Now For The Financial Hangover

Ready For The Financial Hangover?

I wish I had better news. But the economy shows no signs of getting better, and the worst pain is yet to come. This is the last time I am going to write about his for a while, because it is so damn depressing! However, since I am working on a series of financial books, I need to write something about what is going on.

Those of you who know me understand that I am a pretty optimistic fellow. I’m always doing something fun and creative, and see the world as a glass that’s half full. But a good deal of my training is in economics and investing, and what I see is truly ugly.

This all began more than a decade ago. Alan Greenspan was at the help of the Federal Reserve. Al Gore had just “invented” the Internet, the “Information Superhighway,” that was supposed to make us all rich and cure cancer.

The stock market took off like the proverbial rocket. I could use a more graphic image here, but I refrain. Bill Clinton was in the Presidency and it was a “feel good” time, where America was king and the world was laying at our feet. I could get graphic here, too, but that is not my intention.

What we saw was an “irrational exuberance” (Greenspan’s word) that defied reality. People were thinking that the Internet was going to lead to enormous profits, while forgetting the fact that it would lead to cutthroat competition.

I realized this in 1999 when I decided to buy a high-end video camera. The Canon recorder that I wanted cost $3,800 at local retailers. This included the big box stores that usually sell things at reasonable prices. The list price was over $5,000. Being the hip consumer that I am, I logged onto the Internet and shopped at hundreds of stores with the click of my mouse. I was able to find the same recorder listed in Texas for $2,100. I could have bought it in Singapore for $30 more. But I was able to check the Houston store out in the online yellow pages and the BBB, so I was reasonably sure that my money was good if I sent it there (again over the Web).

A couple days later I had my super dandy, movie quality recorder. I had also learned a powerful lesson, that the stock market was in deep doo doo. With the S&P selling at more than 36 times earnings, more than twice its usual P/E ratio, all based upon the assumption that the Internet would lead to greater profits, I had learned the opposite, that it would lead to a consumer revolution of lower prices and greater competition among businesses.

In late 1999, I told any client that would listen that it would be a good thing to move a good deal of assets to cash. I did the same thing last September, when I issued my first blog warning on the impending bear market.

How are the two related?

In the year 2000, when reality set in, the market was more than 100% overvalued. A “normal” market would have been about 50% lower. Now, if the stock market drops 50%, we have another word for that. Depression. Maybe not a full-blown depression, but a severe recession that would cause a great deal of problems.

Alan Greenspan decided to soften this blow by creating the housing boom. American business had just gone through an enormous spending binge, updating to the new world of the Internet. So, the economy would have to be driven by consumers. This is usually the case, as about 70% of our economy is consumer driven. As business spending went into shut-down mode, it was up to you and me to keep the economy afloat. And we did. Each new interest rate drop brought greater real estate values. We took out new mortgages and spent our equity like never before. We bought new cars and new homes. We went on vacations. We had fun.

Well, all good parties come to an end. And this one was a grand party, one worthy of John Belushi and Jamie Widdoes. A real toga. Now the hangover begins.

While consumers had their mortgage party, Wall Street did the same. Few of you have (probably) ever been to a Wall Street party. Suffice it to say, the old adage that the “rich” don’t think like you and me is magnified on Wall Street. Guys were spending $100,000 per seat for the Victoria’s Secret show. They were spending millions of dollars on new cars and their weddings, and tens of millions on their homes. All of this was fueled with equity out of your home and mine, courtesy of big Al.

While this was going on, Wall Street got fooled again. They started to believe that all of the mortgages were real. I know that they believed this somehow, because so many of them got caught with their pants down on stage. They lost billions. No, hundreds of billions. No, maybe trillions. Most of the people that created this mess are still living in their Westport homes and driving their Porches. They may have sold their Ferraris and their third vacation homes, but they are still living well.

It is the American taxpayer that will pay for this toga party. We are going to have to clean the puke off the floor and pick up all the ash trays. That’s a nasty thought, hey?

The latest shoe to drop in this whole mess is the fact that Fannie Mae and Freddy Mac are in trouble. (Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation). Well, duh. These names may or may not be familiar to you, but you better learn their names. Because you may own them soon.

