People are getting ornery about the financial rescue plan, known as “TARP”. Taxpayers of all stripes are voicing frustration and anger about the situation, which is understandable. For those folks, as well as those who want to learn more about the situation, I urge you to listen to Charlie Rose’s interview with Warren Buffett (http://www.charlierose.com/shows/2008/10/01/1/an-exclusive-conversation-with-warren-buffett).
Over the course of sixty minutes, the Oracle of Omaha did what Henry Paulson, Ben Bernanke, President Bush and countless members of Congress could not: he explained how we got to this place, why government intervention is necessary and his view about where the US economy is going.
[The interview was recorded before the Senate vote, but Buffett assumed that it would pass and that the House would follow, when it votes later today. He was right--the Senate handily passed a TARP but did so by adding some provisions, some of which are good, other that were just pork. The interesting additions include an increase from 100K to 250K for FDIC limits, a suggested change to mark-to–market accounting rules and a $150.5 billion package of unrelated personal and corporate tax cuts.]
Back to Warren…one of the best analogies that he provided was comparing the US economy to a fine-tuned athlete that is in cardiac arrest--something must done quickly to revive the patient so that he can return to his previous form. Obviously as the athlete is lying on the ground, there is not time for discussing why he is in cardiac arrest--maybe he worked out too much, maybe he should have rested between workouts. Who cares? He’s lying on the floor and we need to get him out of harm’s way! No, the first priority is to treat him so that he survives this event. Note that Mr. Buffett did not say that the patient on the floor is Wall Street, it is the US economy—and therefore, we all have something to lose if the patient is left to wither.
In essence, while the patient is on the floor and his condition is unknown, financial institutions do not want to do anything--they don't want to lend to each other (who knows which bank will fail next?), they don't want to lend money to consumers (sure, you seemed like a good risk a few years ago, but today, who knows?) and they don't want to lend to businesses (your biz could be next if the bottom falls out!) And while the patient is in trouble, those who are making loans are demanding higher interest rates and raising the hurdles for qualifying.
And here is the ripple effect that nobody wants to talk about: while the patient is not functioning, credit dries up, municipalities can't finance projects (poof--there goes your after-school program and new roads), businesses stop earning as much money, they lay off more people, who then can't make mortgage payments and we start on a terrible downward spiral. That is what we are trying to avoid with the rescue plan.
For those who want the patient to suffer to curb his behavior, that does not seem reasonable right now. The Wall Street fat cat has suffered but he will not die. Maybe his net worth has gone from $25 million to $5 million, but he still has $5 million—he will be just fine. You on the other hand, could lose your job, watch your home equity erode, lose basic services and if you are lucky enough to have a retirement account, you may see value erode.
Let’s save the patient and then rehabilitate him. After all, as Mr. Buffett notes, the Americans are likely to be better off in ten years—but only if we don’t allow the patient to die on the floor without any assistance.
Friday, October 3, 2008
Thursday, October 2, 2008
Crash into You
It’s been amazing to read the number of headlines that liken our current problems with the Crash of 1929 and the subsequent Great Depression. It is quite telling of the level of fear and anxiety that plagues the market as we enter the fourth quarter. But how apt a comparison is our situation today to the Crash/Great Depression? I had to revisit the history books to find out.
The first interesting note was that crash of 1929 in and of itself did not create the Great Depression. In fact, as the new decade started, the US economy had not yet retrenched in a major way. But at the end of 1930, a series of bank panics started to spook other banks, as well as consumers. Hundreds of banks eventually closed and by 1932, consumption and investment collapsed, stocks had fallen more than 80% from the top and economic activity cratered by a staggering 30%.
This brings us to the present, where stocks have fallen by over 20% from the October 2007 top, people are starting to worry about bank failures and all of the sudden, the current credit and housing crises are compared to the Crash and the Great Depression. Let’s start by understanding how things are different today.
First of all, one commentator recently noted that the best reason that we should not believe that “the big one” is coming is because we are actually talking about it. Depressions do not often occur when the mainstream media and ordinary people are openly voicing concern about them, as is the case today. Rather these seismic events usually occur when the opposite it true--when no one is worried about them.
Additionally, today we do have the benefit of history upon which to draw. Many economists, including our very own Federal Reserve Chairman Ben Bernanke, have examined the Great Depression and its roots causes. Remember that the Fed was not established until 1913 and after the crash of 1929 the central bank was not as strong as it is today--years passed before the government could flood the economy with cash.
