Friday, February 06, 2009

The Recession of 2009

I haven't posted in a very long time for various reasons. However, due to current events and rereading many of my posts (last post: 11/07), it is a good time to update my blog. I thought we wouldn't go into a recession assuming most banks (posted on Jan, 15, 2007; Slumping Housing Market effect on Economy) didn't get caught up in bad loans (they did). Anyway, what a 2008! Since banks got caught in the credit crunch throughout 2008, the economy would of remained very weak. However, after the Lehman Brothers bankruptcy, this changed everything and we will see a steep recession. Basically, every day, trillions of dollars trades hands and on that day it came to a screeching halt. This will significantly effect all companies cash flow and personal finances as credit is no where to be had. Also, LIBOR spiked so high since no banks knew who was next to declare bankruptcy. We will see amazing dislocations in the market that were never thought possible. Banks will have to take more capital losses due to mark to market rules when a market doesn't even exist! I'm shocked that Lehman was allowed to fail and at the very least, the treasury and banks didn't get together to salvage it, but will result in the following:


The night I heard Lehman was declaring bankruptcy (was a Sunday night, Sept 14th), The first thing that came to my mind was the huge global unemployment that will occur. It won't be the ones who made bad decisions borrowing money but will now effect ones who had nothing to do with bad decision making. I thought we would see significant deterioration in the job market in January... But to my surprise, it was evident a few weeks later when GE couldn't roll over their debt. Can you imagine a transparent, publicly traded triple A company having trouble borrowing money. Imagine what it is like for the private small businesses and personal loans. Companies can only reduce expenses and layoff employees to compensate for the lack of short term credit (used for payrolls) and funding uncertainties. Interestingly, everyone rapidly adjusted their spending habits but now this will cause further reduction in employment as companies have to adjust to current revenue/income streams. Unemployment will go up quick, I won't be surprised if we see 10% unemployment by the end of 2009. Many friends and colleagues didn't take me serious when I said this the following day but it appears, unfortunately, we may reach this number.


This steep recession gives Washington DC an excuse to spend and pass more egregious laws: we will get through this recession like we did in the 1800's and early 1900's without government help. What worries me the most is what the government planning to do now. I'm all for good regulation: Such as Credit default swap rules so we don't have another AIG. But in general, the more they get involved the worse off, as a whole we will be. Upon a brief view of the stimulus package, this will do very little for growing the economy. I can't get over all this policy and talk about consumption. Everyone wants to spend on all things but it doesn't give incentive to work hard and take entrepreneurial risk. So if we give incentive to produce (like cut corporate taxes, marginal taxes) then we will have "animal spirits" grow the economy.

Another problem with this stimulus package; we are borrowing money from the future which means we still have to work to pay it off some day. Moreover, we have proved many times over (in many different cultures) giving money to people for nothing does nothing for the economy. If there was such a world, we could give everyone a billion dollars each and no one would ever have to work again! Funny, but that's the logic Keynesian's really are saying. (By the way, Keynesian was a great Monetary economist and made great contributions to the field. To his credit, when he went to government conferences in his older age, he was the only one who didn't believe in his own earlier theories by growing the economy via consumption. He said "the only non Keynesian in Washington DC is me".). Clearly, this logic doesn't make sense!

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Thursday, November 08, 2007

Weak Dollar, Federal Reserve and a good idea for our Government

The weak dollar has deteriorated so much lately that the fed may have to stop cutting rates. Originally, I didn't think the dollar would deteriorate this fast in the last 2 months. When previous credit crunch problems occurred, the dollar was very strong so inflation wasn't a threat. As a result, the fed could cut the rates when these problems came up in the past (1990 crunch, 1998 crunch, etc). Bernanke will have a tougher time, as compared to Alan Greenspan, deciding what interest rates should be with these current economic conditions.

This weak dollar is more fundamental economic problem than a liquidity problem. Our government (federal, state, local) and entitlements (our new prescription drug plan is an 8 trillion dollar liability) has grown so much in the last 7 years that this makes our economic growth potential is much lower going forward. Moreover, our government has protectionist sentiment as well as threats of bank regulations. As a result, investors are looking for more investor friendly environments such as Europe, Asia, India and South America. Can you imagine that these countries have a better relative future capitalist environment than the US. Its shameful that we promote freedom around the world yet we aren't evolving more that way as well.

Going forward, our government should immediately cut the corporate tax rate to strengthen the dollar. This is an easy one since our corporate tax rates are the highest of all developed nations. President Bush is finally doing the right thing by vetoing pork programs but the Congressman and Senate may override his vetoes. Its unfortunate that these representatives have no idea about the damage they are doing to our future prosperity (as per my equation). This is another reason why government should focus on governing people and not meddling around with economics. Its a shame that voters no longer have a choice since both parties believe in big government.

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Saturday, November 03, 2007

Global Growth and Emerging Capital Markets

The Global growth story is for real now since there is actually more freedoms in the world. Europe, South America and Asia are going toward a more free society and this a wonderful thing for prosperity. This makes me very happy since more people have come out of poverty in the last 10 years than the previous 100 years before 1997.

On another note, the stock markets in these respective economies are growing faster than companies earnings. As a result, the markets seem to be in a bubble type scenario. However, considering all the investment dollars flowing into these emerging markets (since their economies are more supportive of capitalism), these capital markets will not crash all together. Moreover, the strong currencies in these markets will help keep up the value of emerging assets. Even if a countries stock market does crash, they will still be able to grow their respective economies at a healthy clip (assuming their banks aren't caught up in the crash).

