The sub-prime lending industry’s troubles have been dominating the headlines in the last few months, which has been the primary reason for the wild swings we have witnessed most recently in the stock markets across the globe. The most recent housing boom was partly fueled by attractive interest rates and aggressive mortgage lending practices, e.g. loaning to borrowers with high credit or default risk. As many of these adjustable-rate sub-prime loans have reset to much higher interest rates, delinquency and foreclosure rates have risen.

Although there is a range of opinions about the depth and breadth of these problems, the consensus is that, while significant, the sub-prime market woes will not have a devastating impact on the overall economy. So far, the credit markets have continued to perform well and, late last week, the Federal Reserve was largely applauded for injecting about $62 billion of liquidity into the short-term lending marketplace.

This mortgage lending problem and the fear of a possible credit “crunch” makes us look back in history at a similar period of time, the savings and loan crisis of the 1980s. The de-regulation of the banking industry led many S&Ls to overextend themselves by lending far more money than was prudent to risky ventures that they were not qualified to assess. The result was a “run on the bank” as investors cleared their accounts in fear of S&L insolvency and an act of Congress to create the Resolution Trust Corporation to help liquidate assets of failed S&Ls . The stock market (as defined by the S&P 500 Index) went through some volatile periods of time during the worst years of the S&L crisis from 1988 through 1991; however, the end result was a positive double-digit average return during this 4-year period. 

We are not claiming that the stock market today will react similarly to how it did during the S&L crisis, but it does allow us to reflect back on just one of many historical events that threw fear and uncertainty into the financial marketplace. While volatile markets are difficult to stomach, times like these highlight the benefits of a diversified portfolio. We encourage you to maintain a long-term view and adhere to the disciplined investment policy that is in place. As always, please contact us if you have any questions or concerns regarding your portfolio.

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