In the 1980’s, Bernanke wrote extensively about the Great Depression and believed that one of the root causes was the fact that as banks closed, loan officers vanished and left nobody to vouch for the borrowers credit quality. Bernanke and many others have studied the causes and solutions to that period and as a result, when the Fed finally woke up and realized what was going on, it acted by implementing creative and unusual liquidity measures.
One big difference between then and now is the existence of the Federal Deposit Insurance Corporation (FDIC). The program was established in 1933 to guarantee the safety of checking and savings deposits. Today, with that insurance in place, the average investor is assured that his or her deposits up to certain amounts are safe. In fact, there is now consensus forming around increasing FDIC insurance from 100K to $250K.
Finally, our economy and the global economy is so different from the world of 1929-1934. The country is far richer today, which means that far fewer people are living on the edge of despair. This does not mean that we do not have poor people, but that the numbers have been reduced. In fact, most households may not have the same net worth that they had two years ago, but the vast majority are in decent shape.
None of the aforementioned historical reference means that all is honky-dory in the US economy. We have serious problems that need addressing and perhaps that is the best lesson of the awful Great Depression—doing nothing would be repeating the past and potentially dooming us for some pretty nasty times ahead. The doing something is not about “bailing out Wall Street,” rather it is about trying to avert a long-term and damaging consequences.
The first interesting note was that crash of 1929 in and of itself did not create the Great Depression. In fact, as the new decade started, the US economy had not yet retrenched in a major way. But at the end of 1930, a series of bank panics started to spook other banks, as well as consumers. Hundreds of banks eventually closed and by 1932, consumption and investment collapsed, stocks had fallen more than 80% from the top and economic activity cratered by a staggering 30%.
This brings us to the present, where stocks have fallen by over 20% from the October 2007 top, people are starting to worry about bank failures and all of the sudden, the current credit and housing crises are compared to the Crash and the Great Depression. Let’s start by understanding how things are different today.
First of all, one commentator recently noted that the best reason that we should not believe that “the big one” is coming is because we are actually talking about it. Depressions do not often occur when the mainstream media and ordinary people are openly voicing concern about them, as is the case today. Rather these seismic events usually occur when the opposite it true--when no one is worried about them.
Additionally, today we do have the benefit of history upon which to draw. Many economists, including our very own Federal Reserve Chairman Ben Bernanke, have examined the Great Depression and its roots causes. Remember that the Fed was not established until 1913 and after the crash of 1929 the central bank was not as strong as it is today--years passed before the government could flood the economy with cash.
In the 1980’s, Bernanke wrote extensively about the Great Depression and believed that one of the root causes was the fact that as banks closed, loan officers vanished and left nobody to vouch for the borrowers credit quality. Bernanke and many others have studied the causes and solutions to that period and as a result, when the Fed finally woke up and realized what was going on, it acted by implementing creative and unusual liquidity measures.
One big difference between then and now is the existence of the Federal Deposit Insurance Corporation (FDIC). The program was established in 1933 to guarantee the safety of checking and savings deposits. Today, with that insurance in place, the average investor is assured that his or her deposits up to certain amounts are safe. In fact, there is now consensus forming around increasing FDIC insurance from 100K to $250K.
Finally, our economy and the global economy is so different from the world of 1929-1934. The country is far richer today, which means that far fewer people are living on the edge of despair. This does not mean that we do not have poor people, but that the numbers have been reduced. In fact, most households may not have the same net worth that they had two years ago, but the vast majority are in decent shape.
None of the aforementioned historical reference means that all is honky-dory in the US economy. We have serious problems that need addressing and perhaps that is the best lesson of the awful Great Depression—doing nothing would be repeating the past and potentially dooming us for some pretty nasty times ahead. The doing something is not about “bailing out Wall Street,” rather it is about trying to avert a long-term and damaging consequences.
Wednesday, October 1, 2008
Kiss that Sucker Goodbye
Well the third quarter is done—good riddance! It has been a wildly volatile roller coaster ride these past 90 days. But it was September that really did the bulk of the damage—I guess we shouldn’t be surprised -- 4 of the worst 25 percentage-loss days for the S&P 500 over the last 50 years occurred during September 2008, including Monday’s drop of 8.6%. (source: BTN Research).
Thankfully we ended on a more positive note yesterday, with all of the major stock indexes recovering ground lost on Monday, but still, stock market performance for the three months of July, August and September was rough. The S&P 500 rose 5.3% yesterday to 1164.74, but still finished the quarter with a 9% loss. The Dow got off to a strong start and saw its gains accelerate as the closing bell approached, marking the end of 2008's third period. The 30-stocks index soared 485.21 points, or 4.7%, to close at 10850.66, off 4.4% for the quarter. The Nasdaq Composite Index was up 5% to end at 2082.33, off 9.2% for the quarter.
