The Everyman Economist

In case the Everyman hasn’t noticed, medium term and long term interest rates have been skyrocketing for the last few weeks. Ever since the day the Fed announced that they would enter the market to buy securities and rates dipped briefly, they have reversed course. The rate on 10 year US government securities is nearly 4%, which is up from 2.25% earlier in the year and even 5 year securities which were as low as 1.38% earlier in the year, have now climbed to almost 3%. These are massive moves, especially without any real changes in the economy, so why has it happened? And will the impact on mortgage rates, which have also risen by about 1%, hurt an economic recovery?

First, a little background information. We’ve probably seen the worst of the downturn in the economy, so it’s no surprise that most markets are in the process of consolidating their huge declines. Stocks are up, oil is up, commodities are up and the dollar is down. This is all part of the normal process that markets should go through after the recent global financial meltdown. But make no mistake about it, many markets are now in the process of believing their own baloney. After the Dow bottomed at about 6500 and now has climbed to 8500, there are lofty predictions of a new bull market. The same is true of oil, metals, and many other markets. Unfortunately, the big picture scenario does not support this thinking. The economy is just too far from health and is very susceptible to aftershocks from every direction. Whether it’s the auto industry, consumer debt, private and commercial real estate or interest rates, the economy needs a lot of good things to fall into place and they are just not happening yet. The markets may wish it to be, but wishing and hoping does not make for sound investing.

And that brings us to interest rates. The securities markets are about to be overrun by new supply. All of the government spending that we’ve seen over the last several months will get paid for by issuing securities. With a deficit the size of the Grand Canyon, that means there are a lot of securities in the pipeline. The more securities, the more upward pressure on interest rates, as they seek a price level where the supply can be absorbed by investors, traders and foreign governments. You can throw in predictions of runaway inflation and a collapsing dollar, and interest rates have a steady stream of bad news to deal with. In all likelihood, rates will top out for the short term near their current levels. Any more climbing and whatever plans the Obama administration has for an economic victory celebration will have to be put on hold. So the environment will take care of itself and rates should settle down soon. They will not likely fall too far, however, and they will continue to be plagued by supply and demand issues, but the economy will be the big determining factor. Choke off a recovery and we will see lower rates again and quickly. The recovery is not yet guaranteed and even if it was, it would be feeble at best, so don’t expect rates to soar much more.    

Just when the Everyman thought that the financial system had learned its lesson, here we go again. The traders are at their old games and the markets are acting like we’re back in the chips. We’ve just come through the worst scenario since the Great Depression and nobody can seriously believe that we’re off to the races, or can they? Well apparently the pundits, the pros and the posers can. In their views, we’re either in a raging bear market or a raging bull market, and nothing in between. Stocks can go from 14,000 to 6,500 and back to 14,000 again…oil can go from $147 to $33 and back to $147 again…and so on and so on and so on. Of course when you can leverage yourself 10, 20, 30 times or more, you can force things your way for a time and that’s where we are once again. The same people that did it to us before are at it again, but this time we have to put a stop to it. The global economy isn’t suddenly growing by leaps and bounds, yet oil is nearly double in price in a few short weeks. If we don’t regulate these guys soon, we’ll be back to $4 a gallon, but this time we won’t have the jobs and income to pay for it. Enough is enough. It’s going to take a number of years to get through these dire times and we don’t need the same old overzealous risk mongers running loose in the markets. It’s time to grab them by their necks and slow them down before they take us all down with them. Where is the regulation we were promised and when will it begin? It better be soon or we’ll have an even steeper price to pay than we’ve paid already. Call your Congressperson, your Senator and anyone else who will listen and demand the regulation the markets need NOW!   

Back in the 1940s, the Everyman could buy a house in the USA for $5,000 to $10,000. Even at those prices, however, there were naysayers who suggested that a house was a bad investment. In 1947, Time magazine wrote “the prices of houses seem to have reached a plateau, and there is reasonable expectancy that prices will decline.” In 1948, House Beautiful magazine further opined that ”the days when you couldn’t lose on a house purchase are no longer with us.” As if those thoughts weren’t enough, the view of Science Digest magazine in 1948 was that “houses cost too much for the mass market…..with the average price around $8,000, it is out of the reach for two-thirds of all buyers.”

So much for the naysayers of the 1940s. But the doom and gloomers continued to shout from their rooftops during the 50s, 60s, 70s, 80s and 90s, consistently warning the Everyman that the value of their homes would collapse.

