Market Report: July 2008

It makes little sense to continue to look around for villains in this latest economic morass. Fault can be assessed everywhere so to do so is a waste of time. I am arguing that as a privileged public accommodation, the banking community is going to have to provide more credit and debt-write downs to both the commercial and residential sectors. I suspect these troubled financial institutions will do nothing and in the end be forced to swallow a very bitter economic pill imposed from Washington. How that gets accomplished is enmeshed in the quadrennial circus in the Beltway.

On a brighter note, our latest investment opportunity in a senior mobile home park is about 95% funded and our group has a decent loan in place. Call me if you would like to invest with as little as $25,000 for this very stable cash flow property.

The Bailout, Part II

Congress and the President are now fighting over the details of proposed legislation designed to arrest the free-fall of housing prices. While the debate is predictably divided along party and ideological lines, there is a consensus that without some Federal intervention into the foreclosure crisis, the general economy will slide into a serious recession. Complicating matters is the election this November, a wobbly economy and a sitting President with scant political capital. Rome is burning and there is little time for deliberation among the ideologues over the fine points of free market philosophies.

Until recently pols and their apparatchik have been able to duck this problem, leaving the heavy lifting to Mr. Bernanke and his crew at the Fed. The Chair has applied the traditional nostrums of liquidity and low rates and has little to show for the effort. His strategy, however well intentioned, has failed because no one had an idea of the sheer size and complexity of the problem.

In the past the Fed was more or less able to quarantine housing, when it got sick, from the economy. The wild west of global finance has changed the rules and thus rendered some of the old cures impotent. Housing woes are contagious and in the new world order local has become international. The realization of that fact is forcing Congress and the President to re-examine their core values about the role of government in the private business sector. The decline of housing prices, once viewed as just desserts for our personal failings and avarice, is now seen as a threat to the overall economy. If lenders will not accept their responsibility for the sub-prime crisis and act to redress the mistake, the Feds will do it for them. Charles Dickens is going to be shown the door.

We got to this point precisely because of an excess of financial freebooting bordering on land piracy. There appear to be no limits to financial creativity in lower Manhattan. Financiers of all stripes found myriad ways to continually profit from a group of ill-conceived mortgages. The idea was pure genius. Put a dress and some lipstick on a pig and sell it. Change the dress and sell it again and so on. Collect a huge fee on each sale until someone discovers there is a pig under the dress. Think of it as a high stakes game of musical chairs wherein the loser was pre-ordained.

This is why Mr. Bernanke is fresh out of ideas and, given the weakness of the dollar and inflation, has no more room to maneuver. Lower mortgage rates did not resuscitate the housing market because banks were not interested in loaning money to people who needed it. His aggressive rate cutting did help drive down ten-year Treasury note rates to a low of 3.28% last January leading to a dip in the average 30-year fixed rate mortgage to 5.48%. (The ten-year Treasury note yield determines the rates for fixed rate mortgages) Since that time, inflation and the dollar are dominating the financial markets and long Treasuries are now above 4.1% and investors providing 30-year mortgages are now demanding 6.5%. Presumably rates will continue to climb, along with a drop in the dollar, until oil's inevitable pratfall.

The Other Feds

The combination of earlier aggressive actions by the Federal Reserve Board and the various quasi-governmental bailouts of several players involved in complex mortgage schemes have not solved the housing problem. As I mentioned in an earlier column, the crisis must be addressed from the bottom and not the top. Curing Wall Street does not necessarily fix Main Street. The guy in Stockton still needs to make his house payment.

The solution, while simple, is fiercely at odds with the direction of this country in the post-Great Society era. The solution is not to save only the Bear Sterns and Chryslers of the world---you also need to bail out the homeowner. This runs against the grain of our free enterprise philosophy which in theory operates in an unfettered atmosphere relatively free of governmental interference. But that is nothing more than hollow cant and an illusion. Ever since we discovered sawdust in our sausage the body politic has always accepted some form of government interference into free markets. To argue otherwise is to ignore our history. Saving homeowners with a direct subsidy will not destroy our national character.

Banks owe a duty, as a public accommodation, to provide a reasonable flow of credit. They are given the opportunity to borrow huge amounts of money from the Fed at cheap wholesale prices and then retailing it to us on a very profitable basis. But the bargain cannot be all one way. Blame about sub-prime loans does not solve the problem. Borrowers and lenders alike all have their fingerprints on the murder weapon and all must pay some part of the cost of fixing the mess. Banks cannot continue to avoid making loans to those in need just because they are losing money.

Congress and the President will have little choice but to act. The cancer, known and unknown, is spreading. Consumers, who drive most of our economy, are sitting on their wallets. Eventually economic pain will begin to spread from Keokuk to La Jolla. Foreclosures are now popping up in the neighborhoods of our betters and once that process accelerates you can bet there will be action in Washington. Self-interest and ideology are comfortable bedfellows when times are good. Because no one has any idea of the size and potential damage of this crisis, there will be many on both sides of the aisle ready to embrace the New Deal.

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