Over the past few weeks we’ve focused so tightly on the investment banking and capital markets difficulties our country has experienced that we’ve bypassed some important economic information. The following is a synopsis of some of the more meaningful data and what it might mean to all of us.
PRICES AND INFLATION
The August PPI (Producer Price Index) fell by .9% and the CPI (Consumer Price Index) fell by .1%. These lower figures signal an overall price decrease, or deflation, in our economy largely due to decreases in the cost of oil and reduced demand brought on by higher unemployment. Such a decrease, to the extent that it simply reverses the prior inflationary trend can be healthy, but if extended too far, the implications are more complex.
Inflation was the most outwardly expressed concern of the Federal Reserve for much of the last year, as the Fed decreased interest rates to stimulate the economy. At the same time that rates were coming down, the availability of credit was tightening; and in the end the decreased rates only drove inflation by helping support higher oil prices as the US dollar weakened. Now that consumers across the globe have decreased their demand for oil, and the Fed and Treasury have tightened monetary policy enough to stabilize and strengthen the US dollar, we have actually seen a deflationary trend, which can be just as concerning overall. What the Fed missed, and what this commentary has addressed more than once over the last year, is that an economy can’t have sustained inflation without rising personal incomes. And real incomes have been stagnant for the middle class.
The cost of oil has largely continued to move lower, though derailed for several days by the credit crisis in the capital and investment banking markets. It will likely continue to do so through the end of the year. We remain firm in our expectation of crude prices between $90 and $100 per barrel by year end, with the possibility that we’ll see levels dip towards $80. This is already having a positive impact on consumers at the gas pumps, in spite of the refinery delays caused by recent hurricanes in the gulf.
Lower energy prices not only help the consumer, but also impact trade balances between the US and foreign markets. Just as important is the affect of reducing the enormous amount of US capital that we’ve been exporting to unfriendly governments - the suppliers of most of the oil we use in this country. Hundreds of billions of US dollars have entered these foreign economies, and have emboldened their leadership in their efforts against democracy at the cost of the US taxpayer.
HOUSING SALES, STARTS AND INVENTORIES
New home sales were down 11% and existing home sales were off 2.2% in August over the same period last year. Housing starts were down 6.2%. The issue here is less one of sales and starts than it is one of inventory. The inventory of homes on the national market is now at 10.3 months, meaning that if no other homes were built or went on the market it would take 10.3 months of ‘normal’ home purchasing activity to exhaust the current inventory. 10.3 months is much better than the 14 months of inventory we had some months ago, but it is still a good 7 months greater than it can be in order for housing prices to begin to regain some of their former luster, and 4 months greater than the level at which prices stabilize. Even though the un-sold inventory is decreasing, it is doing so at a painfully slow rate. This is largely due to the tight availability of money in the mortgage markets, and the increase in homes being placed on the market by sellers who aren’t turning around and purchasing another home.
MANUFACTURING AND DURABLE GOODS
The ISM (Institute for Supply Management) Manufacturing index ticked down to 49.9 in August from 50 in July. The consensus had expected no change at 50. The output components of the overall index were mixed. Stronger components included new orders, and new export orders. Weaker components included supplier deliveries, employment, and production. The prices paid component of the index declined. In all, the change in this index likely has more positive attributes than negative, but levels below 50 signal contraction, while levels higher than 50 signal expansion.
Durable goods orders were off 4.5% in August, signaling a possible reversal of the upward trend seen for most of this year. Though a decrease in durable goods orders is not unusual in August, such a large decrease is troublesome, and likely reflects the difficulty corporations and individuals are having obtaining credit with which to purchase and fund expansion.
TRADE BALANCES
The trade deficit in goods and services rose to $62.2 billion in July. Exports increased $5.4 billion in July and are up 20.1% versus last year. The gain in exports in July was led by automobiles/parts and non-monetary gold. Imports increased $8.7 billion in July and are up 16.8% versus a year ago. Crude oil accounted for most of the gain in imports in July.
Adjusted for inflation, the trade deficit in goods was $41.2 billion in July, $11.8 billion smaller than last July. Without adjusting for inflation, the trade deficit for goods and services was $4.9 billion larger than last year.
With the dramatic decline in the cost of oil, August and September Trade Balances should be much improved. The increased strength of the US dollar is partially reflective of this, too much strengthening of the dollar would put pressure on exports, as would a continued global economic slowdown.
Friday, September 26, 2008
THE PAULSON PLAN: TAXPAYER INVESTMENT OR EXPENSE
Virtually all other events in our economy and society have been overshadowed this week by the wrangling in Washington DC regarding the proposed bailout of the US credit complex, capital markets, and investment banks; and for good reason. This is perhaps one of the most important pieces of legislation to have crossed the house and senate in our lifetimes. There is more than enough blame to go around regarding how and why our financial system got to where we are today, and the politicians seem to love spreading that blame to anyone and everyone else. The reality is that we are all to blame, in one way or another, and virtually every one of us benefited from the scenario that brought us to where we are today. Conversely, it will take the efforts and resources of all of us to bring this situation under productive control.
You may not agree with me on this, but it is absolutely the case. Regardless, it is clear to all of us that something must be done to turn the situation around. What is less clear, thanks to those politicians who’ve been grand-standing before their constituents, is the real outcome of various elements of the Federal Reserve and Treasury proposal – the ‘Paulson Plan’.
At its core, the Paulson Plan would have the US taxpayer purchase the troubled assets of financial institutions critical to the operations of the credit and capital markets. With the liquidity provided these institutions, they can return to the profitable lending and investing process so vital to our economy. Without it they are all but frozen, and the economy would suffer a significantly greater slowdown than we’ve imagined or experienced thus far.
