached its most recent cyclical low at one and a half percent.
Since the beginning of TD ICAV, we have been steadfast in our belief that the most effective way to acquire knowledge and broaden one's comprehension is via the utilization of an organized approach. In other words, we expressly characterize our knowledge as a collection of principles that we can argue, test, and integrate into our investing systems as we uncover new insights into the workings of the universe. We have found that this strategy works well even for difficult things to assess. We improved our understanding of depression by using the same approach to systematizing our previous learnings. "The Risk of 'Depression'," which was published in a Daily Observation in September 2002, stated the following: In the event that interest rates are impossible to reduce (for example, because they are unable to go below 0%), depressions always result. Consequently, the inability to reduce debt service obligations necessitates the sale of assets to generate cash. However, bubbles stand out due to their rapid debt growth, resulting in abnormally high asset prices and global gross domestic product. In light of this, the most appropriate time to express alarm is after a bubble has occurred, when debt burdens are at their highest and short-term interest rates are close to zero percent. To warn us of this danger, we created a depression risk gauge because depressions have different economic and market relationships than other periods. The chance of a deflationary depression is rather high, according to this proprietary metric, which implies that the likelihood of such a depression is roughly 25 percent. This indicates the need for immediate attention.
During the height of the Great Depression, monetary policy played a significant role in numerous documented cases of severe depressions and debt crises. For the purpose of enhancing our understanding of the usual functioning of such circumstances, we looked at examples from the past, such as the Great Downturn and the continuing downturn in Japan. One topic we studied was monetary policy effectiveness. In November 2002, we engaged in a discussion about our respective perspectives on this matter: we believe that a prolonged and severe recession is not the same as a depression, which is a distinct occurrence. Both in the United States during the 1930s and in Japan during the present deflationary depression, monetary policy, which consists of dropping interest rates, was unsuccessful in stimulating economic development or financial markets. This led to an uncontrollable economic contraction, severely curtailing the central bank's influence. Normal economic ties preserve during economic contractions, but they break down during depressions.
The present value effect and easy leverage presented potential risks. The huge reductions in interest rates that took place after the bursting of the tech bubble had a beneficial effect on both borrowing and expenditure. On the other hand, they were also responsible for paving the way for the succeeding bubble, which achieved the highest rate of expansion between 2004 and 2006. The bulk of metrics that were available during this time period suggested that the economic circumstances in the United States were far better than average. However, we failed to effectively address the relevance of leverage in accelerating asset values and solidifying economic circumstances. The rise in housing costs has already contributed to an increase in households' net worth. Because credit was easily accessible, households borrowed a significant amount of money, which led to a rapid growth in the amount of debt that they owed in comparison to their wages. However, it's highly probable that a significant portion of the generated "wealth" was merely an illusion, setting the economy up for future challenges. Our analysis provided further elaboration on the following point: Individuals who have a high net worth are more comfortable taking out loans and spending more money because they have the perception that they are value more than they actually are. However, the majority of our wealth is not yet of considerable value; it is the discounted present value of the projected future profits. This particular part of our value is not yet significant. Treating the present value of future expectations in the same manner as current wealth encourages individuals to borrow money and spend wealth they haven't earned yet. You could say we're spending tomorrow's wages while awake. A substantial quantity of current spending has occurred at the expense of future consumption as a result of the "present-value effect" and the availability of leverage, which have combined to produce an environment that is significantly more dangerous. We find it fascinating that despite the economy's deep leverage, credit spreads remain low. We believe that longer-term risks, particularly those with a forward period of two to five years, hold significant value. In 2010, the prices of equity in the United States of America were approaching their peak. Because the economy and the markets were both doing extraordinarily well at this point in time, there was a relatively low level of fear among the general population.