If those losses did not catch your attention, perhaps the news cycle did. Let’s review what has occurred in the 30 days of September:
1) On September 7th, the US took over the reins at Fannie Mae and Freddie Mac, agreeing to inject up to $100 billion into each company.
2) On September 14th, 158-year-old Lehman Brothers filed for bankruptcy.
3) On September 15th, Bank of America bought Merrill Lynch in a $50 billion emergency acquisition.
4) On September 17th, the US Treasury extended an $85 billion loan to AIG
5) On September 18th, markets were in freefall before news leaked out of potential $700 billion government package to purchase distressed mortgage-backed assets from various financial institutions.
6) On September 25th, Washington Mutual was seized by federal regulators and sold to JP Morgan Chase & Co.
7) On September 29th, Citigroup purchased Wachovia
8) On September 29th, the House of Representatives voted against “TARP” and sent global stock indexes down by 4-9%
Ladies and Gentleman, I do not know about you, but I sure am ready to kiss this month, not to mention the whole quarter, goodbye and to turn over the calendar page to (gasp) October. Yes, I know October can be scary and you may even be tempted to pull the trigger and make a rash decision to sell everything in your portfolio and go to cash, but this very act may be among the most dangerous decisions you could make. Clearly these are trying times that test every investor from Main Street to Wall Street, but remember if you bailed out in at the bottom of the last stock market bottom (October 2002), you may have missed the bounce from 2003-2007, when stocks returned 12.8% annually. It’s hard to stomach, but this is part of the process.
Thankfully we ended on a more positive note yesterday, with all of the major stock indexes recovering ground lost on Monday, but still, stock market performance for the three months of July, August and September was rough. The S&P 500 rose 5.3% yesterday to 1164.74, but still finished the quarter with a 9% loss. The Dow got off to a strong start and saw its gains accelerate as the closing bell approached, marking the end of 2008's third period. The 30-stocks index soared 485.21 points, or 4.7%, to close at 10850.66, off 4.4% for the quarter. The Nasdaq Composite Index was up 5% to end at 2082.33, off 9.2% for the quarter.
If those losses did not catch your attention, perhaps the news cycle did. Let’s review what has occurred in the 30 days of September:
1) On September 7th, the US took over the reins at Fannie Mae and Freddie Mac, agreeing to inject up to $100 billion into each company.
2) On September 14th, 158-year-old Lehman Brothers filed for bankruptcy.
3) On September 15th, Bank of America bought Merrill Lynch in a $50 billion emergency acquisition.
4) On September 17th, the US Treasury extended an $85 billion loan to AIG
5) On September 18th, markets were in freefall before news leaked out of potential $700 billion government package to purchase distressed mortgage-backed assets from various financial institutions.
6) On September 25th, Washington Mutual was seized by federal regulators and sold to JP Morgan Chase & Co.
7) On September 29th, Citigroup purchased Wachovia
8) On September 29th, the House of Representatives voted against “TARP” and sent global stock indexes down by 4-9%
Ladies and Gentleman, I do not know about you, but I sure am ready to kiss this month, not to mention the whole quarter, goodbye and to turn over the calendar page to (gasp) October. Yes, I know October can be scary and you may even be tempted to pull the trigger and make a rash decision to sell everything in your portfolio and go to cash, but this very act may be among the most dangerous decisions you could make. Clearly these are trying times that test every investor from Main Street to Wall Street, but remember if you bailed out in at the bottom of the last stock market bottom (October 2002), you may have missed the bounce from 2003-2007, when stocks returned 12.8% annually. It’s hard to stomach, but this is part of the process.
Tuesday, September 30, 2008
“Hope for New Year 5769”
Yesterday at sunset, Jews around the world began to celebrate Rosh Hashanah for Jewish Year 5769. I like the tradition of both reflecting on the past and looking forward to the future. Considering what has just occurred yesterday, over the past two weeks and the entire year, there is certainly a lot of material for both activities.
I want to stay positive for the New Year, so here is my number one hope: that Congressmen/women and their constituents review their investment accounts through yesterday and then rethink their positions on the “TARP” proposal from the Treasury. Yesterday, the House of Representatives delivered a surprising defeat to the plan, which was designed to rescue the nation's troubled financial system. The 228-205 vote spoke to the mistrust and general discomfort among lawmakers in both parties with what would be an unprecedented intervention in the private sector.