Why then is there so much posturing over what could have been a relatively simple, though major, solution? Because those tasked with making decisions for the population at large have lost confidence in the very markets they are working to correct, and in the executive branch of our government. With less than six weeks to go before the entire US House of Representatives, fully one third of the US Senate, and Senators McCain and Obama face an election, they are all posturing before the nation. They are doing their level best to act as though they have the knowledge, expertise, and credentials to make better decisions than the US Treasury, SEC, and Federal Reserve, whom many see as agents of an unpopular president.
It is reasonable to expect that executives of companies that will benefit from a federal bailout ought to be limited in their compensation packages, and that there should be responsible oversight of those making decisions with $700 billion dollars of taxpayer money. It is not reasonable to place other onerous requirements and limitations on those executives and shareholders, or to cloud the issue by labeling the enormous taxpayer investment as a taxpayer expense. Doing so not only hinders the timely passage of the legislation, but also lessens the likelihood that it will have the desperately needed outcome for which it was designed. For important participants in this process to come forward fully one week into what must be a very short process, and start proffering alternative proposals, is irresponsible and shameful.
POLITICIANS! Can’t live with ‘em, can’t ..…. , well, you know.
Contrary to what many politicians and the media have represented, The Paulson Plan would not be a $700 billion taxpayer expense. No more than buying a house or investing in your 401(k) is an expense. It would be an investment. It would exchange dollars for valuable assets that should be able to be sold in the future for more than what was paid for them. While there would certainly be some considerable expense in managing the investment, buying the assets and selling them at appropriate prices and advantageous time frames, the expense would be far less than the expense to the US taxpayer and economy of not taking the appropriate action now.
Bill Gross of PIMCO, one of the most respected bond investors in US history, estimates that The Paulson Plan would yield 10-12% for the taxpayers if handled reasonably. Ben Bernanke, Henry Paulson, Chris Cox, and many others, are leaders with the appropriate credentials, knowledge and expertise, who employ some of the best trained and most knowledgeable financial minds in the country. They likely stand to have little personal gain from the passage of this plan. They’ve jointly recommended it to the president and have continued to work tirelessly, with amazing flexibility, to bring it to fruition. Though I’m not sure any of us should expect the federal government to hand us a profit, I do think we can look at this and accept the beneficial outcome the plan has to offer. That is, bringing liquidity to a very illiquid market, restoring confidence in the US financial system, and restoring value to a depressed real estate and volatile equities market.
For those who want to further punish corporate executives and shareholders for their parts in this debacle, there is resistance to the administration’s recommended course of action. Others want to target resources to homeowners and taxpayers directly, supposing that this will remedy the situation. And others still want additional language added to the legislation that would specifically benefit their own agenda, regardless of what is good for the country and the economy. These are short sighted and wrong minded individuals who haven’t the proper perspective on the situation at hand.
Executives and shareholders have already lost hundreds of billions of dollars as their stock values have disappeared before our eyes. Though many homeowners and taxpayers face tremendous difficulty due to this crisis, many of them have also benefited directly from the causes of it over the last five to ten years. And those opportunists that want their own agendas catered to at this time of crisis deserve nothing less than to be exposed for what they are.
President Clinton came to the nation almost 16 years ago and asked us to invest in various state and federal programs though increased taxation. He effectively persuaded us that our sacrifice then would pay off later, and in large part it did. Towards the end of his term in office critical decisions were made that laid the foundation of what we are living through today. In the early days of his administration, President Bush asked that we support an effort to rid our world of terrorists and terrorism. He warned us that it would be a long and unpopular effort, and that it would come at a terrible cost. Like Clinton before him, he was correct. Each of these presidents has had to deal with the issues left behind by previous administrations, just as all leaders do. The next president, Obama or McCain, will have to do likewise. We will need to trust in those they appoint to positions of power and authority, just as we need to continue to have trust in those in the very same positions in Bush’s administration today. This is not a time for political posturing or the self-serving actions - it is a time to take a unified stance for the benefit of the economy and the nation.
A WORD ABOUT DELEVERAGING
The effects of deleveraging have been discussed thoughout the markets over the past few weeks. Deleveraging takes place when numerous financial institutions reduce the financial leverage applied to certain assets, either in an attempt to exercise caution, or as a byproduct of the decrease in the value of the asset, and they do it all at about the same time. This reduces the amount of working capital in our markets and, depending on which economic philosophy you might adhere to, can slow the growth of an economy, or stimulate new growth through economic determination and innovation. Regardless of the anticipated outcome, the process of deleveraging can be uncomfortable, especially at a time when there are so many other factors working against our economy.
Brian Wesbury of First Trust Advisors posted a short video presentation on the internet regarding his take on deleveraging and what it might portend for our markets. It’s worth viewing. Go to the following link to see Wesbury’s comments: http://www.ftportfolios.com/Commentary/EconomicResearch/2008/9/25/bailouts,_de-leveraging_and_japan.
You may not agree with me on this, but it is absolutely the case. Regardless, it is clear to all of us that something must be done to turn the situation around. What is less clear, thanks to those politicians who’ve been grand-standing before their constituents, is the real outcome of various elements of the Federal Reserve and Treasury proposal – the ‘Paulson Plan’.
At its core, the Paulson Plan would have the US taxpayer purchase the troubled assets of financial institutions critical to the operations of the credit and capital markets. With the liquidity provided these institutions, they can return to the profitable lending and investing process so vital to our economy. Without it they are all but frozen, and the economy would suffer a significantly greater slowdown than we’ve imagined or experienced thus far.
Why then is there so much posturing over what could have been a relatively simple, though major, solution? Because those tasked with making decisions for the population at large have lost confidence in the very markets they are working to correct, and in the executive branch of our government. With less than six weeks to go before the entire US House of Representatives, fully one third of the US Senate, and Senators McCain and Obama face an election, they are all posturing before the nation. They are doing their level best to act as though they have the knowledge, expertise, and credentials to make better decisions than the US Treasury, SEC, and Federal Reserve, whom many see as agents of an unpopular president.