At just about the turn of the 21st century they all stopped shouting. Instead, they were buying. They bought houses to live in, houses to vacation in, and houses to invest in. Credit flowed like tap water and it was easy to buy a house in any price range with virtually no money necessary. Suddenly, there was no doom and gloom, only blue skies and a warm sun.

And then it happened - the greatest housing collapse in US history and all the pain that went with it. And where were the naysayers? Right alongside the Everyman, in deep financial distress and with very little hope.

There are only a few examples of major market collapses throughout our nation’s history, but they all share one thing in common. A recovery followed each collapse, but it took many years to unfold. And so is the likley scenario with our current housing situation. There are already signs that prices in the lower end of the market may be bottoming out, but don’t expect too much more than that for quite some time. You will definitely not see those lofty prices of 3 years past and you might NEVER see them again. And here’s why.

Through the decades since World War II, the Everyman has seen continued increases in income. This consistent pattern has been the foundation of our economy and our spending. As long as we see our incomes growing, we buy. Unfortunately, we reached the heavens at least 15 years ago. Not every Everyman of course has achieved his greatest potential, but salaries overall have been bumping up against absolute ceilings for almost 2 decades. It was the housing bubble that gave the Everyman reason to buy well beyond his means, as he borrowed against the “implied” equity in his home. We know what happened next. Even with some future inflation, it’s impossible to envision an income explosion that would blast us back to and through the housing prices that we experienced a few short years ago.

And then there’s demographics. The baby boom population is huge and it’s aging fast. An overwhelming number of these boomers are owners of larger houses where they raised their kids and sent them off to college or work. Now they’re sloshing around in these big old houses and they want out. There are too many bedrooms, too much grass to mow and just too many expenses. But they can’t sell. Their neighbors are just like them and the youngins certainly can’t afford to pay the prices. So the prices of these larger homes have no place to go but down. The youngins are looking for starter homes and that market has already seen some large declines. With mortgage rates now below 5% and the government providing financial incentives, they are picking away at their first time home buying experience. They can finally afford to consider owning a house, even with a 25% downpayment. As a result, prices in the lower end of the housing market are beginning to bottom out and that’s good news. But that’s all the news. Everyone in between the top and the bottom is on hold. There are too many houses at the upper end that won’t sell and with the only buyers at the lower end, the mid-range housing market is a disaster. This is the harsh reality that won’t disappear any time soon and we have not seen the worst of it yet. Only after the economy goes into full recovery mode will the homeowners in the middle begin to see movement. Not so much in price, but at least some buying will return to the market and stabilize prices.

And that is the short to medium term outlook for housing in America. The highest end will always attract the rich and not many of us care what happens there. The high end for us normal folks will have a glut of baby boom houses for sale, with virtually no buyers in sight. The low end will continue to attract our kids, as they begin to make their way in life. And the middle range will be stuck in the mud. When the smoke clears, a house will be a place to live and anyone who is lucky enough to turn a profit will have icing on the cake. Otherwise, you can think of your home as you would think of your car. They are both necessities at some point, they are likely to be declining assets, and they both require a fair chunk of change to afford. Sorry, and I may be wrong, but the future of housing is no longer bright.         

The Everyman’s head is spinning. He’s angry all over again and he can’t believe what’s he’s reading in the press and hearing from the talking heads about AIG, Citibank, Bank of America, Merrill Lynch, bonuses, toxic assets, earmarks and tons more. Everyman’s looking for a scapegoat. Someone needs to pay for this mess, right? One day it’s the overpriced traders and their obscene bonuses who are to blame and the next day it’s those overpriced senior executives and their obscene mansions in New York, New Jersey and Connecticut. But this blame game has to STOP. When historians look back at these times, it’s not the details that will matter the most, it’s the big picture and how we got here. And the overwhelming reason for our turmoil is one thing - lack of regulation. We became so complacent in our abilities to produce meaningful financial products that would serve all parties simultaneously, that we forgot the essential component of all good plans - the rules. We allowed Everyone, the Everyman included, to reap the benefits, but we threw caution to the wind and it all ran amok. Is it any wonder that the SEC was contacted many times over a period of many years about Bernie Madoff and his fraudulent activities, only to turn a blind eye. If the SEC wasn’t watching the chicken coop, then Everyone was asleep at the switch.

So what do we do now? First, let’s stop the finger pointing. Nobody is going to get it ALL right. Mistakes will be made and people will be human. It makes no sense to make ourselves feel good by making someone else a culprit. Instead, we need to demand of our leaders that we NEVER have this happen again. We must have prudent safeguards in place that will regulate the financial environment and prevent a meltdown. In the 1930s, Congress passed the Glass-Stiegel Act, which went a long way in helping us sort out the mess of that decade. Some say that when Glass-Stiegel was repealed in 1995, it was the beginning of our current problems and that may be true. But true or not, we need today’s form of Glass-Stiegel to pave the way to a healthier economic environment.

