Individual investors largely sat out the most recent bull market, and the wisdom of the crowd seems to have been vindicated. The Euro zone is the latest debt-fueled asset bubble to pop. The 16 nations that use the Euro are being forced by skittish creditors to deleverage. Since the European Central Bank won't deliberately weaken the Euro (and may be quietly supporting it through sovereign debt purchases in the secondary market), Euro bloc governments have to cut spending. Some may even have to restructure their debt (although none will admit to that). The U.K., with Europe's largest economy outside the Euro bloc, is also retrenching.
In Asia, China is trying to rein in overheated asset markets. North Korea's bellicosity frightens cash into bank accounts. The war in Afghanistan grinds on, with no clear end in sight. Although Asia's emerging economies (i.e., excluding stagnant Japan) are in growth mode, they are too small a bunch of ponies to pull the huge, lumbering wagon that is the combination of the European and North American economies. (China, India, South Korea and the other emerging economies in Asia combined barely total a quarter of Europe and the U.S. together.)
More Sisyphean than the Afghanistan war is the British Petroleum oil spill in the Gulf of Mexico. Nothing has stopped the outflow. Even though yet another temporary fix is being attempted, there is apparently no hope of a permanent solution until August. The amount spilled is in dispute, but there's no doubt it's a lot. Oil is not only spreading throughout the Gulf states, but may come up the East Coast of the U.S. in the Gulf stream. At some point, the spill will discernibly slow U.S. economic growth, and that point could be close.
That said, the U.S. economy keeps growing, at a moderate rate that has pretty much been imputed in stock market valuations. More moderately good news won't revive the bull. There's no indication of a large economic stimulus in the future. With the recession over from a statistical standpoint, and populism surging from sea to shining sea, there isn't enough political support for another spendapalooza by the U.S. government. The Fed can't lower interest rates below the zero level where they now are, and may have to soon begin selling off some of the trillions of dollars of mortgage-backed assets it reluctantly holds.
All in all, this may be a good time for investors to play defense. Be cautious about putting new cash into the market. Ease back on equity exposure if you're losing sleep over downside risk. Since stocks are no higher than they were in 1999 (or 1997 if you consider inflation), there isn't a strong argument that you need always need a large proportion of your portfolio in stocks.
Cash has a beauty that becomes luminescent in uncertain times. Fraidy cats who kept their money in passbook savings during the last decade proved more perspicacious than most professional money managers and most stock market investors. Intelligent and rational people can look at the stock market and reasonably opine it's a looney bin.
That's not to say that stocks need be shunned like a carrier of typhoid. Defense can serve as the foundation for offense. Build up cash and keep it ready for use. If stock values fall to attractive levels, consider buying. Don't think you can time the market perfectly. But with a lot of conventional investment wisdom upended by the volatility of today's big bank, big investor centric market (i.e., the market being of big money, by big money and for big money), it's hard to contend that market timing should be counted as a cardinal sin.
Like all else, however, sin in moderation. Invest only a small proportion of your available cash at a time. Think in terms of cost averaging, not hitting a home run. If the market continues to look attractive, infuse more cash bit by bit. Don't get discouraged if the market declines again. Use the further decline as an opportunity to feed a little more cash into the market. Unless civilization ends (and the combined military strength of North Korea, Iran, al Queda and the Taliban can't end civilization; the recklessness and greed of bankers presents a greater risk), your investments will become profitable eventually.
Showing posts with label financial crisis: risks of investing in government policy. Show all posts
Showing posts with label financial crisis: risks of investing in government policy. Show all posts
Monday, May 31, 2010
Wednesday, April 15, 2009
Hitting the Limits of Governmental Action
Even as various government programs aimed at easing the recession and financial crisis are reaching the implementation stage, we are already seeing their limitations.
Bank Bailouts. Several small banks have recently repaid their TARP money, and Goldman Sachs will do so very soon. It's understandable why banks want out of TARP. No business likes the government to dictate executive compensation and other market-driven business policies and practices. But, considering that TARP was meant to stimulate lending, and do so in a way that did not make any bank look weak or endangered, action by a few stronger banks to opt out begins to push TARP down the slippery slope. For competitive reasons, other banks may decide to repay their TARP money, and rely on the FASB's recently relaxed accounting standards for toxic assets to look good while staying in business. TARP's effectiveness could be damaged in the process.
