If you think the credit crunch is bad now, wait — you ain’t seen nothing yet.
So says Theodore J. Forstmann, co-founder of Forstmann Little & Company, a private equity firm which was once the world's most successful. Until 2005 Forstmann was also a member of the elite Forbes 400 richest Americans list.
"We are in a credit crisis the likes of which I've never seen in my lifetime," Forstmann told The Wall Street Journal in a recent interview.
"The credit problems in this country are considerably worse than people have said or know," Forstmann said.
"I didn't even know subprime mortgages existed, and I was worried about the credit crisis."
Forstmann was among the pioneers of the private equity business in its boom years of the 1980s, and he accurately predicted the implosion of the junk bond business.
Now he's forecasting a similar calamity for the credit business.
Forstmann contends that our current economic problems began almost immediately after 9-11 when the Fed unleashed a torrent of money into the economy.
Too much cash easily available and freely circulating skewed both incentives and the decision-making process of banks and the finance industry.
As Forstmann explains it, short-term interest rates dropped to zero in real terms, and then fell below that level. In effect, you could borrow money free.
And money borrowed at less than zero is virtually a worthless debt as a generator of profit for the lender, observes Forstmann, with its value dropping and loan interest not accumulating.
"I don't know when money was ever this inexpensive in the history of this country," Forstmann says. "But not in modern times, that's for sure."
Printing too much money also depresses its value and hikes prices — that's economics 101.
So cheap money may be no bargain.
Yet another lesser known consequence of an over-abundance of cash is more troubling for Forstmann: the propensity of banks and the financial industry to assume greater risks for smaller returns.
"Something that's free isn't worth much," says Forstmann, referring to the cost of money for a time after 9/11. Therefore, he argues, the usual prudence and caution which once characterized the financial industry were compromised as riskier ventures were financed.
"They [the financial industry] could not find enough appropriate uses for the money," he says.
Adding to the problem were loan syndication and securitization, loans which could be removed from the banks’ ledgers, permitting the raising of more capital, beginning the cycle anew.
Hedge funds then bought the loan products with money they borrowed from the same banks that syndicated and securitized the debt.
We're feeling the results of all this now, according to Forstmann. To remedy the problems, "there's going to have to be a certain amount of pain," he says. "The market's going to have to clear somehow ...
"Things are going to fail," he predicts. "Enterprises are going to fail. The economy is going to slow [even more]."
Forstmann does not blame Alan Greenspan, who was Fed chairman for four-plus years after 9/11, for the current economic problems.
"Greenspan had really tough decisions to make, so I don't think it's a black-and-white kind of thing at all," Forstmann says.
Yet, he says, Greenspan had "... no idea of what the consequences [of his monetary policies were] going to be."
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