September 2009 |
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With the stock market up about 50% from its lows only six months ago, many investors are breathing a sigh of relief. This particular bear market created an angst that many investors will not soon forget. For some, instead of taking decisive action to stem the losses, they simply froze. This reflex wasn't unlike the instinctive defense mechanism of a hunted animal. Investors froze by leaving their brokerage statements unopened. They froze by taking no action in the face of serious consequences. In the wild, this defense does work often enough. That's precisely why it feels so natural.
However, for investors now sensing the passing danger and finally feeling they can exhale, please note that the urge to bolt is rooted in nature as well.
It appears that revisionist history is at work by market soothsayers. When you think about it, they have no other logical choice. With the stock market down only 35% from its high reached nearly two years ago, how could they really advocate selling stocks now?
In part, to justify riding this rally further, the revisionists point out that the lows set six months back reflected an overly pessimistic view of an economic Armageddon that never happened. What isn't said is that stock prices - measured against real things like earnings and sales - certainly didn't match the depths recorded during the recessions of '82 or '73-74. All of this dismissive "the market was priced for Armageddon" talk feels like an excuse to stay the course, once again.
The relief felt by the recent market moves should be seen as a wake up call to all those who froze some months back. The instinct worked, this time. The advice to sit tight worked, this time. But, frankly, after the third or fourth instance it probably felt a little like the boy who cried wolf.
While few can reliably predict the next short-term move in the market, what can be said with clarity is that sticking your head in the sand is not a dependable strategy. For many investors, this fortunate rally begs loudly for a review of everything about your money from top to bottom.
The Great Housing Subsidy
As we look back on the government policies put in place over the past year, we are struck by how little has actually changed. Yes, certain entities that provided unseen and unseemly levels of leverage to our financial system have all but disappeared. They're done operating in the unregulated shadows because they died in those shadows. Yes, the rabid call to increase regulation on our financial system certainly earns some political points. But in reality, financial players, regulators and politicians liked the system just the way it was. It's no wonder they are doing their best not to change things much.
For example, more than 90% of all originated home mortgages are ultimately purchased by our federal government. That is an astounding figure. It is even more astounding when you consider that Fannie Mae and Freddie Mac - completely bankrupt entities that have quietly been given nearly $100 billion by Congress since they were officially taken over - are as busy as ever financing and refinancing home purchases. And now the FHA, another government agency created to lend money to traditionally less credit-worthy borrowers, is busier than ever. The demand for FHA mortgages isn't surprising given the ultra-low 3.5% down required to get a loan. However, there is now legitimate concern over the FHA's growing credit risks and the possibility of taxpayers holding the bag again. Sound familiar? But, for now, getting money flowing to the beleaguered housing market trumps all concerns. In many ways, our government is still "all-in" on housing.
For all intents and purposes, all this government involvement means that almost every homeowner has a lower monthly mortgage payment than they otherwise would have. In fact, many homeowners wouldn't be homeowners at all were it not for this government financing subsidy. To that, we can also add the large tax breaks gained by allowing the deduction of mortgage interest and from granting relief from capital gains taxes on real estate sales. This all amounts to one massive government housing subsidy. Is it any wonder then why government is now so desperately trying to turn the real estate market around?
Not only has our national over-focus on real estate hamstrung our banking system and falsely enticed millions of households to go deep into debt in pursuit of the American Dream, but it also poses a serious threat to the finances of our state and local governments that are simply too dependent on wobbly property tax revenues.
This is a problem that cannot be fixed by continued unrealistic property tax assessments and by grasping for more ways to subsidize the real estate industry. What is needed is fundamental change based on the real fundamentals of the real estate market. To adjust to that, it seems some more pain must be felt.
Austerity on the Horizon
There is a lot of talk out there about the role of government spending in response to this deep recession. The lack of consensus is obvious. It isn't a stretch to say that a majority of Americans don't understand what our politicians are doing. Alarmingly, it also isn't a stretch to say that most of our elected officials don't really have much of a clue either. What politicians do understand, however, is how to get re-elected. In fact, currying favor with the voters is what many of them are all about. And, as such, they are literally kicking the can down the road.
Too many of our municipalities, states and our federal government are running on fumes funded by borrowed and printed money. The alternative policy of living within our public budgets is largely framed as a recipe for total economic disaster and sure path into a second Great Depression. It is perfectly valid to say that running fiscal deficits - during a normal recessionary dip - is a "proven" policy response. It must also be acknowledged that the level of government stimulus has limits as well. You get the feeling that adding a projected $7-$9 trillion in additional national debt over the next decade to our already massive and growing obligations will be a real test of those limits. You also get the feeling that politicians aren't worried about this test and are instead just punting the ball down the electoral calendar.
It isn't widely known that our national debt is currently financed for an average of only 2-3 years. Amazingly, the average interest rate we must pay on our debt is nearly the lowest it’s been in our nation's history. This makes our debt seem nearly free to us now. It is most assuredly not.
The fact that investors and foreign creditors are willing to lend money to the US at such low interest rates is in part a testament to our nation's inherent strengths. What is worrisome is that our strengths are increasingly based on our past reputation rather than our true economic might. If we spend money as our current ten-year budget projects, we most surely will lose the advantages of our reputation and will be forced to pay the real price of borrowing in the years to come.
To understand what nations must do to compete effectively in a global economy - without the benefit of borrowing in your own currency from willing foreign creditors - it is useful to watch what is happening in Ireland, Iceland and parts of Eastern Europe. Austerity is a word that has yet to enter the American lexicon.