It is reasonable to expect that executives of companies that will benefit from a federal bailout ought to be limited in their compensation packages, and that there should be responsible oversight of those making decisions with $700 billion dollars of taxpayer money. It is not reasonable to place other onerous requirements and limitations on those executives and shareholders, or to cloud the issue by labeling the enormous taxpayer investment as a taxpayer expense. Doing so not only hinders the timely passage of the legislation, but also lessens the likelihood that it will have the desperately needed outcome for which it was designed. For important participants in this process to come forward fully one week into what must be a very short process, and start proffering alternative proposals, is irresponsible and shameful.
POLITICIANS! Can’t live with ‘em, can’t ..…. , well, you know.
Contrary to what many politicians and the media have represented, The Paulson Plan would not be a $700 billion taxpayer expense. No more than buying a house or investing in your 401(k) is an expense. It would be an investment. It would exchange dollars for valuable assets that should be able to be sold in the future for more than what was paid for them. While there would certainly be some considerable expense in managing the investment, buying the assets and selling them at appropriate prices and advantageous time frames, the expense would be far less than the expense to the US taxpayer and economy of not taking the appropriate action now.
Bill Gross of PIMCO, one of the most respected bond investors in US history, estimates that The Paulson Plan would yield 10-12% for the taxpayers if handled reasonably. Ben Bernanke, Henry Paulson, Chris Cox, and many others, are leaders with the appropriate credentials, knowledge and expertise, who employ some of the best trained and most knowledgeable financial minds in the country. They likely stand to have little personal gain from the passage of this plan. They’ve jointly recommended it to the president and have continued to work tirelessly, with amazing flexibility, to bring it to fruition. Though I’m not sure any of us should expect the federal government to hand us a profit, I do think we can look at this and accept the beneficial outcome the plan has to offer. That is, bringing liquidity to a very illiquid market, restoring confidence in the US financial system, and restoring value to a depressed real estate and volatile equities market.
For those who want to further punish corporate executives and shareholders for their parts in this debacle, there is resistance to the administration’s recommended course of action. Others want to target resources to homeowners and taxpayers directly, supposing that this will remedy the situation. And others still want additional language added to the legislation that would specifically benefit their own agenda, regardless of what is good for the country and the economy. These are short sighted and wrong minded individuals who haven’t the proper perspective on the situation at hand.
Executives and shareholders have already lost hundreds of billions of dollars as their stock values have disappeared before our eyes. Though many homeowners and taxpayers face tremendous difficulty due to this crisis, many of them have also benefited directly from the causes of it over the last five to ten years. And those opportunists that want their own agendas catered to at this time of crisis deserve nothing less than to be exposed for what they are.
President Clinton came to the nation almost 16 years ago and asked us to invest in various state and federal programs though increased taxation. He effectively persuaded us that our sacrifice then would pay off later, and in large part it did. Towards the end of his term in office critical decisions were made that laid the foundation of what we are living through today. In the early days of his administration, President Bush asked that we support an effort to rid our world of terrorists and terrorism. He warned us that it would be a long and unpopular effort, and that it would come at a terrible cost. Like Clinton before him, he was correct. Each of these presidents has had to deal with the issues left behind by previous administrations, just as all leaders do. The next president, Obama or McCain, will have to do likewise. We will need to trust in those they appoint to positions of power and authority, just as we need to continue to have trust in those in the very same positions in Bush’s administration today. This is not a time for political posturing or the self-serving actions - it is a time to take a unified stance for the benefit of the economy and the nation.
A WORD ABOUT DELEVERAGING
The effects of deleveraging have been discussed thoughout the markets over the past few weeks. Deleveraging takes place when numerous financial institutions reduce the financial leverage applied to certain assets, either in an attempt to exercise caution, or as a byproduct of the decrease in the value of the asset, and they do it all at about the same time. This reduces the amount of working capital in our markets and, depending on which economic philosophy you might adhere to, can slow the growth of an economy, or stimulate new growth through economic determination and innovation. Regardless of the anticipated outcome, the process of deleveraging can be uncomfortable, especially at a time when there are so many other factors working against our economy.
Brian Wesbury of First Trust Advisors posted a short video presentation on the internet regarding his take on deleveraging and what it might portend for our markets. It’s worth viewing. Go to the following link to see Wesbury’s comments: http://www.ftportfolios.com/Commentary/EconomicResearch/2008/9/25/bailouts,_de-leveraging_and_japan.
Friday, September 19, 2008
IT'S ALL ABOUT CONFIDENCE AND ORDERLY MARKETS
This week’s 'roller coaster ride' in the US and global equity and debt markets has been all about investor confidence, and almost nothing else. There were no concerning economic reports that triggered sell off’s on Monday and Wednesday, nor were there reports of economic optimism that triggered massive buying on Tuesday, Thursday, or Friday. As we close out the week, we do so at about the same level at which we started it: the DOW at, or near, 11,400, the S&P 500 above 1,250, the 10 year Treasury note above 3.5% and oil at close to $100 per barrel. The one striking exception to this was gold, up to nearly $864 an ounce.
