Financial market thoughts...
There has not been much inspiration here for comments since last Wednesday's post. Until yesterday the financial markets have been a directionless mess, and the reprieve is only that. The Democratic primary has gone from being mostly entertaining to almost uniformly unattractive. McCain's skin cancer history has received extensive press coverage as well as his not being friendly to a New York Times reporter. The Spitzer downfall - happening to anyone else it would have been the opportunity for a "what a tragedy" comment but this guy was so awful to other people and so experienced in deceit and blatant ego gratification before this that there's nothing that can be said. Still reeling from all of this here are, nevertheless, some comments on the financial markets.
---Yesterday's Fed action was effective at least for a day or two because it showed an awareness of the real issue which is the lack of almost any liquidity in some major financial market segments. Some analyst said, however, that it's like finally doing the right thing for a patient that's already three quarters dead. That doesn't matter. Nothing will solve this situation soon, but doing the right thing one day or week at a time will ultimately get the market through this.
---Which brings to mind scrolling market headlines during this day something like "Dollar falls to record low as Fed plan won't work" or "Stocks give up gains as credit losses will continue despite Fed move". Does anyone smart really think that there's any solution that will turn this situation around on a dime, like this week? We'll know when the turn comes six months after it happens when we watch market commentators scramble to demonstrate that they knew it all along.
---Want a radical idea for the Fed if this credit market illiquidity continues? It should coordinate with other regulators, Bush or whoever thinks for him, and leading financial folks in Congress to announce that the Federal government stands behind Fannie and Freddie and Sallie. It has been presumed to be the case for a generation if some last resort scenario came up. Why not do it now. They could set a time frame, say three years, for which the guarantee would absolutely be the case and then use that period to come up with business mandates and a system of governance that would work long term for these entities that pay like investment banks but have an implicit back up and chronically poor systems, controls and operating management. This action would at least put some floor under the housing market(that floor might still be in the basement but it would reassuringly be there) and it would create at least one major market related to the mortgage business that has absolute liquidity. Moral Hazard??, we could soon be long past the time to worry about that this time around. Naive and Complex considering all of the stakeholders??, complex for sure and perhaps eventually necessary.
---One thing that it appears might have been left out of all of the modeling financial institutions do is free will. The models for potential losses on mortgages at well run institutions have apparently not turned out to be too accurate. At less than well run institutions these models have been fatally flawed. Sub-prime has been the market most focused on. The biggest modeling mistake was obviously the presumption seemingly of the worst case scenario being stable home prices(no more growth), and from that it follows that one thing left out of the equation completely was that people with negative equity might face up to the facts and decide to start over rather than keep funding a losing investment . In a different way that's now turning out to be the case in the home equity loan market as well. Home equity loans actually have no access to collateral as long as the primary mortgage is being serviced. The majority of home equity loans stand behind a primary. Homeowners can be smart enough to keep servicing their primary and stop servicing their home equity. That puts home equity lenders and securities holders in a pickle to say the least. Might not have been in the model.
---Yesterday's Fed action was effective at least for a day or two because it showed an awareness of the real issue which is the lack of almost any liquidity in some major financial market segments. Some analyst said, however, that it's like finally doing the right thing for a patient that's already three quarters dead. That doesn't matter. Nothing will solve this situation soon, but doing the right thing one day or week at a time will ultimately get the market through this.
---Which brings to mind scrolling market headlines during this day something like "Dollar falls to record low as Fed plan won't work" or "Stocks give up gains as credit losses will continue despite Fed move". Does anyone smart really think that there's any solution that will turn this situation around on a dime, like this week? We'll know when the turn comes six months after it happens when we watch market commentators scramble to demonstrate that they knew it all along.
---Want a radical idea for the Fed if this credit market illiquidity continues? It should coordinate with other regulators, Bush or whoever thinks for him, and leading financial folks in Congress to announce that the Federal government stands behind Fannie and Freddie and Sallie. It has been presumed to be the case for a generation if some last resort scenario came up. Why not do it now. They could set a time frame, say three years, for which the guarantee would absolutely be the case and then use that period to come up with business mandates and a system of governance that would work long term for these entities that pay like investment banks but have an implicit back up and chronically poor systems, controls and operating management. This action would at least put some floor under the housing market(that floor might still be in the basement but it would reassuringly be there) and it would create at least one major market related to the mortgage business that has absolute liquidity. Moral Hazard??, we could soon be long past the time to worry about that this time around. Naive and Complex considering all of the stakeholders??, complex for sure and perhaps eventually necessary.
---One thing that it appears might have been left out of all of the modeling financial institutions do is free will. The models for potential losses on mortgages at well run institutions have apparently not turned out to be too accurate. At less than well run institutions these models have been fatally flawed. Sub-prime has been the market most focused on. The biggest modeling mistake was obviously the presumption seemingly of the worst case scenario being stable home prices(no more growth), and from that it follows that one thing left out of the equation completely was that people with negative equity might face up to the facts and decide to start over rather than keep funding a losing investment . In a different way that's now turning out to be the case in the home equity loan market as well. Home equity loans actually have no access to collateral as long as the primary mortgage is being serviced. The majority of home equity loans stand behind a primary. Homeowners can be smart enough to keep servicing their primary and stop servicing their home equity. That puts home equity lenders and securities holders in a pickle to say the least. Might not have been in the model.
posted by John Borden at 2:27 PM
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