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How long will the market slump last?

After the "long boom" of the 1990s, what's the chance that we now face the prospect of a long slump in this decade _ a Japan-like malaise that may last years before investors recover their fractured confidence?

Unfortunately, some of Wall Street's most seasoned players fear we may have entered just such a period of prolonged decline. And because their confidence about the future is crucial in priming the pump, their prophecies tend to be self-fulfilling.

"In my opinion, the market is headed lower and will not start any serious recovery for some time," cautions James Harmon, former chairman of the investment bank Schroder Wertheim & Co. and former head of the U.S. Export-Import Bank. "This market will not boomerang," Harmon said during a telephone interview this week, "and the earnings of most of the large public companies probably will not keep pace with the growth of GDP over the next few years."

Is he right? There's obviously no way to know. But the fact that growing numbers of Wall Street insiders agree with him is important in itself.

"We have nothing to fear but fear itself," said Franklin D. Roosevelt in his 1933 inaugural address, describing the long slump that had followed the stock market crash of October 1929. The same words apply today: If investors regained their confidence and put their money to work, the slump would end quickly.

But will they? The "infectious greed" of the 1990s, to use Alan Greenspan's memorable phrase in his testimony this week, has given way to an infectious anxiety about the future. As in the 1930s, we're living in a Keynesian world where monetary policy alone can't shake investors from their "liquidity preference" _ and the corresponding reluctance to invest for the long term in productive assets.

Where investors once bragged about all the high-tech companies they owned, they now boast about their cash positions _ the lucky investors, that is. They are husbanding that cash for the moment when stocks finally hit bottom. "I am almost 100 percent liquid," one investment banker confided this week. "I have been waiting for this unique opportunity for some years. It will be comparable to the '70s."

Steven Rattner, who heads a New York private equity firm called Quadrangle Group, noted that one feature of this market is the continuing mismatch between what sellers think their companies are worth and what buyers are willing to pay. Recent experience has taught that if you wait, the price will decline _ and nobody wants to feel like a sucker who paid too much. So potential buyers sit on the sidelines, waiting.

Even the financial reforms that investors have been clamoring for may actually make the situation worse in the short run. Rattner notes that if companies follow Greenspan's advice and record stock options as an expense, that could cut the earnings of the average company in the Standard & Poor's 500 by 20 to 30 percent. And the earnings of high-tech giants such as Microsoft and Cisco Systems, which have granted billions of dollars in options, could suffer even more.

One of the few positives these days is that the world's financial architecture still looks solid amid the howling winds. Unlike the financial crises of 1997 and 1998, this time major financial institutions appear to have hedged their risks fairly well. Investors' losses of trillions of dollars in debt and equity markets haven't led to systemic failures by big banks or investment houses.

How could things get worse? For an answer, consult the annual report of the Bank for International Settlements, issued this month. Under a section titled "Seeds of Concern," the BIS notes that financial consolidation has meant that just a few giant banks now control the unregulated market for financial derivatives. The top three banks controlled 89 percent of foreign-exchange derivatives booked by U.S. banks in 2001, up from 59 percent in 1995; the top three banks' share of U.S. interest-rate derivatives rose to 86 percent in 2001 from 56 percent in 1995; the top three's share of credit derivatives rose to 94 percent in 2001 from 79 percent in 1998.

In laymen's language, that means that, with fewer and fewer big banks, a failure by any one of them could be disastrous. That's one problem with globalization: It puts everyone's eggs in the same few baskets.

Greenspan expressed this summer's rueful financial lessons eloquently in his congressional testimony last week. "It is not that humans have become any more greedy than in generations past," he observed. "It is that the avenues to express greed (have) grown so enormously." And now we are paying the price, saints and sinners alike.

David Ignatius is executive editor of the International Herald-Tribune in Paris.

Washington Post

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