Roach on the Bubble


New York – In a speech given by Steven Roach August 1st, entitled “Pitfalls in a Post-Bubble World”, Mr. Roach discusses the broad trends in the US consumer sector, housing and international impact of the most recent bubble.

His first point is that the bubble we are currently facing is at least twice the size of the dot-com bubble at the beginning of the decade. The dot-com share of US market cap was 6%, while sub-prime is roughly 14.3% of the US market cap. Adding to the mix is another 12.7% that is in Alt-A product.

News this morning in Bloomberg news highlights a potential $4.0 billion write down in the third quarter for Lehman Brothers. This follows write downs within many of the bulge bracket firms. The  New York Times reports that Lehman is considering selling off some or all of its asset management business to shore up its capital. Other bulge bracket banks, notably Citi, Merrill and UBS are looking at forms of restructuring or selling assets to increase capital.

Lehman has circulated a memorandum of understanding to a number of private equity firms to test their interest in the asset management division. Bidders may isolate the Neuberger Berman asset management firm that Lehman acquired in the 2003 and whose value is posited to be in the $7.0 to $13.0 billion range. The machinations of the bulge bracket reflect a deeper concern about the overall economy.

Steven Roach’s speech steps back for the travails of the Wall Street firms and assess the impact of the bubble on the US economy and the global economy. At its root, the current crisis emerged as the US shifted from consuming out of income to consuming out of asset appreciation. Roach indicates that at its peak, net equity extraction from residential property hit 9.0% of disposable income in mid-2006, from 3% five years earlier. As well, the share of consumption to GDP rose to 72%, from about 66% in the earlier.  The binge eventually resulted in bubbles in the property and credit markets.

Roach also discusses the impact of the entire economy which he characterizes as living beyond its means for decades. The current account has ballooned from 1.5% of GDP in 1995 to 6.0% in 2006. To fund this imbalance, the US has relied on foreign interest in US assets, to the tune of $3.4 billion per day in 2006. Clearly, this is unsustainable, even when the US dollar is the denominator of global trade.

As with all bubbles, the US consumer will need to consume less and revert to a more realistic saving plan to repair damaged balanced sheets.

But is the asset-based consumption limited to the property market? What, if anything, does this mean for the mutual fund world? Were these assets similarly impinged upon?  The answer, according to the Dollar is that about 20% of 401K participants are currently paying back loans on these assets. It seems that the economy and the financial markets are in for a fairly long convalescence.


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