U.S. stocks erased Friday’s gains as worries mounted that internal conflict will delay a plan to deal with troubled financial assets and thus keep the credit markets frozen. So the S&P 500 is back to where it ended on Thursday, 4.5% above the September 17 multi-year low yet 22.6% below the all-time high hit nearly one year ago.
Of course, financial shares led the indices lower, plunging 8.48% yesterday. Consumer discretionary, industrial and information technology shares also shed 3% or more – all 10 major industry groups closed down on the day.
Monday’s stock-market activity sends the message not to play around with this thing, get it done – cut and dry. It is imperative to get this facility up and going and to completely dismiss some of the Congressional proposals that are delaying the process. We’ll soon find out if Congress is listening.
Market Activity for September 22 2008
And speaking of the government plan, we’ve heard a lot about the financial system and what ails it over the past few days – and a good thing too as the credit markets completely froze up last week. But almost universal among the many proposals to fix this thing is a refusal to lay any blame for who is responsible for this mess, so long as the particular pundit’s solutions are implemented. Well, let’s be clear, we better lay some blame because without it we fail to concentrate on what got us here and thus will not learn from the mistake. So let’s discuss the primary mistakes.
There are two things that brought us to this dead end – and I mean that as credit markets had failed to work of late and the write-down game becomes a never-ending loop; it is Federal Reserve policy and mark-to-market accounting. (Yes, there are many other things that have exacerbated the issue, but these two are the main problems as the former is the root cause, the latter providing the coup de grace).
The FOMC believed – as it still does – they could manage the economy using their flawed Keynesian models and as a result left their benchmark interest rate at 1.25% even as nominal economic growth average 6.5% -- 3.2% in real terms – in the 12 months ending June 2004; that’s running on all cylinders. (In fact, the Fed left fed funds at 2.00% or below for three full years.)
Why did they leave fed funds so low for so long? Simply because the unemployment rate remained below where Greenspan and Co. wanted it. That’s the reason. They ignored that this Phillips Curve mentality has proven feckless, and at times harmful, for 30 years now and continued to grasp it no matter how precarious the hold.
It was the low interest rate environment that encouraged all of the worst things we now know about the credit/housing market situation. We must not allow this to occur again.
The next thing we should learn is not to fall for so-called “sophisticated” models used to price assets – especially for the financial sector where these assets have 10-20 year lives. We were told these models were much more dynamic than the commons sense ways of the past, which used an original cost framework on which the financial sector based capital adequacy ratios.
These new models were developed largely during a period in which asset prices almost only went up -- never tested against what we now face.
Beyond that though the idea never made much sense from the get go. Mark, or price, assets that have 10-20 year lives to a market that is distressed? Not smart.
When asset prices fall firms must raise capital – lest that capital falls below the required level --, they then must sell off more assets to do so, which sends prices even lower, or at least the models that are used to price these assets. The process snowballs and becomes a never-ending loop until a firm is driven out of business. If we only returned to the rules these assets were accounted for just a few years ago, I’m convinced capital adequacy would have never have become a problem and asset prices would reflect a value that is actually close to intrinsic value – right now that is not the case and why an RTC-like facility to house and eventually sell off these assets will not be a losing proposition. (Sure thing, those firms that were leveraged to the hilt would still be in a world of hurt, but I’m talking about the industry as a whole. If we had mark-to-market based accounting during the S&L crisis one only knows how bad things would have become).
So while we listen to all of the solutions – some quite good and some very bad – let us not forget that a recklessly easy Fed and moronic accounting rules are the preponderate mistakes that have led us down this road.
The dollar is getting hit on news that it will take roughly $750 billion to create this facility to house and then sell off troubled assets in an orderly way. This dollar move is both logical and expected based on that number, but without a change in the accounting rules, I’m not sure there is another choice. (Under the Treasury Department’s original intent these assets will be bought at a substantial discount and will come out ahead on the deal – ie. No taxpayer harm, so long as the Congress doesn’t screw the thing up).
Concerns that the cleaner proposal presented on Friday may become saddled with New Deal-type programs likely caused more dollar harm than would otherwise have been the case.
The October contract for crude soared yesterday, jumping $16.37 per barrel, or 15.7%. That contract expired yesterday and it’s pretty obvious the jump was due to the classic short squeeze. Those that remained short had to cover those positions or be force with actually delivering the oil. The November contract rose at only half that amount. You’ll see oil open around $107 per barrel this morning. That’s not because oil has suddenly plunged $13 but because the November contract only rose to $108 yesterday. The two charts below illustrate this point.
We were without an economic release yesterday but get back to it today with the Richmond Fed Index and OFHEO’s Home Price Index. Data on both new and existing home sales, durable goods orders and the final revision to GDP will round out the week.