We published our Daily Observations titled "Growing Financial Risks," and expressed our belief that the system's inherent dangers remain significant, even though the markets are discounting the lowest risks in decades. We perceive a similar trend of money shifting from the art, jewelry, and high-priced real estate sectors to the financial instruments market. Despite the fact that yields and carries are declining, the values of hazardous assets, particularly those with positive carry, are growing. This is causing the predicted future returns to be low. Over the same time period, volatility has decreased, leading to the assumption that low volatility will continue to exist. By increasing their leverage in order to seek yields, traders have been attempting to squeeze a higher return from the small spreads and carry trades that they have been engaging in. Although we have not conducted sufficient research to determine the precise effects of such a crisis on other financial institutions and corporations, we are of the opinion that the financial system is not excessively exposed to a moderately adverse market or economic environment but rather is significantly exposed to a very adverse environment. Because we believe the market and economy are very bad, significant amounts of derivative exposures remain outstanding, and their size is rather large. More specifically, the total amount of outstanding over-the-counter derivatives was $262 Trillion at the end of the previous year. This figure is almost five times the amount that was present in the year 2000. Our gut-level assessment is that these holdings would be problematic in the event of a major increase in credit spreads and liquidity premiums.
In June 2007, the first widespread indicator of financial hardship was the result of tightening pressures. These pressures were the huge losses that larger banks were facing as a result of the growing number of foreclosures and delinquencies. The investment firm Bear Stearns, managing two hedge funds that invested in subprime mortgage-backed securities, experienced a surge in losses and a surge in investor redemptions in July. The investment firm forced both of these investors to withdraw their money. In the end, the funds saw a collapse. In the middle of July, the United States equities markets achieved new highs, which indicated that economic growth was still favorable. This was despite the fact that the debt and tightening circumstances had not yet impacted the economy. Nevertheless, the bubble had already started to burst at that point.
We sent the following message “[We] believe that interest rates will continue to rise until the financial system collapses, at which point everything will turn around (that is, the focus will change from greed to fear, volatilities will increase, and carry and credit spreads will explode)”. On the other hand, we were not aware of the specific date of this occurrence, and we are still not sure whether the current circumstance is the most important. We are aware that:
- We want to avoid or minimize the impact of this foolishness
- No one can confidently predict the outcome of this contagion in the financial market
We conducted an exhaustive examination a few months ago to determine the positions of market players, particularly in the derivatives markets. Consequently, we delved into the 10-K reports of financial intermediaries, collected and assessed all available data, and scrutinized all the studies conducted by government overseers and financial intermediaries. We arrived at the conclusion that there was a lack of understanding among stakeholders. It is hard to perform a full evaluation of these exposures at a single level, which is why this is the case. Nevertheless, it is undeniable that they have grown substantially (roughly four times as large as they were five years ago) and are enormous.
In July and August 2007, numerous hedge funds faced challenges and had to sell their assets due to the ongoing decline in the housing market.
From a comprehensive perspective this is not your typical economic downturn. At the beginning of 2008, the Federal Reserve decreased interest rates in reaction to unsatisfactory economic statistics, which caused the economy and markets to begin to display signs of fracture. During that time period, a large percentage of people were of the opinion that the economy was now experiencing a contraction. Our study detailed the unique process we observed during that period, one that a decrease in interest rates might not be able to undo. We believe that we are on the verge of witnessing the end of an era, specifically the period that began after 1981 and was characterized by solid growth, lowering inflation rates, and declining interest rates. We have frequently used the term "recession" to hint at the potential decline in economic activity. We now refer to all contractions as "recessions," but using that phrase to describe the current scenario would be misleading. A "D" (expression) is a contraction in the economy that results from financial deleveraging, which in turn leads to the sale of assets such as stocks and real estate. This process results in a decrease in asset prices, which in turn leads to a reduction in investment levels. As a result, additional assets are sold against their will, resulting in a reduction in credit and economic activity. Consequently, this leads to a worsening of cash flows and an increase in asset sales, creating a cycle that reinforces itself. Although interest rates have fallen, equity levels have fallen relative to debt levels, and credit spreads have widened. This trend will continue until risk-free interest rates approach zero percent, at which point monetary policy will no longer be effective. August 2008: Through a frantic sale, JPMorgan Chase was able to purchase Bear Stearns. On April 2nd 2008, no experience had yet been gained with the loan losses. The predicament continued to deteriorate over the first few months of 2008. In March, JPMorgan Chase purchased Bear Stearns, an investment bank that is considered to be of systemic significance, at prices that were comparable to those of a fire sale. Following the near-collapse of a major financial institution, a crucial inquiry was how the losses would ripple across the entire financial system. We noted: Financial institutions have gradually accumulated losses on derivatives and securities of diverse types. Over time, these losses have accumulated. However, the losses from the conventional method (bad loans) are about to reach their peak. On the other hand, markets experience souring in anticipation of problems, while loans do not experience souring until their cash flows become negative. We anticipate a substantial impact on the loan books from the quick downturn of the economy, the ease of credit conditions, and the velocity of these changes.