If the Everyman is going to vent his anger, it’s time to yell at the politicians and let them know that we need to bring rules back to the game. Only regulation will help create the proper solutions as we move forward. So forget about the anti-regulators - they’ve had their day and look where we are now!     

Back in September we applauded the idea of creating a Good Bank/Bad Bank scenario to solve the banking crisis and get the financial system working again. We don’t know why, but so far this scenario has not unfolded. Instead, the government has plowed good money after bad money into failing banks and while they have alleviated the pressure and brought the system back from the brink, they have only mustered a temporary fix. Make no mistake about it, as long as the toxic assets continue to plague these institutions, we will soon be back to where we were before…on the brink of collapse. We continue to believe strongly that the ONLY way to cure the system’s ills is to get the toxic assets off the books of financial institutions, even at a steep price, and let the assets take safe haven in a Bad Bank owned and operated by the federal government. Over time, these assets will crawl their way back to a level of reality and the government will likely profit from the distressed sales by the banking system. In the short term, the banks will be rid of this albatross and they will be able to get back to the business of providing money and credit to the Everyman and Everybusinessman, responsibly. Stop wasting time Uncle Sam! Stop allowing the patient to slowly bleed to death! Administer an immediate blood transfusion and let’s get the patient back to health right away! YOU MUST DO IT NOW!!! 

The Everyman has reason to be hopeful. There is light at the end of the tunnel, even if few are predicting good times ahead. What stands in the way at the moment, however, is the Party of NO. These are the political obstructionists who believe that it’s better to resist than to act. It’s better to stick to your dogma than to wake up and hear the voices of millions of Everymen screaming for change. Having gotten us into this mess, the Party of NO is now trying to tell us that the new administration is reckless and irresponsible. Talk about the pot calling the kettle black. Fortunately, in spite of these naysayers, bold actions are being taken to get us out of the worst economic crisis since the Great Depression. Is it all good? Of course not! But there is always a percentage of pork in every piece of major legislation. It’s been the American way for 200 years and it’s not about to stop now. So you hold your nose, you vote for the big picture and you let some stinkers have their pet projects. If that’s what it costs to get the job done, you don’t throw the baby out with the bath water. But that’s not okay with the Party of NO. They would rather pursue the same policies of the last 8 years than get on board with the American people. And that’s why it’s time to Just Say NO to the Party of NO!

The Everyman is angry, and who’s to blame him? The government has already bailed out investment banks, commercial banks, retail banks, insurance companies and now they’re considering throwing another $34 billion into a potential black hole known as the US auto industry. Where will it end? Truth be told, nobody knows for sure. I’ve said it before and I’ll say it again, this is a historic period and we haven’t seen one like it since 1929. But historic periods require historic measures and we won’t know if we’ve done the right thing until years into the future. What’s most important is that we don’t repeat the mistakes we’ve made in the past and turn what’s already a painful economic slowdown into a catastrophe.

Do the car makers deserve the government’s support? Probably not. Will America lose 2 million jobs if the government steps aside and lets the chips fall where they may? Probably not. Will the Everyman stop buying US cars from a company that’s allowed to go bankrupt? Probably not. So why not let it all happen? Just say no and let the market sort out the winners from the losers. After all, that’s what capitalism is all about. Survival of the fittest and all that, right? Unfortunately, not this time. This time it’s the Everyman’s economic health that’s on the line. Can the Everyman afford to bet the ranch on a roll of the dice? Can the Everyman take the chance with an economy that’s teetering on the brink of collapse? Absolutley not! So what do we do?

First, we’ve got to give the bums a lifeline. We need to bridge the gap between NOW and BANKRUPTCY and avoid the worst case scenario. But it has to be a bridge loan only, and only for the company or companies that must have the bridge to survive the next 90 days, but not $34 billion. In return, all 3 companies PLUS the UAW MUST agree to sit down at a table with a SWAT team of financial, political and corporate representatives and sign on to a major restructuring of the US auto industry. It could include mergers, selling or closing business lines, organized bankruptcy, you name it. But don’t let them out until a real plan is on the table that will change the nature of the industry. The plan would then be approved by Congress and any additional money that might be necessary could be considered at that time. Only then will the Everyman be assured that the future will not be more of the same. It sounds simple and maybe even naive, but unless the Everyman gets some real changes, the future for American cars is bleak.  

