The least useful investment books are those that describe
either extremely bright or very dark outcomes for the markets.
The quality of predictions in both types tends to be so awful
that they generally provide reliable contrarian indicators. If
the author says buy, you should sell, and vice versa.
Michael Panzners Financial Armageddon, which was
published in early 2007, is an exception to this rule. The
books deeply gloomy predictions have proved so accurate
that, if the text were changed from the future to the past
tense, it would read like a financial history of the past year
and a half. Theres more bad news to come, says Panzner.
Given his extraordinary track record, investors are bound to
One seldom profits from following the advice of a
doom-monger. In September 1981, The Coming Currency Collapse by
Jerome Smith was published. Over the next year the dollar
appreciated by roughly one third against the yen. Richard
Zambells Hyperinflation or Depression appeared in 1984.
This book ushered in more than two decades of stable consumer
prices. James Dale Davidsons The Plague of the Black
Debt: How to Survive the Coming Depression went to press in
1993, just as the U.S. economy was about to embark on a decade
and a half of credit-fueled expansion. The optimists
havent much to crow about, either. Far from tripling in
value, as the authors of Dow 36,000 predicted back in the
summer of 1999, U.S. stocks are currently worth one third less
than a decade ago.
The style of Panzners Financial Armageddon is typical
of the genre. The forecasts are grim, they are presented with
deep conviction, and the crisis deepens melodramatically with
each successive chapter. What distinguishes Panzner is that his
predictions have come true.
More than two years ago, Panzner warned that the collapse in
the housing market would drag the United States
and ultimately, the rest of the world into a deep and
dark abyss, the likes of which we havent seen for
decades. He anticipated that the hardest-hit countries
would be those emerging markets that depended most on the
bloated American consumer and that had accumulated
massive reserves of dollars and holdings of U.S. assets in an
expensive yet ultimately failed strategy to maintain an export
market for their rapidly expanding output.
Panzners analysis of the credit system has been
vindicated. Banks no longer knew their customers. Instead, they
depended on credit scores and risk modeling. But the risk
models were flawed: They understated risk during the good times
but would force financial players to make fire-sale disposals
after a crisis appeared. Panzner pointed out the dangers of
subprime and negative-amortization mortgage loans long before
this credit detritus became common knowledge.
He described banks originating loans for a fee and
parking them in off-balance-sheet funds, which in turn issued
commercial paper to investors. In time it would become clear
that allegedly sophisticated investors had struck
something of a Faustian bargain during the good times, by
exchanging immense quantities of borrowed money for unsalable
assets. Panzner excoriated the securitization of loans,
which had created an overflowing mess that will
contaminate the financial groundwater for years.
This analysis wasnt wholly original. However, by
synthesizing a knowledge of eco-nomic history with a deep
understanding of recent financial developments, Panzner boldly
imagined how events would unfold. His description of how the
credit system would unravel was specific and, as things turned
out, accurate. The trigger for a fully fledged systemic
crisis will likely be the abrupt and unexpected failure of an
aggressive operator. Banks and prime brokers would
scramble to call in loans.
By that time there will almost certainly have been a
dominolike collapse of more than a few large intermediaries and
allegedly sophisticated global financial firms, including hedge
funds, insurers and brokers. Concerns about counterparty
risk, Panzner predicted, would reach a fever pitch.
In the early stages of the panic, the dollar would climb in
value as leveraged financial players required the U.S. currency
to unwind dollar-denominated positions.
A number of financial institutions would fail, including
Fannie Mae and Freddie Mac, Panzner forecast. As commercial
paper soured, several money market funds would be set to
break the buck. The collapse of the bond insurers
would lead municipal bond spreads to blow out. By then many
near-bankrupt states and municipalities would be forced to
raise taxes, cut costs and turn to Washington for a handout.
Highly rated securitized bonds would likely suffer steep and
instantaneous downgrades. Big banks would be no safe haven:
A long overdue economic slowdown or turn in the credit
cycle will almost certainly decimate the financial position of
Americas largest banks.
It wouldnt be long before bogus appraisals and
valuations would come to light. The newfound
transparency in the wake of the unfolding financial
crisis, wrote Panzner, will expose a scale of
fraud, corruption and self-dealing that many will find almost
impossible to comprehend. Day in, day out, reports will surface
about hidden losses, false accounting, inflated appraisals,
sizable balance-sheet obligations, valuation discrepancies,
unregulated offshore entities, phantom profits, insider trading
and businesses bled dry to enrich a few individuals at the
expense of employees, investors, bankers and
The authorities would be caught off guard by the severity
and speed of the crisis, according to Panzner. Initially, the
Fed would be slow to respond. But as deflationary fears grew,
the central bank would respond by cutting rates to zero and
adopting a policy of quantitative easing. As the crisis spread
around the world, protectionism would resurface.
What of those anticipated events that have yet to occur?
Panzner elaborates on them in a new book, When Giants Fall. The
crisis, he predicts, will provoke a backlash against
globalization. Nationalism will resurface as faith in
multilateral institutions, such as the European Union and the
World Trade Organization, diminishes. The euro is at risk of
collapsing. Unions will grab more power for themselves, and
state capitalism will make a comeback.
The long-term outlook for the dollar is bleak, Panzner
asserts. There are too many unnatural holders who
own the dollar only because of its status as a reserve
currency. But in the dark times ahead, as capital is
repatriated around the world, dollars will be sold. More
worryingly, Panzner fears a loss of confidence in fiat
currencies, as central bankers around the world turn to the
electronic printing press as a palliative. A deflationary
psychology could suddenly give way to concerns about
hyperinflation. At that moment money would become a hot potato,
passed from hand to hand as quickly as possible.
Investors must judge for themselves the likelihood of these
outcomes. However, they shouldnt ignore them. The biggest
losses over the past year and a half were suffered by those
wishful thinkers who refused ever to consider the worst-case
Edward Chancellor is the author of Devil Take the
Hindmost and a senior member of GMOs asset allocation