The Fed's new role: Sugar daddy
Posted
Sep 16 2008, 06:15 PM
by
Andrew Horowitz
Rating:
Since when do we rely on government to intervene in every case of a failing business? If anyone wonders why we have such a mess on our hands, look no further than our boneheaded government that has obviously forgotten its way. Think of this week's action within the financial markets as a result, not the cause of our problems.
AIG is in a battle for its very existence, Merrill has been absorbed and Lehman is bankrupt. And we're only part way through the week. What's next?
These days, many people are wondering what our government will do to stop the insanity. Yet, in a capitalistic society that relies on a free market system, we should only look to the government to guide and regulate against fraud and the manipulation of the system. Sometimes known as a laissez-faire philosophy, the government has a role, but it is not to be a business partner and a sugar daddy there to provide a backstop to the bad business practices of the banking system.
Surely, not everyone is in favor of bailouts. Reuters recently reported that when asked whether the government should provide a bridge loan or some other support for the company, which faces a liquidity crisis, Alabama Sen. Richard Shelby told reporters, "Absolutely not ... I hope that they will not bail out, or get a bridge loan, to AIG."
He added, "Where do you stop? Where do you draw the line?"
Now that the market sentiment lives and dies with the actions of the Fed, it appears that investors and companies are getting used to the idea that no matter how bad it gets, money is available, rate cuts will appear and the Treasury will help with some kind of handout. This is not the way in which we create a market that is considered healthy. By constraining market gains and losses to the whims and taxing power of the regulators, we will never have a stock market that will make or lose money. In effect, it becomes net-neutral as losses that are absorbed will become a positive on investor's P/L statements, but the tax payments to fund the losses will trickle down and become a negative item.
This week has cost the taxpayer upwards of $400 billion as we have seen the bailout of Fannie/Freddie and the Fed pushing $70 billion of temporary money into the the financial system to help prevent a seize up of the credit markets. Then, we heard the 2:15 announcement of the Fed, which was initially greeted with a thud, eventual put some life into a sagging market. While most would have thought that a "no-change" policy would cause markets to collapse, odd as it seemed, they actually rallied.
The Federal Open Market Committee decided to keep its target for the federal funds rate at 2%. Below are the relevant segments of the official statement and inline comments/translation.
Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.
Translation: The Fed is here to act as a safety net if need be. Don't worry, that nasty inflation thing we spoke about in the last few meetings was a mistake. Go about your business.
Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain."
Translation: We have conveyed a posture that helped to strengthen the dollar and it worked to weaken commodity prices. All we had to do was to mention that we were thinking about a rate increase and the dollar rallied. Now, go about your business as usual, we got your back.
The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.
Translation: Speak loudly and carry a big stick. The first order of business is to keep the financial markets from imploding. Then we will make sure that prices are stabilized.
This is all on the heels of the August report that shows a dramatic increase to confidence and Tuesday's report that showed consumer prices saw a marginal decrease on an annual basis 5.5% in July to 5.4% in August. The report also found that the core inflation remained at 2.5% on a year-ago basis. As commodity prices have tumbled, the more recent data came in to show a slight decline on a month-to-month basis. It seems that inflation has left the house! Of course, this assumes that gasoline prices are not of consequence as they have not moved down appreciably.
If the Fed continues to play the Greenspan Put, we will eventually have an ineffective market as investors will have no real ability to analyze or project the outcomes of stocks. Businesses that are allowed to survive, even as they are insolvent and illiquid will only further corrupt the system.
Let the market work out its problems and likely, over time, the strongest will survive. If you don't believe me, just ask Mr. Darwin.
Related Reading:
The Crash of '08 Podcast (Andrew Horowitz Host)
Fed to Wall Street: Drop Dead
Analysts make dramatic forecast cuts
Why I am shorting MasterCard
Disclosure: Horowitz & Company managed account clients do not hold positions in securities mentioned as of the publish date.
Andrew Horowitz is a money manager and the founder of Horowitz & Company. He is also the author of the bestselling book, The Disciplined Investor . Check out his latest investment idea or listen in as he hosts, The Disciplined Investor Podcast.
