Wednesday, November 19, 2008

It Ain't Looking Good, Folks!

[Originally posted at "Down with Absolutes" on 11/19/2008]

On Friday, 11/14/2008, the Dow Jones Industrial Average closed at 8497.31, down 337.94 points from its previous close and down 5% for the week. Though up and down volatility has been the order of the day (we were up 552.59 on Thursday), the general trend has been unmistakably downward. As of Wednesday, 11/19/2008, the Dow hit a five year low of 7,997.28. Yeesh!

Do any of you remember when the Dow closed at 14,000 on July 19, 2007? That was before we started getting a whiff of the ensuing trouble: the housing bubble was starting to burst and people were no longer able to refinance their adjustable rate, sub-prime mortgages because their houses were suddenly not worth what they owed on the mortgage. There was some action and adjustments by the government to stave off the crisis, but not enough to counter an increasing sense of uncertainty. Though the Dow reached another high of 14,164 on 10/09/2007, it went steadily downward from there, dropping briefly below 12,000 on 01/09/2008 and steadying above 12,000 through the first half of this year. We were told then that the worst was behind us. If only that had been so.

Like many, I am continuing to watch the shrinking value of my 401K and the rest of my portfolio. Technically, I haven’t lost anything yet because I haven’t sold anything. I’m riding out the storm, taking solace that the stock market will eventually recover, and things will look much better ten to fifteen years down the road when I start to consider retirement. Any financial advisor worth his salt will tell you to take such a long view of things. And furthermore, it’s not like we have much choice in the matter. But with what I have seen in the last several months, I am not so sure anymore.

Yes, the economy is in a very bad patch, and the stock market has taken a beating. The questions being debated now are:

1) How did this happen?

2) Who or what is at fault?

3) What do we do about it?

I suppose there is plenty of blame to go around, but what I am hearing most often is the generally accepted and unchallenged notion that the fault lies with (all together now!) “the Bush Administration policies of the last eight years”. My question has always been and still is, which Bush Administration policies are they referring to?

a. Is it the Bush tax cuts? Actually, they spurred economic growth, so how can this be the problem? Any economist worth his salt will tell you that cutting taxes is a surefire way of stimulating an economy (and of course the converse is also true, which is why now would be a horrible time to raise taxes). Were it not for the tax cuts, I sincerely doubt we would have so quickly rebounded from the double whammy of (1) the recession of 2000-2001 that followed the bursting of the technology stock bubble and (2) the 2001-2002 economic downturn caused by 9/11. Up until the middle of last year, there was indeed impressive economic growth and very low unemployment.

b. Is it the level of deficit spending during the Bush years? I would tend to agree that this cannot have helped. I find it extremely disappointing that even with Republicans in charge of Congress, the Bush administration has spent money like a drunken sailor and run up the deficit. But then again, it’s not like the other side has ever believed in spending restraint, and even now they are proposing more than a trillion dollars in new spending, above and beyond the multiple “bailouts” which have already exceeded $1 trillion in the aggregate. Actually, it is more than that, and I will explain that later.

c. Is it the Bush policy of “deregulation” (as has been repeated ad nauseam)? If that is so, please tell me exactly what has been deregulated in the past eight years. What has been abundantly clear but only grudgingly conceded and otherwise deemphasized by the media and the political left is that our current crisis was caused by the freezing up of the credit markets, which was the result of banks and investment firms realizing they had an unspeakable amount of bad debt on their books. The vast majority of this debt has been home mortgage debt, and the heart of the problem lay at the doorstep of two “Government Sponsored Entities” (GSEs): The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

Contrary to popular belief, the mess we are in has nothing to do with the failure of free markets, but rather with the reckless and irresponsible intrusion of government into the free market. The above mentioned practices of Fannie and Freddie were facilitated and encouraged by the government, primarily through the 1995 expansion of the Community Reinvestment Act. In their zeal to provide “affordable housing”, the federal government and the GSE’s facilitated, encouraged and even coerced banks into making bad loans at sub-prime rates, loans that no bank in their right mind would otherwise want to make because they are simply too risky.

If the “free market” or “greed on Wall Street” can be blamed for anything, it is for going along with the reckless behavior encouraged by the government. Their response can be summarized like this: “Okay, so these are the new rules of the game? You are actually encouraging bad loans? You are actually putting a quota on the number of loans we have to make to people who otherwise don’t qualify? We’ll go out and do it with a vengeance. We’ll even come up with all kinds of nifty products like sub-prime, adjustable rate mortgages, interest-only loans, etc. We’ll then sell them and pass them around like hot potatoes until they are “securitized”, creating an indecipherable maze so nobody knows that the mortgage security they are holding is actually high risk and relatively worthless.