The financial storm has been raging for more than a year and has recently grown into a category 5+ hurricane. It has blown the roof off housing, tossed companies to the wind, and drowned many of our safest investments. But like all storms, this too shall pass and a calm will settle in. The damage will have been done and the recovery efforts will go on for quite some time, but the calm will return. How can I be so sure? Because never in the history of the modern day global financial system have so many resources been unleashed by so many. Trillions are being spent around the world to shore up institutions and national economies and it’s not over yet. That is no small matter and the world WILL see results, albeit slowly, and normalcy will return. The landscape will change and history will look back on these days and call it our great Depression. Not the same as in 1929, to be sure, but a game-changer nonetheless, as we see a transformation of rules, regulations and corporate and Everyman habits. They say “old habits die hard” and we are now living proof.  

We were On The Brink…and now we’re Back From The Brink…But…We are not alone. The financial crisis is not just a problem on our shores, it’s a problem on European and Asian shores as well. We were first to deal with the problem and now it’s their turn. Fortunately, we showed our friends and enemies what democaracy is all about, warts and all, and Europe and Asia will follow. But this is not going to be a pretty picture. Markets will fall, rise and fall again, and economies will be hurt badly. The credit squeeze will ease back from the brink of despair, but economic conditions will remain weak. This week the world will need even more encouragement and bold initiatives and I believe the Fed will supply some help. Interest rates will be lowered, but now is the time for some VERY bold action. With US interest rates already at 2%, what can the Fed do? What they MUST do now is remove the guesswork from the markets and stop pegging the Fed Funds rate to a specific target. Instead of lowering rates by 1/4 point or 1/2 point or even a full point, the Fed should formally announce that they will allow the Fed Funds rate to float freely, which is approximately what’s already happening in the markets anyway. Let natural market forces continue to dictate the overnight Fed Funds rate and let the pundits all go home. After all, they are no help with their predictions that often leave the markets disappointed, even when the policy is right. In addition, the Fed should officially lower bank reserve requirements and ease some more of the pressure that’s built up in the financial system. Now that we have $810 billion of fiscal policy relief on the way, we need to adjust the monetary policy spigot so that market psychology begins to believe that this is all for real. We all need to know that the financial system will not be abandoned and we need to be sure that it will get through this incredible mess. When we have a crisis of such immense proportion, leadership is the most important component to getting us back on track. That’s what FDR did in the 30s and 40s, that’s what JFK did in the 60s and that’s what Rudy did on 9/11, and we now need that same kind of bold leadership. We may be Back From The Brink…But…It’s Now Time To Reverse Course.

The Everyman is angry. He wants to know why the government is asking Everytaxpayer to bail out Wall St when it was the government and Wall St that got us into this mess. A fair question to be sure, but there’s no simple answer. Truth be told, George Bush couldn’t satisfy the Everyman with any answer right now, even if he was able to articulate it with 100% accuracy. In the mind of the Everyman the President has lost his credibility and he’s like the boy who cried wolf, only worse. He’s used fear in the past to get his way and the Everyman thinks he’s doing it again. Unfortunately, the wrong guy is trying to send the right message, but nobody believes him. And that’s why we are On The Brink…

The President offered a plan that was crafted primarily by the heads of the Treasury and Federal Reserve to stave off a financial meltdown. What they are seeing developing is REAL and it will impact the Everyman in a very REAL way. Banks and financial institutions have been unable to obtain the necessary funding that keeps their doors open Everyday. It’s only a series of temporary emergency measures taken by the Fed that has prevented this problem from mushrooming already. Some companies and banks have failed, even with the emergency measures, and it will get much worse if something isn’t done VERY SOON. Case in point, WAMU -the nation’s largest Savings and Loan failed overnight. The Everyman’s deposits are safe because JP Morgan Chase acquired the assets of the bank and is now holding all of the accounts. But what if the WAMU situation were to be multiplied tenfold, or fiftyfold? Is Chase or Citi or Bank of America or all of them together big enough to take on all of those failed institutions? Absolutely NOT! And that’s where we are right now…On The Brink…

We need to put anger aside. We need to put politics aside. We need to suspend the disbelief and we need to trust that the situation is as bad as Warren Buffet put it - “we are facing financial Pearl Harbor.” And if this all begins to unravel, it will unravel very quickly. The list of failures will grow and the impact will be seen in the Everyman’s savings account, checking account and IRA & 401k accounts. This is not just a Wall St problem, it is now Everyman’s problem and we are perilously close to it becoming a reality. If Congress does not take action on a plan TODAY, FRIDAY 9/26/08, the global markets will begin to take action and we will no longer be On The Brink…