The Dow Jones Industrial Average plummeted 777.68 points, its biggest one-day drop in history, down 7% at 10365.45. The broader based S&P 500 plummeted 8.6%, or 103.98 points, to 1109.03 and the technology-heavy Nasdaq Composite Index fell 9.1%, or 199.61 points, to 1983.73. Spooked investors flocked to U.S. government debt: the yield on the three-month Treasury bill, considered the safest short-term investment, fell to about 0.14% from 0.87% late Friday; the price of the benchmark 10-year note jumped 1-29/32, pushing the yield down to 3.624%, compared to 3.827% late Friday.
Oil futures plunged $10.52, or 9.8%, to $96.37 a barrel in New York as fears about slowing demand due to global economic weakness gripped the commodity markets. In a flight to quality, gold futures jumped after the bailout plan was rejected -- after settling $5.90 higher at $894.40, December gold futures surged in after-hours electronic trading -- at 3:34 p.m. EDT, the contract was up $38.90, or more than 4.3%, at $927.40. For those who wanted some suffering for the evil Wall Street-ers (see yesterday’s article), here is the silver lining: about $1trillion in market capitalization was lost in yesterday’s stock market drubbing—just vaporized in a day. That kind of action makes you pine for a mere $700 billion being used to actually buy something, doesn’t it?
The most disheartening part of the bill’s demise was not the stock market plunge—that was to be expected when the deal was scrapped. No, the worst part was the absurd performance of the nation’s politicians amid the upcoming elections. It was disheartening to see how many lawmakers could not put the nation's financial and economic safety before political gamesmanship. Even those who voted for the bill could not help but turn the whole thing into a political fiasco. It was ultimately a bipartisan embarrassment.
Well as the sun is about to set and I am off to temple, I’m going to pray for world peace, for troops who fight on our behalf, an end to the genocide in Darfur and that our lawmakers come to their senses. Perhaps with a little perspective, they may come to the table and help restore our confidence in their abilities to lead.
I want to stay positive for the New Year, so here is my number one hope: that Congressmen/women and their constituents review their investment accounts through yesterday and then rethink their positions on the “TARP” proposal from the Treasury. Yesterday, the House of Representatives delivered a surprising defeat to the plan, which was designed to rescue the nation's troubled financial system. The 228-205 vote spoke to the mistrust and general discomfort among lawmakers in both parties with what would be an unprecedented intervention in the private sector.
The Dow Jones Industrial Average plummeted 777.68 points, its biggest one-day drop in history, down 7% at 10365.45. The broader based S&P 500 plummeted 8.6%, or 103.98 points, to 1109.03 and the technology-heavy Nasdaq Composite Index fell 9.1%, or 199.61 points, to 1983.73. Spooked investors flocked to U.S. government debt: the yield on the three-month Treasury bill, considered the safest short-term investment, fell to about 0.14% from 0.87% late Friday; the price of the benchmark 10-year note jumped 1-29/32, pushing the yield down to 3.624%, compared to 3.827% late Friday.
Oil futures plunged $10.52, or 9.8%, to $96.37 a barrel in New York as fears about slowing demand due to global economic weakness gripped the commodity markets. In a flight to quality, gold futures jumped after the bailout plan was rejected -- after settling $5.90 higher at $894.40, December gold futures surged in after-hours electronic trading -- at 3:34 p.m. EDT, the contract was up $38.90, or more than 4.3%, at $927.40. For those who wanted some suffering for the evil Wall Street-ers (see yesterday’s article), here is the silver lining: about $1trillion in market capitalization was lost in yesterday’s stock market drubbing—just vaporized in a day. That kind of action makes you pine for a mere $700 billion being used to actually buy something, doesn’t it?
The most disheartening part of the bill’s demise was not the stock market plunge—that was to be expected when the deal was scrapped. No, the worst part was the absurd performance of the nation’s politicians amid the upcoming elections. It was disheartening to see how many lawmakers could not put the nation's financial and economic safety before political gamesmanship. Even those who voted for the bill could not help but turn the whole thing into a political fiasco. It was ultimately a bipartisan embarrassment.
Well as the sun is about to set and I am off to temple, I’m going to pray for world peace, for troops who fight on our behalf, an end to the genocide in Darfur and that our lawmakers come to their senses. Perhaps with a little perspective, they may come to the table and help restore our confidence in their abilities to lead.