Throughout the week, the markets were pummeled by concerns over liquidity for some of the most important players in the domestic and global credit markets, and whether or not those firms would find the resources to continue operations critical to our economy. The concern over these issues was immediately reflected in the equities markets and stock markets around the globe began to see a level of emotional and pricing volatility that may well be unprecedented. These concerns were born of the recognition that if capital market providers (investment and money center banks, etc.) were unable to meet their obligations it would slow the economy yet further, which in turn would make it more difficult for these organizations to do their jobs, and a spiral might ensue that could be devastating. These are issues pivotal enough to warrant federal intervention, and intervene they have. Governments around the world began to make decisions to shore up the capital markets, and in most cases these are the very decisions for which the equity and debt market leaders have sought support over these last many months. Perhaps the most important of them involving the reemergence of the Resolution Trust Corporation (RTC), and dramatic revision of the short sale rules and regulations. Though we can’t begin to address the complexity of all of the various issues at hand, we can discuss the two of these.
Treasury Secretary Paulson, Fed Chairman Bernanke, and SEC Commissioner Cox have jointly recommended various ‘big fixes’ to the current financial turmoil; solutions that are, quite frankly, the embodiment of the phrase, ‘necessity is the mother of invention’. President Bush announced this morning that his administration, along with various house and senate leadership, from both sides of the aisle, are standing behind these recommendations, and will move them through the appropriate legislative bodies with all due haste. The RTC and short sale reform stand at the heart of their recommendations.
The RTC is designed to acquire illiquid assets from capital market providers desperately needing liquid assets, in exchange for cash, and then to take the time to sell those assets to investors in an orderly and timely manner, to realize their full value. Under the premise that the RTC will purchase these assets at ‘reasonable’ prices, and then sell them for fair market values over time, the RTC should be able to return to the US taxpayer the funds the RTC was provided to the acquire the assets. While that’s a pretty substantial presumption, it makes sense. The assets at issue are too big and under too much pressure to be able to remain on the balance sheets of capital market providers without exasperating the current economic slowdown. There are even too many of these assets to stay on the balance sheets of the Federal Reserve and the US Treasury, but the US House and Senate have an even bigger balance sheet, and the assets can reside there until such time that they can be sold off to others, and not damage the economy or critically burden the US taxpayer. Most of these assets are bundles of mortgages, or mortgage-backed securities over which there is considerable concern of default, and foreclosure against devalued properties. The reality is, that while too many of these mortgages will fail, most will not, and the long term value of the bundled mortgage package is far greater than the apparent, or ‘fire sale’ value the SEC’s mark-to-market rules require the holders of these instruments to report and capitalize against.
The RTC was successfully utilized in the wake of the Savings and Loan debacle of the late 1980’s and early 1990’s. It helped restore confidence to the real estate, debt and equities markets, and did so at a reasonable cost to the economy and tax payer. Bringing the RTC back into operation once again, with capable leadership and sound regulatory oversight, can offer our economy and taxpayers the same benefit today.
Short selling in the stock markets isn’t a very intuitive process, and for most of us it’s not only hard to understand, but hard to justify. It is also an important tool in a free market, and worth continuing within appropriate guidelines. In the past, one could sell a stock that they didn’t own as long as they provided adequate capital in their brokerage accounts to assure that they would be able to purchase the stock in the future. The presumption being, that the price of the stock when sold was higher than it would be when purchased, and the result would be a profitable series of transactions. Investors were only allowed to sell stock in this manner, or ‘short’ the stock, in the event that the last transaction for the stock was on an ‘up-tick’, or higher than the transaction before. This assured that a series of ‘short selling’ transactions could not result in an ever declining value for the stock at issue. Essentially, the ‘short seller’ couldn’t create the value decline from which they hoped to profit.
For many decades this strategy actually assisted in the maintenance of an orderly stock market. But over the years, certain ‘short sellers’ found ways around some of the rules, and realized they could manipulate markets in ways that buyers of stock could not. They didn’t have to publically disclose the amassing of major ‘short’ positions, they found ways of ‘shorting’ the stock without ever having to actually purchase it in the future, and ultimately, when the largest of the US stock trading organizations, the New York Stock Exchange (NYSE), began to delineate transactions in penny increments rather than in 1/8’s the ‘up tick’ rule was declared too difficult to administer or regulate, and too inconsequential to make a meaningful difference. WRONG.
The ‘up tick’ rule was eliminated less than a year ago and the ensuing volatility in the markets has been torturous. Market makers, hedge funds, speculators, and ‘volatility traders’ began to focus on individual companies in industries already under economic and market pressure, and began to drive their share values down so far that some of these companies failed, or were forced to consider seeking capitalization elsewhere. The value of companies such as Bear Sterns, Lehman Brothers, Merrill Lynch, Morgan Stanley, Fannie Mae, Freddie Mac, and others have been devastated, and some of these companies have either required federal intervention, been take over by others, or worse.
SEC Chairman Cox has now placed a moratorium on short selling of 799 financial stocks for a limited time; presumably long enough to restore order to the trading of those stocks, and to end the egregious manipulation of these company’s share values and capital base. Included in this action was the restoral of the ‘up tick’ rule. While this is a great first step, the SEC needs to permanently restore the ‘up tick’ rule, to require the same type of reporting of ‘short’ positions as that of investors amassing ‘long’ positions, and to vigorously prosecute those that seek to manipulate markets.
The US House and Senate need to immediately back Bernanke and Paulson’s plan to restore the RTC, and stand with Bush in striving to restore confidence in the financial markets. Additionally, the RTC must be given sufficient funding as to not have to ‘clear’ purchase decisions through politicians seeking favor, but not so much leeway as to allow the RTC to become ‘all powerful’ in the capital markets. Objective criteria needs to be established for the valuation of assets, for both purchase and sale, by those with the appropriate credentials, and having the title of congressman or senator ought not to be considered as a credential in this case.