As we entered the second stage of the deleveraging process, it appeared that the markets were starting to stabilize. This stabilization was facilitated by the efforts of US officials to instill confidence in the financial industry. Nevertheless, these efforts were insufficient to address the basic credit concerns, which were only worse for the time being. In accordance with the rationale that we provided earlier, in those areas where it was reasonably able to do so, the Federal Reserve did an outstanding job of supplying liquidity to the market. In contrast, accounting changes like allowing losses to be written down over several years were not made. We are on the verge of a solvency crisis, which we anticipate will result in a flood of asset sales. People are currently questioning if they can construct a safety net quickly enough to seize these assets, preventing their collapse, which could subsequently trigger the financial system and economy's downfall. To tell you the truth, we think this will feel like a race to the end. A far wider audience than just those who hold these assets will feel the repercussions if there is no safety net in place. As the actual economy continues to deteriorate, capital availability contracts continue to decrease, and the value of all kinds of equity continues to decline, these assets will become accessible to nearly everyone. Thus, I believe we are at an inflection point where policymakers will act or the situation will worsen.
At a time when Lehman Brothers was on the verge of going bankrupt, policymakers were struggling to decide whether or not to provide a rescue and how to go about doing so. On the other hand, they didn't yet have any programs in place to deal with a default. The first-order effects of the insolvency and the lack of transparency surrounding counterparty and credit concerns greatly accelerated the forced asset sales and exposed the financial system to seizures. Both of these events occurred simultaneously. It was at that moment that we issued a warning: It appears that we are entering a new domain in which the traditional monetary instruments will not function, and the dynamic that governed Japan in the 1990s and the United States in the 1930s will dictate the course of events. This is because interest rates are getting closer and closer to zero, financial intermediaries have collapsed, and the process of deleveraging is well underway.
Congress passed a law to establish the Troubled Asset Relief Program (TARP) to manage hazardous assets, following their inability to adopt a bailout proposal on September 29th. This move resulted in the sale of a sizeable amount of equity. Policymakers in the United States implemented a broad variety of initiatives, including the AMLF, CPFF, and MMIFF, in the months of September and October 2008 to address the various problems caused by the crisis, following the collapse of Lehman Brothers. On the other hand, they were not successful in reaching a comprehensive resolution.
Having an understanding of the circumstances, we took this action despite the ongoing efforts by officials at the Federal Reserve and the Treasury to manage the crisis. The following is how we attempted to describe our goal: The purpose of this paper is not to only concentrate on the D-process; rather, we intend to give our overall framework for understanding economic processes, which includes the D-process. This template includes the following three main factors:
- 1) the expansion of productivity
- 2) the "long wave" cycle
- 3) the business/market cycle
According to our perspective, becoming aware of the dynamic relationship that exists between these forces will make a significant contribution to understanding both the past and the future. Furthermore, we are confident that this understanding will significantly benefit any future plans you create.
The Federal Reserve and the Treasury Department announced the purchase of assets and the provision of loans totaling $800 Billion. The purpose of these actions was to lower mortgage rates in order to provide support for the housing market. This was the first quantitative easing (QE) program they ever implemented. This was a crucial and necessary measure in administering a deleveraging process. Central bankers must choose between:
- "printing" extra money (above the necessary amount for bank liquidity) to counteract the decline in private credit
- allowing a severe contraction when credit collapses during times of crisis.
It is inevitable that they will opt for printing, marking a significant shift in the situation. They are the ones who have started this procedure at this moment. As we proceeded, we deduced the following: The Federal Reserve's recent announcements today are merely the latest in a sequence of actions aimed at diversifying the assets under acquisition, augmenting expenditures to reduce credit spreads, and boosting system liquidity. Our expectation is that they will participate in any activity that is in accordance with the law. We expect them to take similar significant actions in the future, including the obvious (like buying long-term bonds and potentially stocks) and the less obvious (like transferring dollars to unimaginable entities, likely indirectly, through the International Monetary Fund (IMF) and removing dollar bills from airplanes).
