President Bush stated last week
that the US wouldn’t bail out speculators in the sub-prime
lending crisis. He also acknowledged that there were excesses
in the lending market, and that homeowners with good credit
histories who are behind on their payments could refinance
into federally insured loans. Fed head Bernanke then followed
by stating that the Fed “will act as needed” to
limit the impact of financial distress on the economy, but
it won’t rescue lenders or investors. Let’s hope
they both stick to their convictions. Every time the government
steps in to rescue speculators in one financial crisis (savings
and loan crisis or CMO crisis to name just two) it leads to
a far worse crisis down the road as speculators feel they
can take on more risk as they will always be bailed out by
the government (read taxpayers). Printing money is not the
answer either as that will lead to inflation (more money chasing
fewer goods is inflationary) and possibly to the next problem
– a currency crisis as each nation prints more and more
fiat currency.
There is more than adequate money on the planet; it’s
just there is currently a lack of confidence to lend this
money. Michael Milken once said: “Liquidity is an illusion.
It’s always there when you don’t need it and rarely
there when you do.”
The bad news is that there may be another shoe or two to
drop, and the real bad news is that Congress is back. What
we don’t need right now is government interference.
The free markets will work this out just fine thank you. The
Bush/Bernanke strategy of a helping hand not a handout is
what the government should be doing.
So, will the Fed cut interest rates like many would like
to see? Only if the Fed senses that the housing market is
likely to drag down the entire economy. We think that is highly
unlikely. Interest rates are already at historic lows. Also,
remember that Japan held interest rates near zero for a decade
and still couldn’t shake their recession. It was only
when they increased their money supply and Japanese investors
recognized the global expansion occurring did confidence return
and start another boom in their economy. Money is not the
problem here nor are interest rates. Gross Domestic Product
for the second quarter was recently revised up to a 4% annual
rate. We don’t expect that rate to continue, but growth
should remain solid at least into next year. Earnings reports
will be hitting the papers starting mid-September and should
make for good reading. If that doesn’t jump start investing
in stocks then the Fed could cut interest rates by a quarter
of a point to 5% which would boost investor confidence.
What could go wrong? Well, with Congress in session we could
see reams of legislation and regulation which would hamper
economic recovery. Worse still would be further calls to repeal
Bush’s tax cuts. The rest of the planet is in a race
to lower taxes as they see their neighbors’ economies
boom after a tax cut. Even former communist countries are
cutting taxes and are considering flat income tax rates. Tax
cuts make more money available for investing, which creates
more jobs.
Most trading in stocks and bonds right now is on the margin.
That is, speculators, traders and bargain hunters are driving
the daily volatility in prices. Common sense does not apply
at the margin. Changes in expectations tend to be magnified
at the margin and emotions are stronger than reason. Bernard
Baruch once observed: “What registers in the stock market
fluctuations are not the events themselves but the human reaction
to these events, how millions of individual men and women
feel these happenings may affect the future.” Moreover,
there is a rhythm to the marketplace, and trends tend to reinforce
themselves. Right now the news as reported by the press is
bad, but at some point prices become impervious to further
decline and the trend reverses. We are seeing signs of that
happening right now. So, it is best at this time to think
about whether conditions are changing for the better relative
to expectations and not whether they are currently good or
bad.
Random thought for September 2007:
The most terrifying words in the English language are: "I'm
from the government, and I'm here to help."
- Ronald Reagan
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