The US economy has shown remarkable resilience in the face of horrendous pressures for the entirety of Bush’s presidency, and longer. Some would suggest it is the Bush administration that has wrought much of this pressure, and others blame the appetites of high-income earners and investors. While they can in no way be held without responsibility, they also cannot be required to shoulder the blame on their own. In the end, it is the public that bears the brunt of the problems our economy has faced. And yet, our economy has continued to grow. The economy, including each and every household in this country, has endured the actions and outcomes of terrorists, market (oil and financial) manipulators, hurricanes, real estate and dot com bubbles, wars, state and national legislators, and previous administrations since the dawning of this millennia, and yet the economy has continued to grow.
Throughout the week, the markets were pummeled by concerns over liquidity for some of the most important players in the domestic and global credit markets, and whether or not those firms would find the resources to continue operations critical to our economy. The concern over these issues was immediately reflected in the equities markets and stock markets around the globe began to see a level of emotional and pricing volatility that may well be unprecedented. These concerns were born of the recognition that if capital market providers (investment and money center banks, etc.) were unable to meet their obligations it would slow the economy yet further, which in turn would make it more difficult for these organizations to do their jobs, and a spiral might ensue that could be devastating. These are issues pivotal enough to warrant federal intervention, and intervene they have. Governments around the world began to make decisions to shore up the capital markets, and in most cases these are the very decisions for which the equity and debt market leaders have sought support over these last many months. Perhaps the most important of them involving the reemergence of the Resolution Trust Corporation (RTC), and dramatic revision of the short sale rules and regulations. Though we can’t begin to address the complexity of all of the various issues at hand, we can discuss the two of these.
Treasury Secretary Paulson, Fed Chairman Bernanke, and SEC Commissioner Cox have jointly recommended various ‘big fixes’ to the current financial turmoil; solutions that are, quite frankly, the embodiment of the phrase, ‘necessity is the mother of invention’. President Bush announced this morning that his administration, along with various house and senate leadership, from both sides of the aisle, are standing behind these recommendations, and will move them through the appropriate legislative bodies with all due haste. The RTC and short sale reform stand at the heart of their recommendations.
The RTC is designed to acquire illiquid assets from capital market providers desperately needing liquid assets, in exchange for cash, and then to take the time to sell those assets to investors in an orderly and timely manner, to realize their full value. Under the premise that the RTC will purchase these assets at ‘reasonable’ prices, and then sell them for fair market values over time, the RTC should be able to return to the US taxpayer the funds the RTC was provided to the acquire the assets. While that’s a pretty substantial presumption, it makes sense. The assets at issue are too big and under too much pressure to be able to remain on the balance sheets of capital market providers without exasperating the current economic slowdown. There are even too many of these assets to stay on the balance sheets of the Federal Reserve and the US Treasury, but the US House and Senate have an even bigger balance sheet, and the assets can reside there until such time that they can be sold off to others, and not damage the economy or critically burden the US taxpayer. Most of these assets are bundles of mortgages, or mortgage-backed securities over which there is considerable concern of default, and foreclosure against devalued properties. The reality is, that while too many of these mortgages will fail, most will not, and the long term value of the bundled mortgage package is far greater than the apparent, or ‘fire sale’ value the SEC’s mark-to-market rules require the holders of these instruments to report and capitalize against.
The RTC was successfully utilized in the wake of the Savings and Loan debacle of the late 1980’s and early 1990’s. It helped restore confidence to the real estate, debt and equities markets, and did so at a reasonable cost to the economy and tax payer. Bringing the RTC back into operation once again, with capable leadership and sound regulatory oversight, can offer our economy and taxpayers the same benefit today.
Short selling in the stock markets isn’t a very intuitive process, and for most of us it’s not only hard to understand, but hard to justify. It is also an important tool in a free market, and worth continuing within appropriate guidelines. In the past, one could sell a stock that they didn’t own as long as they provided adequate capital in their brokerage accounts to assure that they would be able to purchase the stock in the future. The presumption being, that the price of the stock when sold was higher than it would be when purchased, and the result would be a profitable series of transactions. Investors were only allowed to sell stock in this manner, or ‘short’ the stock, in the event that the last transaction for the stock was on an ‘up-tick’, or higher than the transaction before. This assured that a series of ‘short selling’ transactions could not result in an ever declining value for the stock at issue. Essentially, the ‘short seller’ couldn’t create the value decline from which they hoped to profit.
For many decades this strategy actually assisted in the maintenance of an orderly stock market. But over the years, certain ‘short sellers’ found ways around some of the rules, and realized they could manipulate markets in ways that buyers of stock could not. They didn’t have to publically disclose the amassing of major ‘short’ positions, they found ways of ‘shorting’ the stock without ever having to actually purchase it in the future, and ultimately, when the largest of the US stock trading organizations, the New York Stock Exchange (NYSE), began to delineate transactions in penny increments rather than in 1/8’s the ‘up tick’ rule was declared too difficult to administer or regulate, and too inconsequential to make a meaningful difference. WRONG.
The ‘up tick’ rule was eliminated less than a year ago and the ensuing volatility in the markets has been torturous. Market makers, hedge funds, speculators, and ‘volatility traders’ began to focus on individual companies in industries already under economic and market pressure, and began to drive their share values down so far that some of these companies failed, or were forced to consider seeking capitalization elsewhere. The value of companies such as Bear Sterns, Lehman Brothers, Merrill Lynch, Morgan Stanley, Fannie Mae, Freddie Mac, and others have been devastated, and some of these companies have either required federal intervention, been take over by others, or worse.
SEC Chairman Cox has now placed a moratorium on short selling of 799 financial stocks for a limited time; presumably long enough to restore order to the trading of those stocks, and to end the egregious manipulation of these company’s share values and capital base. Included in this action was the restoral of the ‘up tick’ rule. While this is a great first step, the SEC needs to permanently restore the ‘up tick’ rule, to require the same type of reporting of ‘short’ positions as that of investors amassing ‘long’ positions, and to vigorously prosecute those that seek to manipulate markets.
