Good evening !
Let me set the rules of engagement again. I’m not here to make a political statement about the proposed “socialization” of the problem as to what is right or wrong in this situation. It is inappropriate and irresponsible for me to make that statement carte blanche. Off-line I’m more than happy to have this discussion and welcome the various views I know are out there !
However, part of my responsibility is to protect you from the enthusiasm of my industry and the pessimism of the media.
Fast forward to summer of 2007. We’re going to fly at 34,000 feet. The complexity of a global market and the other various investment vehicles that have entered the market in the last 20 years are relevant to stock market performance today. They also are relevant to where the credit markets are but less so. As a result, I will focus less on those activities.
What is a credit market and why do you care ?!
Credit markets come in a variety of shapes and sizes. As a consumer, the ones you are most familiar with are installment loans (automobiles and mortgages) and revolving credit – AKA credit cards. The one in the news is between banks and banks, banks and countries, and countries and countries. That is why the numbers are so large.
Why do you care about the credit market between banks and banks and countries and banks and countries and countries ? Lending is the circulatory system of capitalism and globalization. It allows for growth and expansion of business and countries. Much like your circulatory system, if it gets shut down the extremities suffer. So when banks quit lending to other banks out of fear or charge double digit interest rates and the cost of doing business is too expensive banks stop lending. Take Iceland – an otherwise conservative investment – they are being charged 15% to borrow today.
Individual consumers are the extremities in this case. For instance, in a typical month 83% of automobile loans are approved. Since the beginning of September 63% of automobile loans were approved. Should there be some reduction in lending – probably so ! Twenty percent ? I think that’s an extreme. Small businesses also suffer – they are not able to expand as quickly and as they are one of the largest employers in America this has a direct impact on employment. Another irony to this particular situation is that many times in the face of unemployment the youth of our nation go back to school. However, the pool of lending for Student Loans is DRY.
Why has our circulatory system been put under cryogenics ? I go back to what I said yesterday. When you buy and sell any security there is an assumed underlying value to what you’re buying. As a buyer or seller of a security you should be able to determine what you’re buying. When you buy GE as a stock, you know you’re buying a company that makes light bulbs, they make jet engines, they sell life insurance policies and so on. For the buyers and sellers of CDOs and MBSs they stopped looking at what they were buying and selling and if they could even discern what they were buying and selling. For example: “This one CDO factory--this one office, owns a share of 16 million homes. And each of those homes has lots of other owners--people in other CDO offices around the world--there are lots of them. And, other investors. You start to see what a crazy web of confusing interconnections this whole process is.”
Most lenders are frozen because the value of what they own isn’t clear. Add on top of that the “free-market” isn’t clear on what the value is either. UBS and CitiGroup have their CDOs and MBSs listed for 50-60 cents on the dollar on their balance sheet. Merrill Lynch sold theirs for 22 cents on the dollar in August of 2008. Last summer the hedge funds went to the last resort and sold municipal bonds to raise capital, because the market said there was $0 value to their CDOs and MBSs. Both Goldman Sachs and Morgan Stanley are well capitalized institutions (they have cold hard cash in the bank). While they participated in the CDO and MBS markets their risk parameters were much tighter so their exposure was less. However, because the “free-market” can’t seem to assign a clear value to what they do own they are forced to change their business structure. Herein lies the problem. Firms are not necessarily failing, but they are contracting, they are deleveraging. They are unable to raise capital and are refusing to lend which is squeezing the economy.
Enter in TARP. Mr. Bernanke is a student of the Depression and lived through the 70’s. I think the biggest lesson he took away from all of his academics is that inaction is the worst thing to do. 1933 saw the first large infusions of federal cash into institutions after the crash in 1929. An action Bernanke has argued was “the only major New Deal program which successfully promoted economic recovery.” I believe that both Bernanke and Paulson have the best interest of the United State of America at heart. As Warren Buffet said today this is an effort to save the US Economy not Wall Street. And in saving the US Economy we once again show the world that capitalism and democracy can succeed. Keeping global faith in the US Economy is to the benefit of us all. (I can’t help that aside – I am proud to be an American.)
I do not believe we are entering into a Great Depression. I believe we’re stuck for a while like a rocking chair…. Things are moving back and forth but we’re not really going anywhere.
We’ve flown at 34,000 feet today. If you have any additional questions, you know where I am.
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