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Look, a Fed Headline! Lets Chase It! |
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Everyone is familiar with the Fed’s cutting of the discount rate last Friday morning. After reading numerous articles about the rate cut and its implications (which all seem to have an odd celebratory tone), I keep searching for one that really lets the gravity of what is happening set in… and I am coming up empty. For example, note the bolded text the author selected in this post that begins “Thank you, Ben.” If you want to save time, the bolded text comes from the statement accompanying the half-point rate cut and reads: "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets." In essence, the FOMC is saying that the terrifically bad handling of debt in the last several years is creating huge problems not limited just to financial markets. And on this news, the Dow rallies 300 points. Right. Maybe that move is as much about Ben Bernanke screwing everyone who was short and leading them to cover as it was about a real fundamental shift, given today’s tepid follow-through. At the same time, I look at the credit problems of late and see all of them being isolated back to: 1. Debt being too cheap And to solve this problem, the Fed proposes what? Make debt cheaper, and announce that you are ready to lend money wherever it is needed. The definition of insanity is doing the same thing over and over again and expecting a different result. Ergo, I can deduce that the people in charge of our monetary policy are insane. You heard it here first. The first post I wrote on this site more than six months ago called Bernanke’s depiction of the economy into question. I’ll admit that my view in writing that was much more broad/macroeconomic than just railing on overlevered hedge funds in overrated derivatives, but I think the general spirit I wrote that in is very much relevant. Propping up the economy and markets by using easy money is not a sustainable long-term strategy, and it has to end somewhere. Should the markets rally from here, it will only reinforce the idea that serious downturns are a thing of the past and will eventually lead to a general market crash. Interest rate cuts, as the Japanese know, only do so much for stimulating the economy if you have serious underlying problems. The Fed should force the people who are responsible for the mess we are in to take responsibility. That means all the mortgage lenders with poor underwriting standards, hedge funds who levered up to take advantage of spreads between Collateralized Debt Obligations (CDOs) and LIBOR + whatever they can borrow at, and investors happily raking in money when times were good need to bear the consequences of their overall poor investments when things sour. Keep in mind that the Bear Stearns hedge funds that are in trouble are multi-billion dollar entities; this isn’t Joe Wannabe Wall Street at home on E*Trade creating spread trades on mortgage tranches. And yet, as much as these are “sophisticated” investors, they cry and complain when things that shouldn’t have gone their way, don’t go their way. There are many parallels that can be draw between the present situation in the credit markets and the Summer 1998 crisis brought on my Long-Term Capital Management (LTCM), but I think such an analogy misses on a few points. The main difference that I see between LTCM and today is that LTCM was right in making the trades they did, and the current crop of hedge fund quants dabbling in CDOs are wrong. LTCM was a victim of market irrationality exceeding their financial backing; and the current credit issue comes from markets becoming rational - sub-prime loans deserve more than a 150 basis point premium to AAA bonds and anyone who thinks they don’t is foolish. Of course, another issue is that the problems at LTCM were much more contained and hence quantifiable, but right now the mess extends to a multinational group of diversified financial service companies - which is why I think this rate cut, and even future rate cuts, will fail at propping up the market. You can give a cripple a set of crutches, but you can’t will him to start walking. Likewise, taking a situation with deteriorating fundamentals (as the Fed clearly noted we are in) and reducing rates isn’t going to right anything, it will only spread the bleeding out over a longer period of time. And yet, Wall Street reacts positively to the announcement. Um hm. In the mean time, take a long-term view, search for great companies that aren’t caught up in this mess but have been beaten up anyways, buy them and stand by your convictions. |