Foreclosures rising even as mortgage modifications increase. The Obama administration's mortgage modification program has officially begun, with some homeowners now receiving relief. However, banks and mortgage companies have also increased foreclosures of mortgages that aren't eligible for modification. Apparently, lenders have been holding a large number of foreclosures in abeyance will waiting to see which loans would be eligible for government subsidized relief. Now that the picture is clearer, those eligible proceed to the winner's circle and those ineligible lose their homes. Thus, while many homeowners may get to stay in their homes, housing prices may continue to experience downward pressure from the increase in foreclosure activity.
GM and Chrysler bankruptcies more likely. In any bailout situation, lenders and investors try to shove as much of their losses as possible onto the taxpayers. In the cases of the Bear Stearns, Fannie Mae, Freddie Mac and AIG bailouts, financial market counterparties and bondholders were quite successful in getting taxpayers to cover lousy bets these creditors had made. Meanwhile, shareholders took it on the chin. This precedent appears to have emboldened GM and Chrysler bondholders, leading them to take hard lines in bailout related negotiations. The Obama administration in turn is talking tough to bondholders, both to avoid yet more moral hazard and the spectacle of struggling middle class taxpayers bailing out the institutions and mostly wealthy individuals who hold GM and Chrysler bonds. If they deadlock, bankruptcy will follow. While there is a theoretical framework for a government funded restructuring of GM and Chrysler in bankruptcy proceedings, there is no real world track record. One thing that lawyers know is that when you're in court, you can't be sure of what's going to happen. One or two unanticipated rulings by the court, and the government funded restructuring could evaporate. If that happens, GM and Chrysler would almost surely be liquidated and the administration's goal of preserving jobs undermined.
Bank Stress Tests. The administration is struggling with the issue of how much to reveal of the results of the ongoing stress tests of the 19 largest American banks. Basically, these tests are analyses of how these banks would fare under various economic scenarios ranging from good to bad to ugly. Traditionally, federal regulatory examinations of banks have been conducted confidentially, to avoid precipitating runs by depositors when it turns out that a bank is in trouble. The problem with the stress tests is that they are not routine examinations, but instead highly touted elements of the administration's financial recovery program. By heightening public awareness of the stress tests, the administration is damned if it doesn't disclose and damned if it does. Not disclosing only feeds the rumor mill and fuels concerns that the entire banking sector is insolvent. That would probably freeze the still very cold credit markets. Disclosure would reveal differences in strength among the banks, and the weak would be vulnerable to funding problems and runs. Rosy disclosure would be perceived as grade inflation and heavily discounted. Investors and depositors are well past the point where they believe that all banks are headquartered on the shores of Lake Wobegon. The administration could have conducted the equivalent of stress tests through the routine bank examination process, since federal examiners pretty much continually work onsite at the major banks. But using the stress tests for public relations purposes--indeed, to raise public confidence--may easily fracture public confidence.
Today's stock market is all government, all the time. The value of stocks appears to depend almost entirely on the extent and efficacy of governmental intervention in the economy and the financial system. When the government hits the limits of its power, the stock market will squirm and perhaps swoon.
Bank Bailouts. Several small banks have recently repaid their TARP money, and Goldman Sachs will do so very soon. It's understandable why banks want out of TARP. No business likes the government to dictate executive compensation and other market-driven business policies and practices. But, considering that TARP was meant to stimulate lending, and do so in a way that did not make any bank look weak or endangered, action by a few stronger banks to opt out begins to push TARP down the slippery slope. For competitive reasons, other banks may decide to repay their TARP money, and rely on the FASB's recently relaxed accounting standards for toxic assets to look good while staying in business. TARP's effectiveness could be damaged in the process.
Foreclosures rising even as mortgage modifications increase. The Obama administration's mortgage modification program has officially begun, with some homeowners now receiving relief. However, banks and mortgage companies have also increased foreclosures of mortgages that aren't eligible for modification. Apparently, lenders have been holding a large number of foreclosures in abeyance will waiting to see which loans would be eligible for government subsidized relief. Now that the picture is clearer, those eligible proceed to the winner's circle and those ineligible lose their homes. Thus, while many homeowners may get to stay in their homes, housing prices may continue to experience downward pressure from the increase in foreclosure activity.