Fannie Mae and Freddie Mac are quasi-government organizations that are publicly traded, like IBM and Microsoft. They exist to provide mortgage liquidity to the U.S. homeowner machine. They raise money by selling stock and bonds to the public. They also borrow money from the Federal Reserve. Remember big Al and his Internet party? These companies use their capital to buy mortgages from your local broker or bank. They package these mortgages and sell them to the public through agencies like the Government National Mortgage Association. If you own any “Ginnie Mae” securities, you own some of these. Many mutual funds own these as well, as do foreign investors and foreign governments. In order to keep mortgages competitive, and mortgage rates low, the U.S. government provides a guarantee on the securities issued by these public companies. Oh, oh.

These companies have issued more than $5 trillion in securities that have the backing of the U.S. government. So, when these things go in the “tank” it is the American taxpayer that will provide the mouth to mouth. Our nation currently has about $9 trillion in debt. We may be about to increase it by 50% through the mortgage crisis.

Hundreds of billions have been “lost” due to the ignorant and unscrupulous practices of the financial industry. In the end, I expect that the losses will total more than $1 trillion.

The Federal Reserve has been creating liquidity as fast as it can, by lending money against worthless securities, and giving it to foreign governments and companies by the boatload. They have dropped interest rates to Japan-like levels. This has caused the Dollar to continue its freefall against the world’s currencies. This week Saudi Arabia ended its long-standing link between its currency, the Riyal, and the dollar. They pegged it 30% higher. Does that mean that the U.S. has lost 30% of its value?

Consider this—if you add up the oil reserves of Saudi Arabia and Iran, they could buy the entire U.S. economy. Ouch.

Be prepared for more bad news as all of the Wall Street “dark matter” comes to light. Be prepared to face higher inflation in the upcoming years, as we pay the price for fixing this mess, again without a depression.

Our government is being run by taking out new credit cards to pay off the old ones. At some point, we are going to have to become responsible with America’s money. Otherwise, today’s youth will never hope to be able to achieve the kind of financial well-being we enjoy today. Their taxes will weigh them down like Marley’s chains.

Our Congress needs to restructure itself, so that spending more government money for the constituents at home is no longer the way to get re-elected. We need term limits and we need them soon.

We also need an energy policy that works. We need a Manhattan Project for clean energy. Windmills are fine. Solar is okay, if you like global warming. Ethanol is a cruel joke. Drilling offshore and in Alaska could help in the short run. I have faith that our oil companies will be cleaner in the Gulf of Mexico than the foreign oil companies that have been drilling there for the past 30 years. I really don’t think that the 2,000 acres of mosquitoes in Anwar will be disturbed much by the time drilling is completed up there. If you have ever seen how environmentally friendly major oil can be, (as I have) you know that the population of Alaskan wildlife, particularly the caribou, will only increase rather than decrease. This is no longer an issue of preserving the mosquito population of Alaska, it is a way of life issue for the American people. If you disagree with me here, let me know. I invite the discussion.

What we really need is to perfect the capacitor. (Remember the “Flux Capacitor” in “Back to the Future?”) The capacitor stores energy at virtually 100%. Energy in equals energy out. Compare this to the energy that is lost (about 70%) through batteries. We also need to pursue nuclear fusion on a massive scale. This is not dirty nuclear fission that leaves us with a thousand-year toxic storage problem. This is clean fuel that will last us for the next thousand years. Nuclear fusion occurs naturally in stars. We can do it on earth using heavy water as a main fuel. We can’t expect the oil companies to develop this kind of energy, as it would be 20 years away under the best of circumstances. It will take massive colliders and energy sources that will take hundreds of billions of dollars, perhaps even as much as the government has spent on the Iraq war or on the mortgage crisis.

I digress here from the purpose of this rant. I think my blood sugar has dropped.

When you see the media begin to panic and tell us that the financial world is about to come to an end, that is a sure sign that things are about to get better. I haven’t seen that yet, but I’ll watch for it.

Jay

www.lumbert.com
www.shaksperbooks.com
www.jaylumbert.com