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One Man's Opinion Life in the slow lane of Retirement. |
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One Man's Opinion Life in the slow lane of Retirement. |
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THE MARKETS ESCAPED ARMAGEDDON BUT WHAT NOW? August 17,2007. When I was a kid, one of the simple type games we used to play while sitting around the kitchen table after dinner was a card game I called "building a house" Each player would stand one or more playing cards on their side and in turn place them against or on top of each other so that a structure would be built as high as possible before one or the other players made it fall as they put their last card in place. This "House of Cards" syndrome and its inherent risk of collapse has some anological comparison to how the financial structure of economic systems function here in the United States and around the world. While far more sophisticated, the money, banking and credit system overseen by our Federal Reserve Bank and Central Banks in other parts of the globe nevertheless has tiny elements that could bring into focus the possibility of and fear for financial implosion that is much similar to the House of Cards game we played. Now having said that, lets see if we can gain some perspective of what the "norm" is or should be for constructive administration of monetary policies and the oversight of financial institutions operating in free markets around the world. The health of the U.S. economy is typically measured by the percentage change and direction of its Gross Domestic Product. This GDP is an amalgamation of output in manufacturing and services that are purchased by the individual, institutional and government consumers. The money a producer or provider receives for this output may be made up of a small portion of currency but for the most part it is represented by a preponderance of dollar bank credits. The willingness of a producer to accept dollar bank credits in exchange for their output is based on their expectation that they will be able to turn around and pay their obligations by transferring these bank credits to other producers or service providers. The difference between dollar credits earned by institutions or individuals from their output or work and the amount of their consumption purchases becomes savings. These savings are generally held by banks as an obligation payable to or FBO the saver and for which the bank will add additional dollar credits representing compensation to them for the use of that dollar credit. In many cases, these credits are exchanged for equity or debt ownership in securities, real estate and in some cases, commodities. The structure that provides the tract on which all these transfers of credits take place is governed by State and Federal Banking regulations and by the Federal Reserve turning the money spigot on or off depending on whether or not they see the need to ease the ability for individuals and institutions to obtain temporary loans for their discretionary purchase of consumer items or longer term loans for the payment of mortgages or other fixed obligations. This entire system depends on the degree of confidence consumers have in the ability or desirability to exchange their dollar credits for some other asset. As long as the credits are moving in the system, the economy and the producers of goods and services are selling their product and exchanging value for value. The problem comes and it did come in this summer's near collapse of the financial system when the mortgage banker increasingly came to discover that it became more and more difficult to sell mortgages he was generating and that his source of bank credits needed to hold and create mortgages was drying up. The financial system was freezing up. It is sort of like the human body having plenty of blood (currency) but the heart has stopped pumping it to the circulatory system. One critical form of the "blood" in this system is the financial obligation called Commercial Paper. When banks or institutions cannot sell and investors eschew the purchase of these short term (30-90 day) obligations, it is like the heart stopping its beating. The reason for this near disaster is the growing fear that the underlying values being used to price these and other longer term paper liabilities are over stated. This fear leads to investors selling down collateralized financial obligations (Mortgages, Commercial Paper, etc) and brings to a virtual halt the liquidity of fixed income markets leading to the suspension of funding for private acquisition deals or leverage buyouts. It was early this morning that the Federal Reserve, having concluded that they needed to step in and try to stem the tide, decided to reduce the discount rate by 50 basis points. This act, which is intended to make it possible for banks and mortgage companies to sell some of the paper they hold and provide an alternative for the realization of funds to procure working capital or monies to fund other approved mortgage commitments brought an explosion of buying into the security markets and reversed a great deal of the apprehension Traders and Hedge Fund managers were feeling about going into the weekend heavily unbalanced in their risks. This, along with a multi billion infusion of money into the system by a purchase of Treasury and re-purchase agreements, seemed to generate a strong sense of stability to the money markets around the world. Although the Fed's action brought a sense of calm to the markets and was most appreciated by the investment community, the experience of the past 30 days brings into focus the impropriety of lending money to creditors who's collateral is illiquid and/or probably overvalued to the extent that the loan amount is greater than the fair market value of assets securing it. These type loans will no longer have a secondary market nor will the issuer be able to combine them into a security and sell them at par value. The mortgage broker will now have to limit the amount they lend to borrowers to a figure that investors can be comfortable with, perhaps only as much as 80% of appraised value. This will be good for the financial markets but it will certainly have a negative affect upon the price and volume of real estate transactions. The ultimate negative impact upon the world as well as the domestic economies will be caused by the reduction of and maybe by substantial amounts, the ability of consumers to monetize the excess equity in their primary and secondary residences. This impact will be felt in household purchases and ultimately in the earnings of many if not all consumer companies. With this negative impact upon our economy and those that serve our appetite for imports our economy may be less robust in the coming year. One Man's Opinion -- Bud Brewer
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