• 20 hours Markets Unfazed As Inflation Hits 13-Year High
  • 2 days How the Token Economy is Disrupting Financial Markets
  • 4 days FBI Investigating 100 Types Of Ransomware Attacks
  • 6 days Fed Ends Corporate Credit Emergency Lending Program
  • 8 days AMC Becomes the Latest Winning Meme Stock After GameStop
  • 9 days The Real Reason Your 401k Has Been Lagging
  • 10 days China Lifts Cap On Births, Allows Three Children Per Couple
  • 12 days The Market Is Ripe For Another GameStop Saga
  • 15 days Senate Grills Big Banks Over Pandemic Opportunism
  • 16 days Cannabis Has A Major Cash Problem
  • 17 days Ransomware Netted Criminals $350M In 2020 Alone
  • 18 days Russia Is Taking On Google
  • 19 days Chinese Regulators Deal Another Big Blow To Bitcoin
  • 20 days Ohio Residents Brave Vaccine for Chance To Win $1M
  • 22 days Inflation Is Coming. Are You Prepared?
  • 23 days 3 World-Shaking Trends Investors Need To Watch This Year
  • 23 days Travel Might Get Another Supersonic Disruption
  • 24 days The World Is Running Out Of 6 Key Resources
  • 25 days $15/Hour Minimum Wage Might Happen Naturally
  • 27 days Money-Laundering Binance Probe Report Adds To Bitcoin Woes
The Problem With Modern Monetary Theory

The Problem With Modern Monetary Theory

Modern monetary theory has been…

What's Behind The Global EV Sales Slowdown?

What's Behind The Global EV Sales Slowdown?

An economic slowdown in many…

Zombie Foreclosures On The Rise In The U.S.

Zombie Foreclosures On The Rise In The U.S.

During the quarter there were…

  1. Home
  2. Markets
  3. Other

Whats Next and Why I Like Cool

After a couple weeks of volatility in the markets, many investors have begun to ask themselves: "What's next?"

Will the market slide further? Will the economy be affected? Or are investors panicing without reason, and is the market ready to resume its upward march?

A central focus within these questions - as always - is: "What will the Fed do?"

Let's take the last question first.

Anyone who becomes Chairman of the Federal Reserve is very astute at understanding power structures and who pulls what levers to help someone get to the top. I am 100% sure that Ben Bernanke is aware that the next President of the United States will be the person to decide whether he gets nominated to a second term or not. According to the polls and common sense, that President is most likely to be a Democrat and most likely to be Hilary Clinton.

Everyone on Wall Street expects the Fed to act very quickly to lower rates to help the banking system. Before reaching such a conclusion, isn't it helpful to ask: "Do you really think Hilary Clinton would mind a recession leading up to her presidentail campaign?"

Plagued by the Iraq War AND a recession, would the Republicans have a chance? Wouldn't she actually be very appreciative of a "responsible" Fed chairman who helped induce a mild recession?

Another fact is history. Greenspan spent 18 years encouraging credit growth. That credit growth expanded to ludicrous and dangerous proportions.

Recently, people with bad credit histories who could not qualify to rent a house could easily qualify to buy it! With no money down. The next day after bankruptcy, borrowers could get low interest rates and lots of money. Worse still, many other loans had floating rates, which meant that if interest rates rose (which they did) the homeowners were unlikely to be able to afford their houses in 2 years time. Well, 2 years time is starting to be up for many of these loans, and guess what? Default rates are skyrocketing! Interestingly, late into his tenure, Greenspan actually spoke out in favor of floating rate loans, encouraging more Americans to take them.

Like the dot-com bubble before it, this mortgage bubble is exposing a lot of dubious assumptions and fraud. Given that the Federal Reserve lowered rates to historically low levels during the beginning of this bubble (thereby encouraging it) and neither did nor said anything to prevent it, there is clearly some responsibility that lies in the hands of the Fed. For history's sake, Bernanke does not want anything to do with this mess. He will want to be strong and show that he is not easily persuaded into lowering rates just to bail out the banks and mortgage brokers who acted irresponsibly. Bailing them out might encourage even more irresponsible behaviour in the future and lead to an even greater bubble.

So, because of the Clinton factor and the history factor, Bernanke might be slower or at least more reluctant to come to the rescue than many market watchers are expecting.

That said, once a President nominates the Fed Chairman for another term, the nomination must be approved by Congress. If Bernanke sends the u.s. economy into too deep a recession, he runs the risk of alientating the public to such a degree that no Congressperson will be able to support his nomination.

Therefore, I expect the Fed to lower rates but in a very tempered fashion.

So, what does a tempered Fed mean for the financial world and the economy?

My conclusion is that the lending market will slow.

Banks have been selling CDOs and other CLOs and other fancy products to insurers, pension funds, and foreign banks for the last several years. Those products are now experiencing much higher rates of default than the banks led their clients to believe. As a result, these clients are highly unlikely to accept new products, even with lower interest rates. With the end of excessive lending, look for the housing market to continue to decelerate, with most markets seeing serious price declines. Look for the LBO market to dimiss and asset prices to come down. Most important, look for any company that has lots of debt and weak cash flow (a lot of the companies that have been LBOed) to be in serious trouble. Look for the banks to use the lower interest rates from the Fed to shore up their balance sheets and increase spreads.

But I do not think the banks will have the audacity or willing clients to pass along the benefits of lower rates via newly-conceived "financially-innovative products."

As a result, it is likely the U.S. economy will continue to slow. Without the "juice" from excessive lending, consumers will pull back and consumer-oriented companies geared towards U.S. consumers will experience less growth. The ripple effects will be felt to some degree by many U.S. industries.

At the same time, the strong global economy should provide some level of relief. With new consumers in India, China and myriad other parts of the world, other countries may be able to compensate for slackening U.S. consumption.

Looked at from a different perspective, the U.S. might have to rely less on "financial innovation" and more on good, old-fashioned manufacturing for its next stage of growth.

If such a scenario unfolds as outlined above, the most important conclusion for investors is: "Don't be leveraged!" For years, there has been a strong benefit to being leveraged. Entire industries (private equity, mortgage brokers) have grown out of this idea.

Now, the world might turn on its head. In both one's personal finances as well as one's investments, less might be more. The sages of wall street seem to have forgotten: "Less leverage means more upside in a downwardly moving market." It's a concept that's very out of fashion.

But this time, by being unfashionable, by the end of the night you might be the coolest kid at the party.

I like cool.

 

Back to homepage

Leave a comment

Leave a comment