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December 5, 2008
In one of the few benefits of increasing age, the older you get, the more times you’ve blown off your eyebrows in the lab, and the less shocked you are when things that “can’t happen”... happen.
The markets today, a bunch of kids under 50, are jaw-dropped. So whacked up-side the head they can’t even find the big river in Egypt. They’ve spent their whole working lives back-testing risk models, back to the Civil War (between Athens and Sparta), absolutely certain of what can and cannot happen, leveraged to the eyeballs based on those boundaries. Addled, life-long conceptual frameworks shattered, these kids are frozen, and with them the supply of credit of all kinds. Right beside are commentators, academics, and policy makers clutching familiar pillows, eyes squeezed shut.
Harvard’s miracle investment returns on its endowment... they’ve lost 22% in 90 days, much of what’s left too illiquid to sell. Couldn’t happen -- not to smart guys. The rest of us... Lose 10% on a portfolio of AAA corporate bonds and munis? With no defaults, just market panic? Impossible. Roll over junk bond debt at 20%? Never happen. Fed goes to 1%, T-bills to 0.01%, and all other rates rise?. No way.
You want me to trade, buy, lever, borrow, lend... in THIS?
Please pause to take heart: there are many policy solutions available. It’s not clear which ones or combinations are best, but they will be found. We have only two temporary problems: the last 46 days of this inept administration; and without leadership, a fragmented and equally inept Congress. The economic news this week was so bad that we may get some action shortly on both fronts.
Herewith the list of things that will not work.
1. The 4.50% Mortgage Fairy. Hopeful clients understood quickly that they had been fooled, either by the housing industry trying pressure-by-leak, or by yet another Treasury pratfall. We may get to 4.50% sometime next year, but several trillion dollars worth of refinances lie between then and now. Progressive decline, as ’01-’03, is most probable, even with the Fed buying. Could the Treasury “buy down” rates for buyers? Sure: in today’s market, four points, $40 billion per $1 trillion in loans, but six years to get the full benefit of cash cost versus payment reduction. Silly -- and the reason most people don’t pay points to get a lower rate. Neither should the Treasury.
2. The Foreclosure Fairy. The blown housing bubble was central to economic decline last year and the first half of this. However, as home prices slip in non-bubble zones, and prime mortgages go into default, it is painfully clear that housing trouble is now effect, not cause. Every sensible foreclosure mitigation effort should be pursued, but will have little effect on an economy losing a half-million jobs in a month.
3. Unspeakable Boobs. The no-bailout crowd, joined by Eek!-Inflation! wrong-siders. Senator Richard Selby, (R.AL), puzzled but firm 1930’s re-enactor. CNBC’s Rick Santelli and Larry Kudlow, the last ride of the Mister-Marketeers. Then, Frankn’Doddstein.
4. Additional routine efforts by central banks, cutting rates and hosing cash. Global CB cuts are approaching zero percent, but are neither reducing the cost of credit nor increasing availability. This situation, full-on since September, is called a “liquidity trap,” in which cash floods into the banking system but nothing comes out.
5. “Stimulus” by Federal spending tends to be too late, and tends to fail for two other reasons. Until consumers gain some faith in the future, they will save the windfall, as they did rebate checks. Second, without credit to sustain commerce and jobs Federal stimulus is like transfusing a patient with an open artery.
6. The “quantitative easing” by the Fed that began last week -- outright purchase of debt securities with invented money -- will help to drive down rates, and fund the economy to some degree, but it is no substitute for a functioning banking system.
Therefore, (how hard is this?), get the infernal banking system going again. Every other nation on earth is doing so, and we’ll get to it... maybe inside 46 days.
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