It’s New Year’s Eve – and I am sure many will want to say good-bye to 2008 and look forward to a promising 2009. Certainly – these are unprecedented times, what is even more difficult is trying to fore see the future. Traditionally – when the market hits a bump or the economy slows it is rather easy to point a finger at a certain sector that is creating the problem and how or what other sectors might absorb those losses. However, the credit crisis seems to affect every sector – and it is not just domestic – but also international.
Many blame capitalism or the free markets or the lack of regulations. It is easier to point at something to blame, than really trying to understand the problem or even accept liability for being part of the problem. I have spent many hours thinking about how we got here and where we are going – my conclusion is fairly simple and I am sure many of you will not agree with my assessment, but that’s ok. However, I only ask if you disagree and decide to tell me so in an email (which I seem to get more than my fair share) – please explain WHY, instead of just saying I am wrong. It’s easy to complain or tell people they are wrong, but I suggest you hold your tongue unless you want to offer your own solution or idea. I have a saying, “Don’t complain, unless you are willing to offer a solution (regardless of how crazy it sounds.)”
So let me take a stab at it… (from my very humble observation and reasoning).
1. Leverage – we (collectively – business and individuals) have been allowed to take too much leverage. Leverage comes in all forums – credit cards, auto loans, home loans, margin accounts, carry trade, etc. If we look at the balance sheet of a typical bank – they are anywhere between 4:1 to 20:1 leverage (debt). The bank’s loan money for people to buy things, money they might not have – so they too borrow. If we look at the average consumer in this country, they have a more debt on their credit cards vs. savings, in fact savings has gone negative. Who are we to blame for all this? Well – on some levels – we have to take accountability for our own debt (credit cards, home loans, auto loans, etc.) – No one forced us to borrow money, we did for whatever reason (keeping up with the Jones, greed, need, etc.). Sure some people have emailed (and others will) that people needed to borrow to buy food and medical needs. Sure that is true – but nothing to the extent to explain the trillions in consumer debt. No doubt there are families struggling to put food on the table and have gone into debt doing so – but I would wager that percentage is insignificant as to the net consumer debt as a whole. Companies as well (not just banks) continue to do the same – it can be easily seen in corporate bonds and over-night lending. Expanding to fast, booking future sales, etc. Those companies (and the CFOs) again have to take responsibility and accountability – not blame market conditions for their lot in life. They took on massive debt and didn’t plan for a slow down – that is just a failure in risk management. That covers consumers and business, but what about our government? They are the worst of all – as leaders of this country they have lead us down the path through policy and their own practices – increase debt and continue to deficit spend. Sure if you are a Republican or Democrat you are probably able to justify spending based on whatever your platform is – support our troops, need for social services, etc. Any Republican or Democrat can find an excuse to spend money – however neither of them have found a reason to CUT spending, to save, or even TRY and pay off the debt. Pork barrel and ear marks are added right under our nose (with the TARP bailout) and no one – NO ONE cries foul! Even our new President, when pressed on the issue in the debate stated, “It is only 1% of the budget deficit!” – note it was budget DEFICIT – guess what we DON’T HAVE the money to spend on PORK! It’s like a CFO of the company saying – “it’s OK to buy that $10 million private jet because it is only 1% of the corporate debt”, or for that wife to say, “It’s ok – the shoes only cost $200!” – while the family has $50,000 of debt. It’s not ok! When does the debt get paid. I recently sent a paper about the US Dollar and the economy by Morgan Stanley – one of the factors why we should be OK going forward was titled: ““Unlike individuals, large countries like the US need not ever fully pay down their debt.” – are you kidding me. They went on to justify this by saying, “Debt service is considered sustainable as long as the real growth rate of the economy (g) is above the real interest rate (r) paid on the debt, i.e., as long as g > r over time, the public debt should be considered sustainable.” – Need I point out the economy (GDP) grows because 2/3rds of the growth is measured by consumer spending, thus in order for it to grow consumers need to continue to spend at accelerated rates, which means the debt needs to grow. The formula in my book is unsustainable and THAT is what is happening. The leverage (DEBT) is being called in and NO ONE has any money to pay it! It is that simple! The government is printing money to keep companies and the lenders in business – to continue to lend. The government must of read Morgan Stanley’s paper – because they are justifying the system of massive leverage. It’s not capitalism, it’s leveraged debt!