The US House and Senate need to immediately back Bernanke and Paulson’s plan to restore the RTC, and stand with Bush in striving to restore confidence in the financial markets. Additionally, the RTC must be given sufficient funding as to not have to ‘clear’ purchase decisions through politicians seeking favor, but not so much leeway as to allow the RTC to become ‘all powerful’ in the capital markets. Objective criteria needs to be established for the valuation of assets, for both purchase and sale, by those with the appropriate credentials, and having the title of congressman or senator ought not to be considered as a credential in this case.
The US economy has shown remarkable resilience in the face of horrendous pressures for the entirety of Bush’s presidency, and longer. Some would suggest it is the Bush administration that has wrought much of this pressure, and others blame the appetites of high-income earners and investors. While they can in no way be held without responsibility, they also cannot be required to shoulder the blame on their own. In the end, it is the public that bears the brunt of the problems our economy has faced. And yet, our economy has continued to grow. The economy, including each and every household in this country, has endured the actions and outcomes of terrorists, market (oil and financial) manipulators, hurricanes, real estate and dot com bubbles, wars, state and national legislators, and previous administrations since the dawning of this millennia, and yet the economy has continued to grow.
Monday, September 15, 2008
AND TOMORROW WILL BE ANOTHER DAY 9-15-2008
The
There’s simply no way to color this as anything but ugly and painful, and no one with any credibility should even try. The media will have a hey day, politicians on both sides of the isle will have more fodder than ever with which to battle various incumbents, and pundits of all shapes and sizes will come out of the woodwork to tell us what this means. But in the end, there’s no one to blame, and all it means is that the markets had a lousy day as they reacted to some unexpected news. Tomorrow will be another day.
This is how markets tend to act as they are at, or near, their bottoms. There is virtually no predictability at these levels. Believe it or not, that’s a good sign. We believe that the DOW reached a low point in July at about 10,850 and that while we may continue to see some unwelcomed volatility, we’re not likely to test that level, or at least we’re not likely to pass through it.
Many investors recently shifted from a very conservative stance to one more consistent with their long-term objectives. Not because they expect that the equities (stock) markets are on a fast rebound, but because they know that one should take a more assertive stance towards the bottom of a market so they can benefit from the rebounds that may come.
For those investors that use some of the living benefits, or various guaranteed income or principal riders, offered by certain variable annuity companies, this is a time to be grateful for the peace of mind they might offer. Some of these programs shift investor monies into fixed rate accounts as markets decline to help offset possible further declines and retain value, and it’s not unusual to see as much as 80% of an investor’s portfolio in some of these fixed accounts at this time. That may not look too bad right now – other times it may seem to be too conservative, and investors may fear that it will curb possible upside growth as rebounds occur.
Bank of America’s surprise announcement to acquire Merrill Lynch, at what some are saying is a 70% premium to Merrill’s market value is huge. It stunned the market and it may be days before clear heads prevail and begin to realize that Bank of America made a thundering statement regarding how oversold and undervalued the financial sector may be at this time.
AIG, another of the financial sectors biggest players, and one of the nation’s largest insurers, survived Hank Greenberg’s controversial leadership through the late 1990’s and early 2000’s, but is once again center stage as the markets look for answers to questions regarding liquidity, capitalization and leadership. Hurricane Ike may well have helped batter AIG with as much force as it clobbered the
Market reactions to unexpected events are rarely positive. Likewise, Lehman Brother’s inability to attract a suitable buyer received an icy reception and now, that venerable Wall Street name looks as though it may go the of EF Hutton in the late 1980’s. When Hutton wasn’t able to attract a suitable buyer other Wall Street firms began to pick off various talent from the firm, until there was little left to purchase. This was at a tough time for the financial markets and well established firms were maneuvering to maintain enough liquidity to meet capital reserve requirements. Hutton failed and the financial markets were hit between the eyes with as large a bat as we’d ever seen.
Investors wanted little to do with equities. Many investors reacted and money fled into CD’s, bonds and alternative investments at unprecedented rates. The national media outlets and financial press proclaimed that Wall Street was in for one of the darkest periods in the market’s history, and that average investors ought not to be exposed to the equities markets for some time to come.
That was barely 20 years ago, and the DOW was trading at less than 3,000 – today, even with the recent economic weakness, the DOW closed at almost 11,000, and less than a year ago saw levels in excess of 14,000 points. Is this a difficult time for the markets and the economy? To be sure. And, tomorrow will be another day.
Friday, September 12, 2008
TOO INTERCONNECTED TO FAIL 9/12/2008
Federal bailouts, too big to fail, Bear Sterns, Fannie Mae, Freddie Mac, Lehman Brothers, General Motors, Ford, Chrysler… there’s so much in the financial press and national news regarding all of these that we’ve got to step back and consider what is really happening here and what could be at stake. So today, we’re going to discuss the ‘federal bailout’ and ‘too big to fail’ concepts and try to set some things straight.
The federal government, through the Federal Reserve and the U.S. Treasury, strives to maintain the stability of the US dollar and enough economic growth to fuel positive labor, real estate, and financial markets. Sometimes they get it right, and some times they get it wrong. When Chrysler sought federal guarantees for desperately needed loans in the 1980’s, the government bowed to the pressure, because losing Chrysler as a US employer and automobile manufacturer would have had tremendous rippling effects throughout the entire economy, and it just could not be risked. Chrysler wasn’t deemed ‘too big to fail’, but it was obviously too interconnected to be allowed to fail, and that’s the issue surrounding ‘federal bailouts’ today.
