Harbingers Of The Next Market Bust

I’m not a professional historian. Neither are you probably. But there isn’t anyone reading this who does not remember the bubble in the stock market during 2005, 2006, and early 2007. And since virtually everyone has these first-hand memories, it should be abundantly clear what we should have learned from them.

In those earlier years, market movers on Wall Street were making huge salaries and bonuses puffing up a bubble based on short-term and risky investments. Short-term because this compensation was linked to quarterly returns. Risky because that’s what generates the best quarterly numbers.

Buyers of securities in this same bubbling period were also focused on near-term and risky investments. Mutual funds bought these up because fierce competition meant they had to show good numbers quickly or lose their clients to competitors. Pension funds were under pressure to produce big returns to compensate for larger contributions that companies or local government fund sponsors didn’t want to make or couldn’t make. Individual investors flocked to near-term and risky opportunities because of a long nurtured belief that you couldn’t lose if you just followed along with the big boys on The Street—and besides, they needed a lot of quick unearned money to pay off their rising personal debts.

That was the historical past—the 2005-2007 historical past. Now consider what’s happening in today’s stock market.

After briefly pushing for a greater focus on safer, longer term investments, the government backed off and Wall Street immediately reverted to its usual ways. The same people, the exact same people, who benefited so mightily from the last bubble, and even made out richly in an unfinished attempt to clean up the mess from that bubble, started pumping up the stock market again—and raking in enormous sums doing so.

Goldman Sachs recently announced it is setting aside $11.4 billion in compensation for its people. Morgan Stanley is paying its own people more than 72 percent of all its revenues, rather than the 50 percent or so previously typical in this industry. JP Morgan Chase, too, according to recent press reports, is boosting its own people’s take home by more than 35 percent. And to fill out this picture, Wall Street heavies are again competing madly for the “best producers,” people whose production involves peddling the greatest volume of securities in a single quarter.

Remind you of the 2005-2007 bubble years?

And what of the buyers of these securities? Mutual funds are again seeking to lure clients with bigger quarterly return numbers. Pension funds, especially those of local governments, are under tremendous pressure to generate additional income to compensate for falling tax revenues that are no longer available to meet these funds’ obligations. California’s own buge employees fund, for example, just announced it is turning to riskier investments in search of greater returns. Many individual investors, meanwhile, cash-strapped and desperate after the losses they experienced because of the last bubble, are now flocking back to the markets—especially to so-called emerging market investments, historically among the riskiest.

Does this remind you of the 2005-2007 bubble years? Only more so?

Referring to a previous market upswing, Alan Greenspan once famously commented, “There does seem to be something different about things this time.” Maybe you think that’s the case here. Maybe you think the same people doing the same things in the same way in search of the same ends somehow will lead to a different result.

If you do think that, I hope you’re right. Hope, though, is not the same as belief.