Three (3) Weeks ago, the Sterling Weekly, I briefly looked at five (5) issues that were weighing on the market and causing it long term weakness. Those items were 1. Political Uncertainty, 2. Financial System Weakness, 3. Taxes, 4. the Price of Oil, and 5. Dollar Weakness. In this week's edition of the Sterling Weekly, I want to address the items concerning weakness in the financial system.
It is no secret that the financial system in this country is a mess. The problems in the financial sector are causing problems throughout the economy, and there will be continued problems in the economy until the problems in the financial sector are addressed. In order to properly address these problems and get the financial sector back on solid ground again, I think we need to take a look at a couple of key items, What the Problem is, How the problem came to be, and then how we fix it.
1. What is the Problem: The problem with the financial sector is very complex, yet very simple. In its simplest terms, people bought a lot of stuff that they no longer are sure what it is worth, and or they are seeing declines in values they never thought they would see. What got bought that is causing all the problem? Well, lots of things; but it was primarily houses and the securitized loans that financed their purchases. Basically short term debt was used to buy long term assets, and it was done at the worst possible time. It was done when interest rates were at historic lows. Finance 101 says that the value of bonds, and pretty much anything else, that is tied to interest rates will decline in value when interest rates rise. Common Sense should have told more people that when rates were as low as they were in 2001-2003 they should have been locking in long term fixed rates at historic lows, not rolling over short term debt on long term investments.
2. How We Got and Who is to Blame: Who do I mean when I say "people?" Well, I mean everyone. This includes the people who bought the houses, who ran the banks that loaned them the money, the brokerage firms that syndicated the loans, and the investors who bought the loans. If you are feeling any pain right now over the real estate mess in this country, you probably did something you thought was a good idea in the past but in hind sight might not seam like such a good idea today. Don't get me wrong, I do not think the whole country is to blame. There are plenty of people out there who are not feeling any pain right now. These people may be those who were more frugal during the housing mania, or those who felt housing prices were to high and waited for prices to return to more realistic valuations and are now looking to invest the money they saved and held in reserve. But those of us who are feeling some pain must admit that we have some responsibility for fixing the problem, and more importantly not getting ourselves into this mess the next time temptation arises.
I do want to note that there is a special class of people who must share some blame for the current housing and financial mess who are not feeling any pain as a result the problems, and are actually profiting from the problem they helped create. Care to guess who it is?? The politicians in Washington who for years blocked efforts to reform the Government Sponsored Organizations (GSO) Fannie Mae, and Freddie Mac., and the Politicians who are now finding a way to profit politically from enacting a so called "clean up" of the problem.
3. What is Needed in Order to Fix the Problem: Repairing the damage to the financial system is going to take some time and more importantly it is going to take a sense of discipline that becomes long lasting and changes the way we look at things. I think we are going to be looking at changes occurring in the following areas
A. Compensation: We need to change the way we compensate the people involved in the financial system. This includes the top managers at the financial institutions, the fund managers who invest in the financial products, the people who originate the financial products. Given the level of pain felt by the investors in these organizations, I am fully confident that the market should be able correct itself in this area.
B. Regulation: Like it or not, once the government gets involved in something, increased regulation is almost always sure to follow. Like it or not, it is on its way. Right now our best estimate is that it will probably be some combination of what we see in the public company arena with the SEC and brokerage arena with FINRA. The real trick here is to make sure our politicians do not get carried away, or craft regulation that ends up doing more harm than good.
C. Our Behavior: What is really in need of change is our behavior. By this I mean that we need to change the way we look at things and the level of responsibility that we personally assign to ourselves. We need to take the responsibility to better educate ourselves about basic economics and how the financial system works. I really believe that very few people knowingly entered into transactions that would ultimately become problematic for them, but I do believe that a lot of people wanted what they wanted and made unsound decisions at the time that could have been avoided. For this we only have ourselves to blame, and in the long term only we can fix the problems.
The other area where we need to change our behavior is in the way we monitor and hold our politicians accountable. We need to pay more attention to the policies our politicians support and how those policies effect us. Unless we start doing this our politicians are going to continue to manipulate the system to their benefit, and at the end of the day most of them don't care what happens and ultimately the US taxpayers will be on the hook for the bill to clean up the mess.
In the upcoming editions of the Sterling Weekly I will be taking a look at the other four (4) issues I feel are weighing on the market. If you are not a subscriber, please be sure to sign up in order to see our upcoming comments.