In a free market economy, there is no such thing as being too big to fail, but there is such a thing as being too interconnected with other vital aspects of our economy to be allowed to fail. Bear Sterns, Fannie Mae and Freddie Mac are prime examples of this. Bear Sterns corporate heft, in a global economy that includes more multinational conglomerates – behemoths - than we could even begin to list, wasn’t all that meaningful. However, what Bear Sterns represented to the US and global credit markets at the moment the Federal Reserve and Treasury agreed to back up its assets and finance JP Morgan’s acquisition, was tremendous. So a bailout, of sorts, took place and relative calm ensued.
Relative calm, as compared to what could have happened otherwise. Had the government done nothing the overall cost to the economy would have been horrendous, far outweighing the cost the taxpayers might actually come to bear due to the federal intervention.
Some have decried taxpayer resources being at risk when millions of dollars of market value was realized by Bear Sterns shareholders as JP Morgan acquired the company. Why didn’t those shareholders have to lose? They did. While they may have retained hundreds of millions in share value, they had already lost billions and at the end of the day, JP Morgan purchased a sagging company with questionable assets and will go on to pay hundreds of millions of dollars in corporate taxes each year. Ultimately, it wasn’t a bad trade off. Just like the government securing loans for Chrysler in the 1980’s – it wasn’t a bad trade off for the
In the case of Freddie Mac and Fannie Mae, a similar decision had to be made. What would be the overall cost to the economy if these two primary real estate lending resources simply couldn’t lend more money for residential home purchases? We don’t even want to think about it; we likely couldn’t even comprehend the ultimate answer. So, once again, the government marshaled resources, and this time, took control rather than securing loans or arranging financing. Fannie Mae and Freddie Mac shareholders lost unspeakable value in the weeks and months leading up to this intervention and will only regain that value if these corporations can return to profitable, well capitalized operations in the future. The federal government now has more of a measurable equity stake, and as profitable operations return, it is possible that this whole endeavor will actually net a profit to the
Even if the taxpayers were to end up sinking billions into Fannie Mae and Freddie Mac, it would be worth every cent. Making sure that these organizations have sufficient capital to loan into the housing market was necessary to create a bottom in the real estate and credit markets. In the end, many more billions will likely be saved as people with good credit can once again purchase homes with stable values, and millions of homeowners may be saved from the financial disaster that has beset millions more beforehand. Fannie and Freddie weren’t too big to fail; they were simply too important to every one of us to be allowed to fail, and our government did what governments need to do - maintain a stable currency and protect economic growth.
So now comes Lehman Brothers. Treasury Secretary Paulson, though offering his condolences to shareholders, has not opened up the checkbook. Why? Because even though Lehman is important enough to the financial markets that it oughtn’t to be allowed to disappear, it still has enough capital to not need to borrow at the Federal Reserve’s emergency window, and there are other organizations with an appetite to purchase Lehman from its shareholders. Lehman’s ownership structure may change and its shareholders have already lost all but a pittance of their investments, but Lehman’s financial presence will remain and its connection to the capital and credit markets will most likely be merged with that of another investment bank or money center bank.
Seeing some of the ‘generosity’ offered through the Fed and Treasury, the big three automakers, General Motors, Ford and Chrysler, have thought to line up for some needed additional capital. After all, didn’t they usher in the age of federal bailouts? Certainly, we can’t forget them while distributing federal economic resources. Well, we can forget them. In fact so many of us have done so that our garages, driveways and parking lots are filled with extraordinary cars made by Toyota, Honda, Nissan, Lexus, Infinity, Acura, Mercedes Benz, BMW, Porsche, and too many others to mention. Manufacturers, many of which are owned in no small way by US shareholders, and employ millions of US workers. The big three automakers are not only not ‘too big to fail’, but they aren’t interconnected enough to the
As is the case of the most
Friday, September 5, 2008
JOBLESS RATE INCREASES - STAY THE COURSE 9/5/2008
The August 2008 jobless rate came in this morning at 6.1%, fully .4% higher than consensus expectations. The stock markets correctly called this on Thursday as unemployment claims came in higher than expected and the DOW sold off over 300 points. A jobless number in excess of 6% represents at least two problems for the markets and the economy, but it also represents one meaningful solution.
The problems are easily seen: fewer jobs in the markets equate to lower economic growth and that simply exacerbates the current economic slowdown. If people don’t have income, they can’t spend it at the retail or durable goods levels, and that simply doesn’t help an already sluggish economy.
Additionally, fewer jobs represent reduced economic output in terms of fewer workers producing goods and services.
The solution it offers is less easily seen, but meaningful none-the-less. Inflation, one of the greatest evils an economy can experience, and most often arising from more available dollars chasing a constrained quantity of goods and services, cannot be sustained in the face of rising unemployment and shrinking of incomes. Even though we saw average hourly incomes increase .4% in August – up 3.4% over one year ago – that still equates to a decrease in inflation-adjusted, personal incomes, and that’s the number that counts.
Also troubling is the fact that an unemployment rate of greater than 6% virtually always represents an economy in recession. In five of the last six recessions, however, the recessionary period was at least half over by the time the jobless rate exceeded 6%. Historically, recessions last between ten and seventeen months.
Brian Wesbury, Chief Economist with First Trust Portfolios LP, reports in his September 5, 2008 column titled, August Employment Report, ‘The headlines from today’s jobs report are ugly, but key details show we are not in recession’. Wesbury is a self proclaimed optimist; I tend to share the same attribute, so let’s take an alternative view for a moment. If we’re in a recession, there is some evidence that it began in the 4th Quarter of 2007, with GDP having declined by .7% in that quarter. Eleven months have now passed since the beginning of that quarter, so it would suggest that we’re more than half-way through this recessionary period.
Manufacturing numbers and durable goods orders most often begin to increase in the 2nd half of a recession and ultimately bring the economy out of the recessionary period. U.S. factory orders rose 1.3% in July, with core capital equipment increasing 2.5% and non-durables increasing 1.2%. June’s figures also represented meaningful increases. These increases support that we may be past the halfway mark of a recessionary period.