2. Regulation – we don’t necessarily need MORE regulation, we need ENFORCEMENT of existing regulation. As those had started predicting the economic storm coming and we even became well aware of it by mid 2007 – Congress did NOTHING. Barney Frank (head of Finance) – continued to blame people, however he failed to lead. He didn’t want to change anything – because he didn’t know what to change. He sat there and let things unfold. It wasn’t until January 2008 that Barney (along with his supporters) came up with the brilliant idea that Freddie and Fannie could BUY down all the toxic sub-prime paper if he allowed Freddie and Fannie to INCREASE their leverage (which was the exact problem that got us here). They increased it to 60:1 and even more. He was warned that shifting risk from one bank over to Freddie and Fannie doesn’t eliminate the rsik – but he was under the belief like others that Freddie and Fannie were actually BACKED by Congress – they are not – but that assumption became a self fore filling prophecy – they both went under and were taken over. Chris Dodd (head of Banking) was on the same finger pointing streak. As the leader of the Banking committee – he didn’t enforce anything and continue to let things slide. Again – what to do? – How about leading, but leading also means taking sometimes an unpopular decision and pissing off the very companies that helped put a politician in office. Too many politicians (on both sides of the aisle) are afraid to stand up to companies or lobbyist that promise re-elections and money for their community. It wasn’t that we didn’t have regulation – it was regulation was not enforced, not even at other government agencies. FDIC continued to maintain the very bare minimums on their balance sheet – the ratio of capital vs. insured was ridiculous and in the private sector would never be allowed to happen. Again – no enforcement – and too much back scratching. It’s not Bush to blame, and will not be Obama to blame in the future – but it is our Congress (both Republicans and Democrats) that draft legislation, add pork, deal daily with lobbyist, and continue to manage this country. In my opinion we spent too much time hating Bush and loving Obama – thus taking our collective eye off the ball as to our Senate and Congress – which have run amok!
3. Policy – the enforcement or lack of enforcement of our regulations is based on policies. Under both Clinton and Bush (note this is not a Republican or Democrat thing – but rather a big government thing) – the belief that home ownership should be a right for all Americans – became the agenda. Freddie and Fannie – lending standards continued to drop – thus this policy was encouraged by other mortgage companies (who sell them back to Freddie and Fannie). The government didn’t care about what people could afford or what they couldn’t – it wasn’t about affordability it was about making home ownership a RIGHT (regardless of the ability to pay). I constantly heard from others who blamed Greenspan for the housing problem. While I might not like all of Greenspan’s policies – I am certainly not going to blame him for the housing problem. Usually the argument goes like this – Greenspan lowered rates to 1% which spurred the housing boom. I then usually counter with the question – what were mortgage rates before he lowered interest rates from 6 to 1%? They usually don’t know. I decided to do some research – what is interesting to note is that the fixed (traditional) mortgage rates remained between 6-8% from the time he lowered rates from 6 to 1% and guess what when he raised them back up to 6% they stayed the same. The data clearly shows that the target rate and mortgage rates have almost no correlation. I then ask – what about Bernanke he just lowered rates from 6% to 0% - where are mortgages? They (until recently – which they came down to 5%) remained at 6% for more than a year – in fact when he was cutting them they actually went higher. Again – no correlation. Please feel free to disagree with Greenspan’s monetary policy (I have no issue with that) – but to blame him for the housing boom and bust is silly. So what did happen, the lenders realized people could NOT afford traditional mortgages (since the rates didn’t really come down) – we started to see all kinds of fancy mortgage systems, like no money down, interest only, option arms, inverted mortgages, etc. You name it – someone came up with it. People wanted to buy a home and by god - we will find away to sell it to them. It was stupidity and greed on both parts – the lender and the buyer. The government stood right behind it and encouraged the policy – especially via Freddie and Fannie (the two largest holders of these crazy mortgages). Now as the bottom falls out – it is everyone’s fault but their own. It was bad policy, which disregarded traditional methods and regulation became slack. It is important to note that Freddie and Fannie (both Congress mandated and now owned by our government) were also some of the biggest lobbyist in DC. The money they gave to our politicians is massive – our politicians got paid to slack the regulations, lower the lending standards, and encourage stupidity – because everyone was spending and we could point to the GDP and consumer spending that the economy was great - who cared if it was based of deficit spending.
So that’s it – deleveraging, the lack of enforced regulation, and a policy that encouraged the whole thing. We are ALL responsible, accountable, and SHOLD be liable for it. But our government has NOT learned that lesson – they don’t want anyone to fail – so instead they will assume all the debt and risk – simply because they can – because they own the printing presses – and they believe (like the Morgan quote) = “Unlike individuals, large countries like the US need not ever fully pay down their debt.” = so when our taxes hit 40%, 50%, 70% (like during the New Deal Depression era) and/or we see excise taxes or a collapse in the dollar. You can explain to your kids and grandkids why THEY are paying for our screw up.
That is, again in my humble opinion, the nutshell of this fine mess we are in.
What does 2009 bring – the only answer I can give is more volatility and uncertainty. For until I can see the fundamental bottom (without government intervention) – I can’t openly justify getting “naked” long equities. For any long position in the coming days MUST BE HEDGED – at all costs.
Go out tonight – enjoy the New Year.
We have a lot of road bumps ahead and lots of uncertainty. Stay hedged!
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