Fixing Today’s Crisis With Mass Economic Stimulus… But Will Asset Values Ever Recover?
Tuesday, February 10, 2009
by Karim Rahemtulla, Investment Director, Smart Profits Report
Dear Smart Profits Report Reader,
Be it around the water cooler, at the dinner table, or in the airport bar watching a television network talking about it ad nauseum… there’s one major discussion point for investors…
Will stock prices recover… ever?
It’s a pretty valid question too, when you consider that to date, the amount of wealth destruction between the market decline and the decline in residential real estate is approaching $20 trillion worldwide.
And as the biggest economy (plus the one that started the mess in the first place), America has suffered the greatest losses.
A Stateside “French Revolution”
You’ve heard that fear and greed are the two main forces that drive the stock market, right? (Check out that link if you haven’t).
Well, the financial pundits have the Fear Machine cranked up to the max at the moment, with some calling for a 10-year recession.
If that isn’t a depression, what is?
This past weekend, protesters bussed themselves to the home of John Mack, CEO of Morgan Stanley (NYSE: MS) to protest about their mortgage terms.
Together, they held up signs, reading: “Fix Our Loans, Save Our Homes” and “Shame On You, CEO.”
The scene was eerily reminiscent of the scenes from the French Revolution that I read about a long time ago in one of my history classes. Except today, we’re vilifying the bankers as if they were the new ruling class that sucked up all the wealth.
But why not pick on Mack? After all, his mansion in Rye is probably a mini-Versailles.
The problem is… if we start blaming the bankers for everything, then we’re fooling ourselves about why the crisis happened…
Sucked In By The Lure Of The “Dream Home”
Don’t get me wrong… these new Barons were culpable. But no more culpable than the couple in the crowd who complained that their house payment jumped from $2,500 to $3,500 after their mortgage rate adjusted.
They said if they’d known things would get this bad, they’d never have bought the house in the first place. And they said they’d have walked away if it weren’t for the possibility that if they’d balked at the loan terms (which they said changed at closing), they’d lose their down payment.
I don’t know about you… but I don’t usually go to a closing unless I know what the documents say in advance.
They mentioned that the down payment was $25,000. Basic calculations tell me that they paid 5% down on their home. That said, their “dream home” was probably well underwater already. And therein lies the problem. No amount of protesting is going to change that.
And the culpability doesn’t end there either…
Al Advocated The “ARM”… But It’s Now Costing America An Arm And A Leg
During the height of the housing boom a few years ago, I remember former Federal Reserve chairman Alan Greenspan saying that people should take out adjustable-rate mortgages.
The old man was wrong on that one. Those kinds of loans are a huge part of what has caused the major hangover for the U.S. economy today.
Then there’s that ill-advised initiative to make sure that everyone who had a pulse be allowed to own a home - even if that meant loosening credit guidelines and offering no-money down mortgage programs.
When the head of the printing press tells you not to worry, chances are you’ll listen. Many Americans did - and although some acted rashly without considering the consequences - let’s dump some blame where it belongs.
It would be easy to say that the bankers concocted these “specials” on their own, but that would exonerate the politicians who planted the seed for such programs by loosening regulations.
What This Double-Edged Problem - Means For The Road Ahead
Put simply, we have a two-fold problem…
- Nobody trusts the value of assets these days - not even the asset holders themselves.
- Nobody wants to lend money to someone who will likely not be able to pay it back because the values of the assets backing the loan are falling.
A close banking industry source tells me that housing appraisers are now coming in “light” (as he puts it) with their property appraisals. That basically means erring to the downside.
He also says that if you want a good rate, you’d better have full documentation and a FICO score of 720-plus - otherwise you’ll pay more. This means that - and wait for this rocket science equation - only those able to repay loans should have money lent to them. Excuse my sarcasm… but what a novel idea!
The bottom line is that credit contraction is all about tight money - and we’re on that road now. Right now, you have to possess great credit to get a loan. But if you have great credit, chances are you don’t need a loan because you know how to manage your money properly in the first place.
But like most investment-related things, it’s reversion to the mean that counts. And there’s the rub…
To Extremes… And Back Again
Whether it’s the markets, investor sentiment, or financial punditry… they all have one thing in common: They always go to extremes before returning to the mean.
The Markets: We’re already down close to 45%. What’s another 10% to 20% from here?
Investor Sentiment: This is so negative at the moment that most agree it can’t get too much worse. That said, the risks are now more to the upside.
Financial Pundits: These guys are out in full force - as would be expected. Names like Dr. Doom are monikers given to guests on financial shows. Analysts who were lucky enough to predict the recent collapse (even while their firms were giving “buy” ratings to the underlying sectors) are now superstars, not unlike the Mary Meekers and Henry Blodgetts from the days of the Internet boom. And we know how that story ended.
Nobody wants to simply hang around and wait for this crisis to play out. Many wanted the answers yesterday morning… with the cure coming by the evening.
Sadly, there’s no quick cure for a full-blown crisis of this scale, which leaves investors, employers and everyday consumers frustrated.
Banks will not give away assets until they have no choice - because the government isn’t going to nationalize banks for fear of a wholesale market collapse. By the same token, individuals aren’t going to pay on loans they’re already upside-down on.
But given time - and with all the stimulus in the pipeline right now - these problems will be resolved. Some of them will be painful, but ultimately the market will revert to the mean and likely head the other direction.
What you must try to do - as tough as it may seem - is have the fortitude to ride it out and be one of the winners when it’s all said and done.
Karim Rahemtulla
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