Having said that, investing 20-30% of your money in diversified international investments (including emerging markets) will be a great way to capture this amazing growth story. Moreover, its a great way to mitigate the risks of a falling US Dollar. Considering the US protectionist sentiment and the growing size of government, our GDP growth will not be so good in the future.

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Thursday, September 27, 2007

Greenspan's Book and Future Entitlements

Haven't read Alan Greenspan's Book, The Age of Turbulence but I will certainly read it soon. I did see his interviews and he is doing a great service to society. He's telling everyone like it is and the imminent problems we will have if we don't make changes today. Entitlements will cripple our future prosperity if we don't make changes as soon as possible. More importantly, if we make changes now, it gives young people the ability to plan for the future knowing that these entitlements won't be available. Unfortunately, many young people still believe that the government will take care of them when they retire. Frankly, it's going to be hard enough to support the retirees in 2015, never mind in the year 2040. As I mentioned in previous blogs, as per my equation, these programs were doomed from the start. Unfortunately, the whole world designed programs similar to ours and will have the same tough choices going forward.

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Wednesday, August 15, 2007

Federal Reserve, Future Fed Fund Rates and Economic Growth

Had three main theme questions about these areas: Despite what the critics say, Bernanke and the Federal Reserve did a great job handling this credit crunch. They injected enough liquidity into the markets without bailing out the overly leveraged market participants. If they yield to the critics, there would be a moral hazard problem (markets will do more mispricing and over leveraging) in the markets and a further weakening of the dollar (which will cause more inflation). Frankly, we have to avoid these scenarios since this will cause bigger economic problems in the future.

On another note, expect the Fed to cut rates going forward. Probably a quarter point rate cut at every meeting until the rate is even with the 90 day T-bill rate, currently a 4.10% yield. Don't be surprised if they cut more aggressively to meet the T-bill rate, say 50 basis points Sept 18th. Nevertheless, it will be interesting if the 90 T-bill yield grows to meet the rate cuts in the next few months. Bernanke will stop cutting rates when the fed rate meets the 90 T-Bill yield, say 4.25% to %4.00.

Economic growth will slow as a result of the credit crunch but we will not go into a recession. As I mentioned on a previous post (1/15/07), banks will have to tighten their lending standards and take some loses on their books. This lose will require banks to raise more capital and tighten their lending standards. Therefore, some previously credit worthy borrowers will not get loans under new terms and the interest rates will go up to reflect the "properly" priced risk. As a result, the slowing velocity of bank financing, tighter loan standards and higher rates will result in a slowing of the economy.

Feel free to ask anymore questions:)

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Tuesday, August 07, 2007

Credit Problems

I don't want to say it but: " we knew this was going to happen". Actually, these recent credit problems have been causing quite a stir at some financial institutions. However, the average person shouldn't worry about these problems. The market is taking out the bad lenders and bad equity funds that mispriced mortgages, credits and bonds. So there is a halt in the flow of funds to figure out what is the market price to sell these instruments. Mispriced risk has to be readjusted so banks can begin selling bonds again. So the sooner the banks holding this debt figures out what to price different instruments, the sooner this credit problems will abate. Unfortunately, all institutions holding this debt are going to take a hit on their earnings but well run institutions have very healthy balance sheets anyway. More importantly, these risk adjustments will go back to normal historic levels which is very healthy for the capital markets (and therefore, economic growth).

The Federal Reserve should not come in and save the most egregious risk takers. We knew for years that these low interest rates, teaser rate ARM mortgages, and the high leverage used by hedge funds couldn't last forever. So all these years of easy profits have finally comes back to haunt many individuals. In summary, this correction will take out all the mismanaged funds and risky market participants.

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Monday, July 09, 2007

Federal Reserve's part in the economy

I'm amazed how much credit people give to the Federal Reserve Board for economic growth. Yes, they have the power to destroy the economy if there is bad leadership. However, the reason why economies grow is due to human nature with the ability to learn and develop new ideas. The best way to understand the purpose of the Federal Reserve Board, we have to look at a time before they existed. So how did our economy perform before 1913? This was the year the Federal Reserve Board was created by our government and before this time, our economy grew like wild fire. The government created the Federal Reserve in 1913 to take the volatility out of the banking system (the banks would have problems with liquidity if some of them failed due to a cascading effect. As a result, other banks had to call back loans since the system is built on leverage. This would cause a contraction in lending).


To illustrate this liquidity scenario, if the Federal Reserve banks would of stepped in and provided liquidity in the early 1930's, the banks wouldn't have to fail like they did. These banks failing and contraction of lending resulted in a recession (Hawley Smoot Act and the new Deal made it a Great Depression). So poor leadership of the Reserve can certainly cause economic hardship.


So the Federal banks main concern is inflation and in times of crisis, liquidity. Is a matter of fact, Milton Friedman proved that inflation is a monetary function and nothing else. Paul Volker, Alan Greenspan and Ben Bernanke believe this since what they say and their actions support this theory. Needless to say the economy has been doing quite nicely by them just focusing on inflation. Looking at empirical economic growth data around the world, the reserve boards that focus on keeping inflation low have been doing quite nicely as well.

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