Monday, September 29, 2008
“Let them suffer”
After watching the Sunday news programs, I learned that most Americans despise the Treasury’s proposed $700 billion plan to address the illiquid mortgage related assets that are plaguing the financial system. One pundit noted that the calls are about 300 to 1 in opposition to the plan. Most of these folks are not looking for more nuance or accountability with the plan—they just want “greedy Wall Street to suffer.”
I understand the frustration---how could it be that traders, speculators, hedge funds, lawmakers and government regulators brought the US economy to the brink? The answer is as old as the Dutch tulip mania: when asset values rise, most participants across the board fall prey to greed and excesses of the cycle. Maybe the only people against the plan are those who did nothing wrong and now have to pay the price for the bad behavior of others. To those folks, this plan simply reeks and feels patently unfair.
But those same people need to ask themselves whether they are willing to live with the alternative, where the government refuses to act and makes the financial geniuses suffer their massive losses – the poor dears might have to sell those Porsches! That notion may provide some sense of satisfaction or schadenfreude to the good guys, but it also significantly raises the risk that a downward spiral could infect the broader economy.
As Joe Nocera noted in the New York Times on Sep 27, 2008, ideological opposition risks seeing the economy “go down the tubes…Henry Paulson is not what you’d call a socialist-nor is Ben Bernanke or President Bush…no deal, no credit markets…And if that happens, the consequences will be far more pressing than the failure of a Morgan Stanley or Goldman Sachs. You won’t be able to get a mortgage. Credit card rates will skyrocket. Businesses will be unable to expand and grow. Unemployment will rise. Every part of our economy depends on the credit markets…if we do not claw our way out of this crisis, the country will face a severe recession.”
For those who cling to a notion of revenge or “damn the consequences-I'm not going to allow money to go to those who screwed up,” ask yourself how you think capitalism might fare if the current panic leads to a massive downward spiral in asset prices and a further contraction in housing. If you choose to allow an economic experiment unwind in such a way, then be prepared for a multi-year recession, ala Japan in the nineties. If you vote for no action and choose to risk a life-altering hurricane instead of a bad storm, then you should be prepared for a 201(k) instead of a 401(k).
Life is not as simple as “Let them suffer,” because the suffering of others could cause devastating damage to all of us, potentially risking the entire economic and financial structure of the United States. One thing is for sure: there will be plenty of time to address the issue of who is to blame for the mess and how we can better regulate financial institutions in the future. For now, the government must deal with a US economy that is under enormous pressure and do its best to prevent it from infecting the broader economy.
I understand the frustration---how could it be that traders, speculators, hedge funds, lawmakers and government regulators brought the US economy to the brink? The answer is as old as the Dutch tulip mania: when asset values rise, most participants across the board fall prey to greed and excesses of the cycle. Maybe the only people against the plan are those who did nothing wrong and now have to pay the price for the bad behavior of others. To those folks, this plan simply reeks and feels patently unfair.
But those same people need to ask themselves whether they are willing to live with the alternative, where the government refuses to act and makes the financial geniuses suffer their massive losses – the poor dears might have to sell those Porsches! That notion may provide some sense of satisfaction or schadenfreude to the good guys, but it also significantly raises the risk that a downward spiral could infect the broader economy.
As Joe Nocera noted in the New York Times on Sep 27, 2008, ideological opposition risks seeing the economy “go down the tubes…Henry Paulson is not what you’d call a socialist-nor is Ben Bernanke or President Bush…no deal, no credit markets…And if that happens, the consequences will be far more pressing than the failure of a Morgan Stanley or Goldman Sachs. You won’t be able to get a mortgage. Credit card rates will skyrocket. Businesses will be unable to expand and grow. Unemployment will rise. Every part of our economy depends on the credit markets…if we do not claw our way out of this crisis, the country will face a severe recession.”
For those who cling to a notion of revenge or “damn the consequences-I'm not going to allow money to go to those who screwed up,” ask yourself how you think capitalism might fare if the current panic leads to a massive downward spiral in asset prices and a further contraction in housing. If you choose to allow an economic experiment unwind in such a way, then be prepared for a multi-year recession, ala Japan in the nineties. If you vote for no action and choose to risk a life-altering hurricane instead of a bad storm, then you should be prepared for a 201(k) instead of a 401(k).
Life is not as simple as “Let them suffer,” because the suffering of others could cause devastating damage to all of us, potentially risking the entire economic and financial structure of the United States. One thing is for sure: there will be plenty of time to address the issue of who is to blame for the mess and how we can better regulate financial institutions in the future. For now, the government must deal with a US economy that is under enormous pressure and do its best to prevent it from infecting the broader economy.
Subscribe to:
Posts (Atom)
