Investing with Dante

October 10, 2008

You know things are bad on financial markets when an investment research note starts talking about Dante‘s visit to the nine circles of Hell with tormented lustful souls and gluttons living in filthy slush.

In the case of State Street Global Markets’ latest report, however, there is a more direct link than simple hyperbole about the way investors are feeling. The firm recently had a chat with former U.S. Treasury Secretary Larry Summers who defined what he saw as the five viciousrtx8t2k.jpg circles of the current financial crisis.

It goes like this:

Circle One: House prices fall in value, putting some people into negative equity and leading some to default on mortgages. Foreclosures further erode asset values.

Circle Two: Falling asset prices erode bank capital, making banks more hesitant to lend, leading to further asset price falls and lower capital levels.

Circle Three: A slowing real economy reduces financial asset prices, leading to less lending and less investment. This causes the economy to slow further.

Circle Four: A slowing economy means less demand for goods and services, leading to lower employment and even less demand.

Circle Five:  Confidence in the financial system breaks down. State Street says that investment flows and moves on global stock markets clearly suggest this is where the financial world is at the moment.

It is worth remembering, perhaps, as investors stare into the inferno, that Dante did come back from his visit to Hell’s circles. But then again, he did not go straight to Heaven. There were seven terraces of Purgatory to manoeuvre through first.

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