We were surprised to see that President Barack Obama seemed to have so much confidence in what the "blue chip economists" were predicting over the next ten years, and criticized him in last week's comment.  This weekend, Obama's presidential election opponent was interviewed on Meet the Press, and in a discussion about the public's anger regarding the financial mess we are in, said he is calling for a "select committee" of Congress to find out what happened.  Mr. McCain said that the "select committee" would find out "what happened, and why it happened, in order to determine what actions we can take to prevent it from happening again".  At the risk of being redundant we will try to explain concisely to our website readers exactly what happened to get us into this mess again. 

We are very surprised that Senator McCain, who came very close to becoming the President of the greatest and most powerful nation on the planet, talked as if he had no idea what took place to get us into this financial quagmire.  We don't mean to ridicule this Vietnam hero, but are amazed that he would want to spend the taxpayers' money on a "select congressional" committee when it seems so clear to us what happened and why.  We have been warning our viewers about this since 1996. 

The Bubbles -Couldn't Have Been More Obvious

Starting in 1996, we entered into the first of two major bubbles in the U.S that were caused by low interest rates and unprecedented debt accumulation.  The first bubble was the stock market mania of the late 1990s.  Now, let's see if this was hard to decipher or not-it is hard to believe this Greenspan quote, "Bubbles are not able to be detected until they burst".  History shows that virtually all bull markets peaked at around 20 times earnings and all bear markets troughed at approximately 7 to 10 times earnings (see attached NDR chart).  However, during the late 1990s the market valuations rose to above 30, then above 35.  Don't you think that this should have been somewhat of a flag that we were in the midst of a stock bubble?  If you weren't concerned about valuations rising far above any extremes in history, couple that with initial public offerings (IPOs) that were typically opening up 3 to 4 times the initial price the day before.  If that still didn't concern you about the potential bubble, imagine that the new glamour stocks (dot com companies involved with the internet) were trading at 300 to 400 times earnings and that is only if that had any earnings or revenues at all.  In fact, two companies we followed were in the business of giving advice to the internet companies in their portfolio (Internet Capital Group & CMGI).  At the peak of the market in early 2000, their combined total capitalization was about $120 billion.  This valuation exceeded the total capitalization (added together) of Alcoa, AT&T, Honeywell, Eastman Kodak, International Paper, and GM.  These two companies are now worth virtually nothing.

After the stock market broke down at the beginning of 2000 we expected that the market would trough at around 10 times earnings and the recession would be severe enough to cleanse the system enough to start a new economic expansion and bull market.  Instead, the Fed lowered the Fed Funds rate 13 times (from 6% to 1%) starting in early 2001 to mid 2003 and kept it there for a full year.  This produced the second bubble, this time in the housing market (see attachment-was that bubble hard to discern?).  This bubble was helped by the Chairman of the Fed encouraging new home owners to continue borrowing on the equity of their homes.  These were homes that had already incurred a record amount of debt while homeowners' equity was falling to record lows. This drove housing prices relative to median family income to almost two times the norm--this is another bubble that should have been easy to spot. 

This housing bubble was accompanied by another stock market bubble which doubled over the next 5 years.  And instead of having the severe recession we expected in order to liquidate the debt build up of the 1990s, we had the mildest recession in history.  With the second bubble in housing starting in 2001 and being accompanied with another stock market bubble in 2003 naturally the debt skyrocketed. 

In fact, the private debt doubled from $26 trillion in 2000 to $52 trillion in 2008 (see attachment).  During this same period of time the GDP grew at less than $5 trillion. It was the generation of this debt without the support of GDP that caused an artificial increase in the household net worth to $64.4 trillion by mid 2007.  This false prosperity could only be resolved by a very severe recession which started in December of 2007.  Thirteen trillion dollars of this net worth was wiped out by the end of 2008 without any reduction in the debt so far.  Eventually the debt will decline, but it is the unwinding and deleveraging that will make the economic recovery so painful and onerous. It doesn't matter how much money the banks have from the stimulus measures, because we must have the multiplier effect and velocity accompanying increases in the money supply to get the economy booming again.  It will be difficult to stop consumers from going from saving nothing, to saving as much as possible, after their latest financial experience of wealth reduction.

The packaging and selling of ridiculously priced mortgages should have been regulated, but if the housing prices were not rising at unsustainable levels (with the Fed's help) this could not have flourished.   Also, allowing bets to take place on bonds defaulting should have only been allowed in Las Vegas.  Vegas would have known to stop the betting at the point of the total amount of the debt outstanding!  Vegas also has a limit in every game-otherwise the billionaires would be able to win by doubling up every time they lost until they broke even and quit after a winning streak. 

If you would like to go into more details about these bubbles associated with excess debt please read our special report titled, "How We Got into This Mess"! Written March 27, 2008 on our home page.  And if anyone has any influence over our elected officials, please advise them to read this rather than form a "select committee" to evaluate what went wrong!!