Friday, September 05, 2008
Back at Purdue, when I used to play a lot of contract bridge, there was a saying that unfortunately I found to be too true: One peek is worth two finesses. It simply meant that if a player could catch sight of an opponent's hand he could see for sure what the opponent held as opposed to using laborious finessing techniques to find the truth of who held what. Yesterday the stock market was down 344 points without economic data that would justify such a sharp fall in prices. Late in the day, my assistant, Carol Stumpf, asked me why the market had fallen so much. It was actually a question that I had been thinking about and just before I answered her, the thought rang through my mind: One peek is worth two finesses. I answered her that bad news on employment during the day had caused some weakness, but that tomorrow (Friday) big numbers were coming out and my guess was that the data were going to be ugly. She asked me how I knew that, and I said that I didn't know for sure, but today's action (Thursday) of stocks told me that somebody knew something for sure. Tomorrow's employment data had leaked and the recipients of the leak had beaten the snot out of the market. So what does this leak have to do with the long-term view of the market? Nothing. It just shows that Wall Street is still up to their old tricks of peeking if they can and pounding us little people half to death with their trading in advance of our knowledge of the the facts. This may seem like a bit of a stretch, but consider this. The employment figures were, indeed, ugly today: unemployment jumped to 6.1%, the highest since 2003. And on the day of this seemingly ugly news, stocks are up nearly 35 points. Please don't try to tell me that the market is up today because there is good news. The market is up today because the short sellers yesterday are covering their shorts today. Many people who had no idea of what was going on were probably drug along in the sales frenzy from yesterday and will regret it in a few months. The bad employment news actually has a silver lining. It definitely puts the Fed on hold; they will not be raising rates anytime soon. Indeed, the rate cuts they have made thus far have not had time to do much to stimulate the economy. It is well known that Fed cuts take 6 months to a year to filter their way through the economy. Bill Gross of Pimco Investments, the largest bond fund in the US, also had a bit to do with yesterday's fall in stocks when he called on the government to start treating the current slow economy like a 1929 type situation. He said a tsunami of selling had caused the markets to freeze up because banks and other financial intermediaries were dumping anything of value to raise enough capital to stay viable. Bill Gross does a lot of lecturing to the government and the markets and I usually think he is full of himself, but in this case I don't think he is far from the truth. I believe, as I have said here previously, that the government needs to quit finessing the weak mortgage and real estate markets and get in these markets directly, especially the mortgage market. They need to be buyers of mortgages, which will drive down mortgage rates and entice people to buy the glut of unsold houses and also allow people with good enough credit to refinance to do so. The Fed has cut rates from 5.25% to 2.00%, yet mortgage rates have hardly budged because of the perceived risk of mortgages. The US government needs to get a lot more aggressive. If they would do this, the banks would also benefit because they could then sell some of the mortgages they have at good prices, freeing up funds that would enable them to make loans elsewhere. Consumers and businesses would benefit because the banks would be back in the banking business instead of in the risk aversion business. Ben Bernanke is considered to be one of the world's experts on reviving an economic collapse. In my judgment, we are a long way from an economy of the 1929 variety, but Mr. Bernanke can be sure that it never gets that bad if the Federal Reserve and the Treasury Department of the US government begin to take aggressive actions to bring stability back to the credit markets. The most expedient way to do that is for them to become direct buyers of a variety of asset classes from corporate bonds to mortgages --even the equity of certain important institutions. I remain convinced that this will ultimately happen, but I believe it would be far better to do this prior to any escalation in the crisis. The US Government is the lender of last resort. The ugly employment statistics today flickers like a 1950s neon sign: "Last Resort Ahead." If the Fed and Treasury do their jobs in a bold and creative way, the real estate market will turn sooner rather than later and with it the stock market, and in a year, today's employment statistics will seem like a aberration . If the Fed and Treasury do not take bolder actions, unemployment is probably going higher and the economy will soften by the fourth quarter. Here is the most important statement of this whole blog. The Fed has done a lot to provide liquidity and keep the economy chugging along; the problem is the banks. As a matter of survival, they have not passed on the rate cuts; they have kept the extra spread for themselves. Thus the Fed's actions have been muted. The US government needs to get directly into the "peeking" business. Not the dishonest kind like some bridge participants, but the kind that puts the Fed in the position of being a direct buyer and seller of a wide range of securities that will enable them to affect the markets in a more efficient way, instead of trying to finesse the economy through the banks.