As the NCAA tournament has gotten underway, many March Madness enthusiasts and my college peers have been missing what should be recognized as the real March madness: volatile action coming out our nation’s capitol and capital markets.
Whether you agree, disagree, or strongly disagree with my views, my hope is that this will help us review some of the major themes of the capital markets and political landscape of the last few weeks and will serve as a springboard for further discussion on the specifics and consequentiality of each item. We are in an extremely important inflection point in history and everyone should be engaging in philosophical thought and spending some time contemplating the events we are witnessing.
The magnitude and velocity of many of the declines in the capital markets and real economic activity in the past 18 months rank it among the most significant shocks ever realized. What is going to emerge as the most consequential news item for the month of March in 2009? Upon thorough review of the contenders (headlines), here are my picks for the Real March Madness Elite 8:
· FAS 157- a divisive and perennial contender that makes for juicy and factious arguments. Some say it has nothing to do with current problems and others blame it many of our troubles. Sheila Bair’s own words on “toxic” assets banks have had to mark down on their balance sheets: “Well, I think they will certainly be worth more than the current valuations. I think that is the assumption. And I think that’s true. I mean, at the FDIC we sell troubled bank assets all the time, . . . so we’re pretty familiar with the market right now. So we think that that is absolutely true that the assets are worth more than the current market conditions assign to them. And so that, yes, over time there will be significant profits from these.” There was some big news out last week regarding FAS 157…although it was pretty much overshadowed by the AIG Bonus-gate. FASB proposed two new amendments for fair value accounting that will provide more flexibility on the rule. One will provide guidelines for making fair value measurements when a market for an asset or liability is “not active” and determine if a transaction is distressed. The second will provide additional guidance on how to analyze illiquid securities that are not likely to be sold before recovery. This proposal would separate losses related to credit deterioration from those related to a distressed market on the income statement.
· Political risk- Mark me down as one that fears the concentration of arbitrary power in the hands of a select few politicians. I worry they will do damage to our economic system that cannot be undone. First a note on Obama’s budget proposal– Obama has had his budget advisors on TV effectively saying “c’mon everyone, we’ve only raised taxes to where they were in the 1990’s, don’t you remember the economic growth and prosperity we experienced then?” …The market quickly responded by taking another giant leg down, drilling stock prices back down to where they were in 1996, before the last capital gains tax cut of 1997. Obama looks to almost double the amount of mandatory spending (entitlements) by the end of 2010. Discretionary spending is projected to stay about the same as during the Bush administration. The stimulus bill was 1,071 pages of government power shifting. It was quite possibly the biggest power grab in the history of US government. That’s one small step for liberals….and one giant leap for socialists…
· Reregulation- Is everyone playing the waiting game because they are unsure what the government will do next? Here’s a quote from a 1962 speech by The Maestro: “Most harmful during the depression era was the general atmosphere of uncertainty engendered by the Administration. Men had no way to know what law or regulation would descend on their heads at any moment. They had no way to know what sudden shifts of direction government policy might take, they had no way to plan long-range. To act and produce, business men require knowledge, the possibility of rational calculation, not faith and hope. Above all, not faith and hope concerning the unpredictable twisting within a bureaucrat’s head.” Amen, Mr. Greenspan.
· Retroactive rule changing- Congress’ Rule #1) We play by our own rules…no one else’s…not even our own. Here’s a rule for them, in fact it’s the first rule of medicine- Do no harm. Up to this point, handicapping Washington’s next move has been a guessing game. Companies, investors, consumers…all want to know what the new rules of the game will be. If the game has no rules or the rules constantly change as you go along, no one will want to play. What’s the new normal?
· Cramdowns & Mortgage Fixes- Cramdowns, that is allowing judges to unilaterally alter loan terms, such as lowering principal amount, may be the single most efficient way to further destabilize the mortgage markets. “…Hey Bob, you think if I stop paying my mortgage I can get a reduction?” Immoral individuals are thinking this and I hear anecdotes of people gaming the system! The mortgage fix and cramdowns will greatly exacerbate the problems in the housing market! Incentives are the cornerstone of modern life and the government is creating perverted incentives that will delay the ultimate recovery!
· Unemployment- Combine layoffs in the millions with the fact that many are dollar-less (and dolorous) and you have a recipe for a top contender that is likely to emerge from the first few rounds as a deserving victor. Will we come roaring out of this slowdown or will we languish for another few years? Are we already seeing signs of economic stabilization because the “second derivative” has gotten better (the rate of decline has slowed)? What could serve as a catalyst going forward? Which industries will lead or emerge?
· European Economies- If you think about global marginal industrial production, it does not take place in the U.S., thus things are much worse abroad. Be sure to keep an eye on the train wreck across the pond.
· PPIP- The Toxic Asset Plan- One could make a convincing argument that economic cycles use to set the tone for financial markets. Now with global financial assets valued at 10x GDP, in retrospect, it appears the current of causality has perhaps gone the other way. The PIPP plans to use $75-100 billion of capital to purchase $500 billion of legacy assets, with the potential to increase that to $1 trillion over time. It’s a market based auction process. My guess is that not many banks will want to participate, because if they have already marked assets down to market, yet are still solvent, why would they sell at depressed prices? If they have not marked down the assets, why would they mark them down and realize losses from them through an auction? Also, the FASB is voting on new amendments to FAS 157 which lessen bank’s incentive to sell distressed assets.
Ayn Rand is without a doubt turning over in her grave as we speak. The government wants to *inhale* prevent foreclosures, attract private investors, increase taxes on investors, stop the severity of home price declines, enhance housing affordability, increase liquidity in the secondary mortgage market, allow judges to unilaterally alter mortgage terms in personal bankruptcy, cap executive compensation, punish greedy bankers, encourage bank lending, increase the consumer savings rate, revive retail spending, and shore up bank balance sheets, increase ‘Keynesian’ spending, and reduce the budget deficit. It doesn’t take a rocket scientist to see that many of these are conflicting goals. Or..wait…
Think about Ronald Reagan’s positions–they were too simplistic to be serious, well thought out policies, right? How can issues that are so complex be framed with political resonance as to be fit on a bumper sticker? Fight communism. Cut taxes. Less government. He once again proved this lesson: Less is more. The Administration is stifling ambition and initiative, when they need to be embracing and unleashing the power of entrepreneurs and small businesses. There is too much complexity, too much regulation, too much bureaucracy.
The show (quite literally the constant Congressional hearings and testimonies) being played out in Washington is like The Real World meets Days of Our Lives meets Judge Judy. The question is does this show have a happy Hollywood ending or is it a Greek tragedy? Will this turn out to be Great Depression 2.0 or The Not-So-Great-Depression? I wish I had more answers and fewer questions. I admit I am extreme in my free market capitalism views (and I take it a lot of the readership here is based on the interest in Ayn Rand literature). I am, however, not so naive as to think that study of the past will yield simple solutions, directly transferrable to our situation today.
If someone ask me how long we have been in recession, the pessimist in me wants to answer “in eight and a half years it will have been a decade.” My undying optimistic attitude usually overrides that and I answer that there are numerous positives on the horizon. In sum, looking through my investment glasses, I am bullish on many individual securities (preferring to stay high in the capital structure), am still finding some selective short opportunities, and am cautiously optimistic on America longer term.
I would love to get feedback from entrepreneurs and business owners.