The Federal Reserve began purchasing Treasury bonds in addition to increasing its purchases of mortgage-backed securities (MBS).
An increase in income may be able to compensate for a drop in credit, but is this even possible? By the spring of 2009, authorities had begun to implement a considerable relaxation of fiscal and monetary policy in order to achieve the goals of stabilizing the financial system and stimulating the economy. In March 2009, the Federal Reserve initiated significant easing actions to counteract the decline in credit market conditions. In the beginning, the Federal Reserve significantly increased the size of its quantitative easing program by increasing the number of mortgage-backed securities (MBS) it purchased, as well as by adding purchases of Treasury bonds. A few days later, the Treasury Department announced that it would be increasing the amount of distressed assets that it would be purchasing from banks. Our writing demonstrates our cautious optimism about the new policies: the Federal Reserve, along with other central banks, is acting swiftly and aggressively to increase money supply to counteract the credit decline. In contrast to standard procedures, this is a new approach. As a result, the questions that remain unanswered are as follows:
- to what degree is it possible for money production to take the place of credit formation (for example, what will happen if the growth of debt does not accelerate while money growth surpasses its capacity to compensate; or, how effectively can we function without credit creation)?
- will this increase in money ultimately lead to an increase in lending or the inflation of assets that serve as inflation hedges?
As a result of these shock and awe-based counterattacks, the stock market saw huge rises and increased optimism. However, it's important to remember that other administrations adopted significant policy changes during previous depressions as a counter-attack. Similar massive rallies and surges of confidence followed these reforms, but the ongoing collapse of the real economy consistently undermined them. Therefore, we should refrain from getting overly optimistic about market gains until they receive reinforcement from robust economic activity and credit. We are in agreement as of May 7th 2009. The torrent of monetary and fiscal easing that occurred in April 2009 resulted in the economy showing indications of stability, and the markets had a major bounce during the same month. The state of institutions was crucial when assessing recovery. Despite recent indications of progress, there was a lack of thorough transparency regarding the extent to which the banks remained burdened by toxic assets or had a high capital requirement. The Federal Reserve took this action despite recent indications of improvement. The Federal Reserve made public the details of its banking stress test at the beginning of May. We wrote down: For the first time in the previous two years, we are satisfied that the authorities have a genuine understanding of the gravity of the banking problem. The only concern we currently have about the banks is that they may excessively focus on raising capital ($75 billion in common stock) to meet regulatory requirements, rather than focusing on raising the necessary funds to support lending at levels essential for the economy's health.
Over time, it would be required to bring down the levels of debt in order for the economy to begin to recover. In 2012, we expressed our views on how to manage a deleveraging process in a "beautiful" way, and we scrutinized the methods used by American policymakers to achieve this. Debt-to-income ratios decrease as the deleveraging process progresses. When the weight of debt reaches a particular threshold, as it is now the case in developed countries that are responsible for the debt, deleveraging becomes imperative. There are two possible outcomes for handling these deleveraging’s: effectively or ineffectively. Some of them have been exceedingly unpleasant, leading to substantial economic misery, social discontent, and even violence, while at the same time failing to lower the ratio of debt to income. On the other hand, others have been extremely nice, making it easier to make a seamless shift to healthy production-consumption balances in debt-to-income ratios. A debt-driven boom preceded the current deleveraging, which is comparable to the deleveraging that occurred in the United States during the 1930s. We carried out the deleveraging process in two stages: first, we experienced a decrease in earnings, followed by a period of reflation and growth. In spite of this, the contractionary phase was very short, lasting just six months (in contrast to the three-year period that occurred in the 1930s). This was due to the Federal Reserve's rapid policy reaction, which included aggressive money printing and debt insurance. Nominal income growth, default, and debt reduction have achieved a mix of debt payback, default, and reflation. We have achieved each of these three goals. Since the beginning of the reflation in March 2009, incomes have recovered, debt loads have dropped to around 335% of their initial starting position, and equity markets have returned all of their losses. At present, the credit markets have mostly recovered, and the expansion of credit in the private sector is showing signs of improvement. The discipline's most elegant deleveraging up to this point would win our prize. In the future, it will be crucial for policymakers to maintain equilibrium in order to guarantee that the ratio of debt to income will continue to drop in a consistent manner.