Thanks to Peter for doing a great job while I was out yesterday.
Have a great day!
Brent Vondera, Senior Analyst
Of course, financial shares led the indices lower, plunging 8.48% yesterday. Consumer discretionary, industrial and information technology shares also shed 3% or more – all 10 major industry groups closed down on the day.
Monday’s stock-market activity sends the message not to play around with this thing, get it done – cut and dry. It is imperative to get this facility up and going and to completely dismiss some of the Congressional proposals that are delaying the process. We’ll soon find out if Congress is listening.
Market Activity for September 22 2008
And speaking of the government plan, we’ve heard a lot about the financial system and what ails it over the past few days – and a good thing too as the credit markets completely froze up last week. But almost universal among the many proposals to fix this thing is a refusal to lay any blame for who is responsible for this mess, so long as the particular pundit’s solutions are implemented. Well, let’s be clear, we better lay some blame because without it we fail to concentrate on what got us here and thus will not learn from the mistake. So let’s discuss the primary mistakes.There are two things that brought us to this dead end – and I mean that as credit markets had failed to work of late and the write-down game becomes a never-ending loop; it is Federal Reserve policy and mark-to-market accounting. (Yes, there are many other things that have exacerbated the issue, but these two are the main problems as the former is the root cause, the latter providing the coup de grace).
The FOMC believed – as it still does – they could manage the economy using their flawed Keynesian models and as a result left their benchmark interest rate at 1.25% even as nominal economic growth average 6.5% -- 3.2% in real terms – in the 12 months ending June 2004; that’s running on all cylinders. (In fact, the Fed left fed funds at 2.00% or below for three full years.)
Why did they leave fed funds so low for so long? Simply because the unemployment rate remained below where Greenspan and Co. wanted it. That’s the reason. They ignored that this Phillips Curve mentality has proven feckless, and at times harmful, for 30 years now and continued to grasp it no matter how precarious the hold.
It was the low interest rate environment that encouraged all of the worst things we now know about the credit/housing market situation. We must not allow this to occur again.
The next thing we should learn is not to fall for so-called “sophisticated” models used to price assets – especially for the financial sector where these assets have 10-20 year lives. We were told these models were much more dynamic than the commons sense ways of the past, which used an original cost framework on which the financial sector based capital adequacy ratios.
These new models were developed largely during a period in which asset prices almost only went up -- never tested against what we now face.
Beyond that though the idea never made much sense from the get go. Mark, or price, assets that have 10-20 year lives to a market that is distressed? Not smart.
When asset prices fall firms must raise capital – lest that capital falls below the required level --, they then must sell off more assets to do so, which sends prices even lower, or at least the models that are used to price these assets. The process snowballs and becomes a never-ending loop until a firm is driven out of business. If we only returned to the rules these assets were accounted for just a few years ago, I’m convinced capital adequacy would have never have become a problem and asset prices would reflect a value that is actually close to intrinsic value – right now that is not the case and why an RTC-like facility to house and eventually sell off these assets will not be a losing proposition. (Sure thing, those firms that were leveraged to the hilt would still be in a world of hurt, but I’m talking about the industry as a whole. If we had mark-to-market based accounting during the S&L crisis one only knows how bad things would have become).
So while we listen to all of the solutions – some quite good and some very bad – let us not forget that a recklessly easy Fed and moronic accounting rules are the preponderate mistakes that have led us down this road.
The dollar is getting hit on news that it will take roughly $750 billion to create this facility to house and then sell off troubled assets in an orderly way. This dollar move is both logical and expected based on that number, but without a change in the accounting rules, I’m not sure there is another choice. (Under the Treasury Department’s original intent these assets will be bought at a substantial discount and will come out ahead on the deal – ie. No taxpayer harm, so long as the Congress doesn’t screw the thing up).
Concerns that the cleaner proposal presented on Friday may become saddled with New Deal-type programs likely caused more dollar harm than would otherwise have been the case.
The October contract for crude soared yesterday, jumping $16.37 per barrel, or 15.7%. That contract expired yesterday and it’s pretty obvious the jump was due to the classic short squeeze. Those that remained short had to cover those positions or be force with actually delivering the oil. The November contract rose at only half that amount. You’ll see oil open around $107 per barrel this morning. That’s not because oil has suddenly plunged $13 but because the November contract only rose to $108 yesterday. The two charts below illustrate this point.
We were without an economic release yesterday but get back to it today with the Richmond Fed Index and OFHEO’s Home Price Index. Data on both new and existing home sales, durable goods orders and the final revision to GDP will round out the week.
Thanks to Peter for doing a great job while I was out yesterday.
Have a great day!
Brent Vondera, Senior Analyst
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