GM and Chrysler bankruptcies more likely. In any bailout situation, lenders and investors try to shove as much of their losses as possible onto the taxpayers. In the cases of the Bear Stearns, Fannie Mae, Freddie Mac and AIG bailouts, financial market counterparties and bondholders were quite successful in getting taxpayers to cover lousy bets these creditors had made. Meanwhile, shareholders took it on the chin. This precedent appears to have emboldened GM and Chrysler bondholders, leading them to take hard lines in bailout related negotiations. The Obama administration in turn is talking tough to bondholders, both to avoid yet more moral hazard and the spectacle of struggling middle class taxpayers bailing out the institutions and mostly wealthy individuals who hold GM and Chrysler bonds. If they deadlock, bankruptcy will follow. While there is a theoretical framework for a government funded restructuring of GM and Chrysler in bankruptcy proceedings, there is no real world track record. One thing that lawyers know is that when you're in court, you can't be sure of what's going to happen. One or two unanticipated rulings by the court, and the government funded restructuring could evaporate. If that happens, GM and Chrysler would almost surely be liquidated and the administration's goal of preserving jobs undermined.
Bank Stress Tests. The administration is struggling with the issue of how much to reveal of the results of the ongoing stress tests of the 19 largest American banks. Basically, these tests are analyses of how these banks would fare under various economic scenarios ranging from good to bad to ugly. Traditionally, federal regulatory examinations of banks have been conducted confidentially, to avoid precipitating runs by depositors when it turns out that a bank is in trouble. The problem with the stress tests is that they are not routine examinations, but instead highly touted elements of the administration's financial recovery program. By heightening public awareness of the stress tests, the administration is damned if it doesn't disclose and damned if it does. Not disclosing only feeds the rumor mill and fuels concerns that the entire banking sector is insolvent. That would probably freeze the still very cold credit markets. Disclosure would reveal differences in strength among the banks, and the weak would be vulnerable to funding problems and runs. Rosy disclosure would be perceived as grade inflation and heavily discounted. Investors and depositors are well past the point where they believe that all banks are headquartered on the shores of Lake Wobegon. The administration could have conducted the equivalent of stress tests through the routine bank examination process, since federal examiners pretty much continually work onsite at the major banks. But using the stress tests for public relations purposes--indeed, to raise public confidence--may easily fracture public confidence.
Today's stock market is all government, all the time. The value of stocks appears to depend almost entirely on the extent and efficacy of governmental intervention in the economy and the financial system. When the government hits the limits of its power, the stock market will squirm and perhaps swoon.
Monday, October 13, 2008
The Financial Crisis: Risks of Investing in Government Policy
After a weekend of solemn pronouncements of vigorous, coordinated action by numerous governments around the globe, stock markets everywhere rediscovered exuberance. The Dow Jones Industrial Average was among the most joyous, rising 936 points, or 11%, today. That was the Dow's largest point gain in a single day ever. The S&P 500 and the Nasdaq were similarly rapturous. Problems solved?
Hardly. The government pronouncements were long on apparent sincerity, but short on specifics. It helps, at least momentarily, that all these national leaders linked hands and sang Kumbaya. The One World, interconnected nature of the world's financial system today necessitates joint action. No nation can go it alone.
However, it is also clear that each nation will choose its own policies and protective measures. The argument here is that each nation's financial system is different from others, and its policies should be tailored to its specific needs. That sounds good. But underneath, it reflects a desire not to subsidize another nation's bailouts. This Balkanization of bailout policies may undercut the recent pledges of international coordination. There are differences of opinion among the world's economic powers as to which policies are best. For example, unlimited deposit guarantees in one country could attract badly needed liquidity from other nations' banks. When there's a credit crunch on (and there still is), that triggers international resentment. The same could be said of proposals to inject government capital into ailing banks. When one nation's banking system is backed by its government, its apparent strength would be improved and it would attract credit away from banks in other nations. Thus, the other nations are forced to inject government capital themselves; they can't wait to see if other measures might lead to private sector recapitalization of their banks. This may well be what's happening to the U.S. government's $700 billion bailout plan. The proposal for the government to buy toxic assets is taking a back seat to a plan for direct U.S. government investments in the largest American banks, which they won't have the option to decline.
