Thursday, August 16, 2007

Sally Forth Mr. Bernanke, Sally Forth

By Greg Donaldson and Mike Hull Terra incognita is a beautiful Latin word that means: "the unknown lands". As Wikipedia says, however, its simple meaning over the years has taken on a sinister quality, because of the word's use in map making. Wikipedia explains that cartographers labelled "unexplored or unknown regions"(terra incognita) with "Here be dragons". Unknown lands, then, are not lands of potential milk and honey or amber waves of grain, they are places where dragons roam. In the recent market selloff, all financial companies have become terra incognita, and thus, knee deep in dragons, whether or not they have subprime loan problems. When Merrill Lynch goes from reiterating a buy on Countrywide Credit on last week, to issuing a sell on Wednesday and using the words liquidity crunch and bankruptcy as the reasons, we realize we are not in a charted territory. There is no way to see a daily map of Countrywide's financial position. We suspect not even the Countrywide people actually know what is going on, particularly after Merrill's call. And we strongly suspect that the list of banks willing to loan Countrywide money is now a lot shorter than is was last Friday. The dragons are on the loose and they will continue to devour company after company until the full extent of the less-than-prime mortgage market is known, and that could be awhile. For this reason, it is time for the Federal Reserve to get into the dragon slaying business. They need to cut rates and cut them now. Don't wait for the next meeting, don't wait for the economic data to show weakness, don't wait for inflation to go to zero. Cut rates now and be prepared to cut them again if the overall stock markets do not calm down. Unless the Fed does this, investors will continue to be left guessing where the dragons will strike next, and the banks will tighten credit farther and farther, which will practically assure more dragons will be loosed. The reason the cartographers put dragons in the unexplored lands was because no explorer had had the courage or resources to go into that unknown land and say that there were no dragons to be found. That is what the world needs Ben Bernanke to do. He needs to stick out his neck and show the world where the dragons are and are not, and he does that best by cutting rates to assure investors that a recession is not on the horizon. In our judgment, this crisis will end when the Fed begins to cut rates. It's just a question of how long before they have the courage to act.