A SIGNATURE UPDATE SPECIAL COMMENTARY 7/14/2008

WHEN THE FDIC STEPS IN AND WHEN THE NATION STEPS UP

Last Friday’s announcement that the FDIC was stepping in and taking over IndyMac, a major mortgage lender and consumer bank headquartered in Southern California, came as no great surprise to the financial markets. IndyMac is a major maker of ‘exotic’ mortgage financing, heavily used in the run-up of the housing market, the same type of financing that is responsible for the majority of home foreclosures nationwide. Its stock value had suffered terribly since the beginning of the housing and credit market turmoil as the value of the real estate used as collateral for its loan portfolio had tumbled and as its expenses in servicing so many struggling loans had skyrocketed. But IndyMac was the architect of its own demise as it aggressively marketed questionable mortgage products and highly compensated mortgage brokers to bring any and all borrowers to its table. As the housing market heated up, IndyMac and its surrogates reaped meaningful rewards. But in the end, some borrowers and all current shareholders are the ones who have suffered. Depositors who have kept their accounts at or under FDIC’s coverage levels and borrowers who prudently managed their mortgage borrowing have either won out or have survived unscathed, being rewarded with higher than usual interest rates on deposits and/or low interest rates on loans.

The failure of IndyMac has been heralded as one of the largest bank failure in history, though when adjusted for inflation the failure of certain banks and savings and loans in the early 1980’s or earlier dwarf that of IndyMac’s today. Along with concerns over the solvency of Fannie Mae and Freddie Mac, it has increased the pressure on the share value of banks, including consumer, commercial and investment banks throughout the country.

The US Treasury and Federal Reserve have announced plans to shore up those institutions (like Fannie and Freddie) deemed to be critical to the nation’s economy, and the FDIC is closely following the capitalization and liquidity of over 200 banks nationwide, prepared to step-in where needed.

Fannie Mae (formerly known as the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Association) serve a critical purpose in mortgage lending. Fannie Mae considers itself ‘a shareholder owned company with a public purpose.’ Though they are publically held corporations, the stock of which can be found in untold number of stock portfolios, mutual funds, and retirement and pension accounts, they are also Government Sponsored Enterprises (GSE’s) and enjoy a relatively unique public/private status. While they are technically able to fail, they are functionally incapable of doing so - so long as the US Government stands. They live and breathe as chartered by the US Government and need only appeal to the House and Senate for relief. No wonder then that the Fed and Treasury acted so quickly to restore confidence.

When the news in any industry segment is as difficult as it is for the banking industry, most investors choose to flee, leaving their stock positions with little of what they may have brought to the table. But it begs the question, ‘who are the buyers for those battered shares?’ The most often answer is ‘the professional investor looking for bargains they expect to turn into substantial long-term gains.’ They are acting out the stock market idiom of ’buy low, sell high,’ and they have the courage and temperament to wait for their gains. The Warren Buffet’s and Kirk Kerkorian’s of the world have made their fortunes with such strategies, while the average investor settles for significantly lower returns. As the markets get tough and share values seem depressed, when we are besieged daily with the purported woes of the economy, and the talk-around-the-water-cooler is replete with concerns over the future, that’s the time to pay attention and look to reposition your portfolio to take advantage of the opportunities such seemingly dismal times afford.

Former Senator Phil Gramm, a top policy adviser of Sen. John McCain's, recently said the nation is in a "mental recession," not an actual one, and suggested the United States has "become a nation of whiners." This comment was certainly great fodder for the media, perhaps bad form for one acting as a surrogate for a presidential candidate, and obviously not what any populist- minded politician wants repeated countless times on the Sunday morning political programs, but maybe not as far off as some would suggest. For those having a tough time paying for food and fuel or those whose families are directly effected by home foreclosures or unemployment, it likely seems like a recession, and in their homes it certainly is one. But is the nation in a recession? Or was Gramm correct? What does it mean to be in a recession, and can the economic slow down of our domestic and global economy qualify?

The textbook answer is that a recession occurs when the economy has decreased in overall size (as measured by GDP) for two consecutive calendar quarters. So here’s the rub, our economy has yet to evidence that we’re in a recession. An economic slow down? Certainly. A period of time when it’s difficult to see economic progress? Of course. But just because we can’t easily see the progress doesn’t mean it isn’t there. Manufacturing orders are up, unemployment is holding at a relatively low 5.5% (low compared to historic recessionary levels), corporate profits are amazingly consistent and robust in the face of extraordinarily high energy prices and unusually tough credit standards. Housing, banking, and transportation companies have taken the brunt of the slow down, but other segments are performing well or in some cases exceeding expectations.

So maybe there’s credence to Gramm’s assertion that we’re in a ‘mental recession’, but what about the cut suggesting that ‘we’re a nation of whiners’? If you judge us by our emotional reactions and fears alone, then Gramm was right. But that’s too narrow a judgment and too broad a condemnation. If Gramm had said that for a nation of remarkably resilient people, of committed and hard working individuals and families, of self-sacrificing and good hearted contributors, we seem to whine a little too loudly when pinched, then his comments may have struck a completely different chord. I’d like to think that someone of Gramm’s stature, representing either of our presidential candidates, would have enough faith in us as Americans to simply have meant that sometimes we should remember how great our lives are before we whine about how bad things seem at any particular time. After all, we live in the greatest country on earth and have and will continue to enjoy the benefits of the largest, most resourceful and most resilient economy ever witnessed.