The truth is that all of the governments involved in the financial crisis are winging it, scribbling out policy measures on cocktail napkins as they go along. After a year and a half of turmoil, we still don't have anything approaching a clear picture of the losses from the mortgage mess and other problem areas. One suspects that the governments themselves don't know where all the bodies are buried. That, if true, is deeply troubling. You can't make good policy if you don't understand the scope of the problem.
By all appearances, the policies announced in the last few days only amount to a large injection of methadone. They focus on loosening up the flow of credit, which is kind of like a taste of the hair of the dog that bit ya. The stock market's exuberance is likely to be a temporary high, because the underlying problems remain. The world's financial system doesn't merely need to be recapitalized. It needs to be reconstituted, with the bad assets writedown fully. A new, more extensive and effective regulatory scheme must be instituted. Bankers must adopt an ethic of prudence and responsibility, not recklessness tempered with greed. Government regulators must adopt an ethic of vigilance, not somnolence.
Has the market bottomed? Should you start buying stocks again? There's no way to tell based on traditional criteria. We're in a brave new world where stock values are determined by that most unpredictable of factors: politics. The financial markets are being nationalized worldwide, not excluding the United States. How effective this will be remains to be seen. The slowdown in the real economy has been virtually ignored by government policymakers. That slowdown--surely a recession even if it hasn't been officially acknowledged as such--and the eventual recovery from it will dictate the timing and pace of the stock market's true revival. By the time policy makers figure out that they need to stop being mesmerized by the gyrations of the Dow, you'll probably know that today's action was just a dead cat bounce.
Hardly. The government pronouncements were long on apparent sincerity, but short on specifics. It helps, at least momentarily, that all these national leaders linked hands and sang Kumbaya. The One World, interconnected nature of the world's financial system today necessitates joint action. No nation can go it alone.
However, it is also clear that each nation will choose its own policies and protective measures. The argument here is that each nation's financial system is different from others, and its policies should be tailored to its specific needs. That sounds good. But underneath, it reflects a desire not to subsidize another nation's bailouts. This Balkanization of bailout policies may undercut the recent pledges of international coordination. There are differences of opinion among the world's economic powers as to which policies are best. For example, unlimited deposit guarantees in one country could attract badly needed liquidity from other nations' banks. When there's a credit crunch on (and there still is), that triggers international resentment. The same could be said of proposals to inject government capital into ailing banks. When one nation's banking system is backed by its government, its apparent strength would be improved and it would attract credit away from banks in other nations. Thus, the other nations are forced to inject government capital themselves; they can't wait to see if other measures might lead to private sector recapitalization of their banks. This may well be what's happening to the U.S. government's $700 billion bailout plan. The proposal for the government to buy toxic assets is taking a back seat to a plan for direct U.S. government investments in the largest American banks, which they won't have the option to decline.
The truth is that all of the governments involved in the financial crisis are winging it, scribbling out policy measures on cocktail napkins as they go along. After a year and a half of turmoil, we still don't have anything approaching a clear picture of the losses from the mortgage mess and other problem areas. One suspects that the governments themselves don't know where all the bodies are buried. That, if true, is deeply troubling. You can't make good policy if you don't understand the scope of the problem.
By all appearances, the policies announced in the last few days only amount to a large injection of methadone. They focus on loosening up the flow of credit, which is kind of like a taste of the hair of the dog that bit ya. The stock market's exuberance is likely to be a temporary high, because the underlying problems remain. The world's financial system doesn't merely need to be recapitalized. It needs to be reconstituted, with the bad assets writedown fully. A new, more extensive and effective regulatory scheme must be instituted. Bankers must adopt an ethic of prudence and responsibility, not recklessness tempered with greed. Government regulators must adopt an ethic of vigilance, not somnolence.
Has the market bottomed? Should you start buying stocks again? There's no way to tell based on traditional criteria. We're in a brave new world where stock values are determined by that most unpredictable of factors: politics. The financial markets are being nationalized worldwide, not excluding the United States. How effective this will be remains to be seen. The slowdown in the real economy has been virtually ignored by government policymakers. That slowdown--surely a recession even if it hasn't been officially acknowledged as such--and the eventual recovery from it will dictate the timing and pace of the stock market's true revival. By the time policy makers figure out that they need to stop being mesmerized by the gyrations of the Dow, you'll probably know that today's action was just a dead cat bounce.
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