Given the recent increases in GDP, there is a dichotomy in all of this. The U.S. economy grew at a rate of 1% in the 1st Quarter of 2008 and by 3.3% in the 2nd Quarter. Even if those numbers receive downward adjustments with future revisions, they will almost certainly evidence economic growth for the 1st half of this year. Some of this is a byproduct of 90 billion dollars in federal rebate checks entering the economy, but that only makes up for a fraction of the growth for these two quarters. Increased exports to foreign economies, due to a weaker U.S. dollar, also represent a portion of this growth. But some of the growth is simply ongoing, core growth in our domestic economy, and that would suggest that any recessionary period we have or will face will be minor (compared to other post-WWII recessions) and of shorter than average duration.
The slowdown we’ve faced is due in largest part to the overheated housing market, the credit difficulties resulting from that decline of that market, and the increase in the cost of oil. This has not only eliminated many thousands of jobs in construction and banking, it has also strapped consumers as energy supplies have become more costly, banks have tightened credit standards, and falling real estate values have decreased. Available home equity, that might otherwise have been tapped for retail and durable goods purchases, has evaporated at the same time that the cost of goods and services to consumers has increased. This, then, has put pressure on the retail sector and more jobs have been lost and, just as worrisome, corporate profits have decreased. As in all economic cycles, this will right itself given an appropriate amount of time and is most likely to be measured in terms of months, not years.
Going back to the presumption that we may have entered a recession in 4th Quarter 2007 and that we should emerge from it within the next 6-9 months, it makes sense that the U.S. stock market should begin to gain value over the coming months. The stock market is an excellent indicator of the economy 6-9 months out. It is an amazingly accurate forecaster of the near-term future, while only being a very short-term reactor of current events. Though these might be concerning times for those of us seeing volatile swings in our investment accounts, these are also times that spell opportunity for those who are willing to stay the course and keep their emotions in check.
The problems are easily seen: fewer jobs in the markets equate to lower economic growth and that simply exacerbates the current economic slowdown. If people don’t have income, they can’t spend it at the retail or durable goods levels, and that simply doesn’t help an already sluggish economy.
Additionally, fewer jobs represent reduced economic output in terms of fewer workers producing goods and services.The solution it offers is less easily seen, but meaningful none-the-less. Inflation, one of the greatest evils an economy can experience, and most often arising from more available dollars chasing a constrained quantity of goods and services, cannot be sustained in the face of rising unemployment and shrinking of incomes. Even though we saw average hourly incomes increase .4% in August – up 3.4% over one year ago – that still equates to a decrease in inflation-adjusted, personal incomes, and that’s the number that counts.
Also troubling is the fact that an unemployment rate of greater than 6% virtually always represents an economy in recession. In five of the last six recessions, however, the recessionary period was at least half over by the time the jobless rate exceeded 6%. Historically, recessions last between ten and seventeen months.
Brian Wesbury, Chief Economist with First Trust Portfolios LP, reports in his September 5, 2008 column titled, August Employment Report, ‘The headlines from today’s jobs report are ugly, but key details show we are not in recession’. Wesbury is a self proclaimed optimist; I tend to share the same attribute, so let’s take an alternative view for a moment. If we’re in a recession, there is some evidence that it began in the 4th Quarter of 2007, with GDP having declined by .7% in that quarter. Eleven months have now passed since the beginning of that quarter, so it would suggest that we’re more than half-way through this recessionary period.
Manufacturing numbers and durable goods orders most often begin to increase in the 2nd half of a recession and ultimately bring the economy out of the recessionary period. U.S. factory orders rose 1.3% in July, with core capital equipment increasing 2.5% and non-durables increasing 1.2%. June’s figures also represented meaningful increases. These increases support that we may be past the halfway mark of a recessionary period.
Given the recent increases in GDP, there is a dichotomy in all of this. The U.S. economy grew at a rate of 1% in the 1st Quarter of 2008 and by 3.3% in the 2nd Quarter. Even if those numbers receive downward adjustments with future revisions, they will almost certainly evidence economic growth for the 1st half of this year. Some of this is a byproduct of 90 billion dollars in federal rebate checks entering the economy, but that only makes up for a fraction of the growth for these two quarters. Increased exports to foreign economies, due to a weaker U.S. dollar, also represent a portion of this growth. But some of the growth is simply ongoing, core growth in our domestic economy, and that would suggest that any recessionary period we have or will face will be minor (compared to other post-WWII recessions) and of shorter than average duration.
The slowdown we’ve faced is due in largest part to the overheated housing market, the credit difficulties resulting from that decline of that market, and the increase in the cost of oil. This has not only eliminated many thousands of jobs in construction and banking, it has also strapped consumers as energy supplies have become more costly, banks have tightened credit standards, and falling real estate values have decreased. Available home equity, that might otherwise have been tapped for retail and durable goods purchases, has evaporated at the same time that the cost of goods and services to consumers has increased. This, then, has put pressure on the retail sector and more jobs have been lost and, just as worrisome, corporate profits have decreased. As in all economic cycles, this will right itself given an appropriate amount of time and is most likely to be measured in terms of months, not years.
Going back to the presumption that we may have entered a recession in 4th Quarter 2007 and that we should emerge from it within the next 6-9 months, it makes sense that the U.S. stock market should begin to gain value over the coming months. The stock market is an excellent indicator of the economy 6-9 months out. It is an amazingly accurate forecaster of the near-term future, while only being a very short-term reactor of current events. Though these might be concerning times for those of us seeing volatile swings in our investment accounts, these are also times that spell opportunity for those who are willing to stay the course and keep their emotions in check.
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