All that is history. What makes me increasingly pessimistic about the future is the government’s response so far, a response which both sides of the political aisle (with a few exceptions) have inexplicably agreed to, showing that they have not learned a thing from history. And it looks like the response of the upcoming Obama Administration will be more of the same and even worse.

It was the Bush Administration that proposed the $700 billion bailout known as “TARP” (Troubled Assets Relief Program), whereby the government would purchase and hold troubled assets and hopefully be able to resell them once they regained a decent market value. They took this action reluctantly (or so they said) because in their mind it was an unprecedented government intrusion into the free market. If they were genuinely reluctant, I suppose their rationale for going forward was that government got us into this mess, and it would therefore behoove the government to get us out of it. At least that’s the way I would look at it.

Both presidential candidates and party leaders on both sides agreed that the TARP legislation was essential. Even major voices on Wall Street were chiming in, saying that things would get much worse otherwise. The only resistance to the bill was among some curmudgeonly conservative Republicans in the House, and they actually caused the first TARP bill to be defeated (in retrospect, God bless their courageous souls!). But after a similar bill in the Senate was laced with some sweet and sour pork, it eventually passed in both houses and was signed by the President.

So what has happened since the passage of TARP (a/k/a the “Emergency Economic Stabilization Act”), the bill of which we were told that the sky would fall if it did not pass? The sky fell anyway. And it continues to fall, not only in terms of the stock market, but also with regard to economic activity itself. And what lesson are we learning from this? Precisely nothing. Both sides of the aisle are continuing to rush like lemmings into a sea of economic oblivion.

How so? First of all, instead of purchasing troubled assets, the government has shifted gears by pouring money into troubled banks. And these are lining up like pigs at the federal trough. We have also been lied to about the cost of not only TARP but the multiple other bailouts enacted so far. Take a look at the Yahoo Finance site hyperlinked below, followed by the three or four paragraphs I quote from it.

Cost of the Bailout: $3.5 Trillion

The bailout bonanza has gotten so big and happened so fast it’s the true cost often gets lost in the discussion. Maybe Hank Paulson and Ben Bernanke prefer it that way because the tally so far is nearly $3.5 trillion, and that’s before a likely handout for the auto industry.

Yes, $3.45 trillion has already been spent, as details:

  • $2T Emergency Fed Loans (the ones the Fed won’t discuss…)
  • $700B TARP (designed to buy bad debt, the fund is rapidly transforming….)
  • $300B Hope Now (the government’s year-old attempt at mortgage workouts)
  • $200B Fannie/Freddie
  • $140B Tax Breaks for Banks….
  • $110B: AIG (with it’s new deal this week, the big insurer got $40B of TARP money, plus $110B in other relief)
Tallying up the “true” cost of the bailout is difficult, and won’t be known for months if not years. But considering $3.5 trillion is about 25% of the U.S. economy ($13.8 trillion in 2007) and the U.S. deficit may hit $1 trillion in fiscal 2009, hyperinflation and/or sharply higher interest rates seem likely outcomes down the road.

Did you catch that last line? $3.5 trillion is about 25%–not of the USG budget, which would be bad enough—but of the US economy; i.e., all of the goods and services produced in the U.S. in the period of one year. And now other troubled industries are starting to line up at the government trough, and nobody seems to be saying “no”. And don’t just blame the Bush Administration. Everybody is in on the act and seems to think it is all a good idea. Has everyone gone insane?

Apparently so, which is why I am not terribly optimistic that things will get any better anytime soon: not in a year, or two, or five, or even ten. It can only get worse if the Obama Administration follows through on its promises (threats?) to raise taxes and propose about $1 trillion in still more new spending. Furthermore, his stated desire to unilaterally renegotiate NAFTA and his coolness toward entering into common sense trade agreements with allies like Colombia strikes me as protectionism, which is the last thing we need at a time like this. Does anyone remember (no, we are all too young) how Herbert Hoover turned an annoying recession following a stock market crash into the Great Depression? Higher taxes and protectionism.

As my 401K nest egg and other investments continue to shrink, my ultimate solace lay in the fact that it really isn’t my money anyway. Wait a minute, Mr. Obama. That’s not what I meant, so stay away! I had better rephrase that.

Proverbs 23:5 -- Cast but a glance at riches, and they are gone, for they will surely sprout wings and fly off to the sky like an eagle.

Psalm 39:6 -- Man is a mere phantom as he goes to and fro: He bustles about, but only in vain; he heaps up wealth, not knowing who will get it.

1 Timothy 6:17 -- Command those who are rich in this present world not to be arrogant nor to put their hope in wealth, which is so uncertain, but to put their hope in God, who richly provides us with everything for our enjoyment.

Otherwise, it ain’t looking good, folks! Somebody please tell me that I am wrong.

No comments: