Today the US Federal Reserve stepped in with yet another emergency effort to ease a building liquidity crisis in world markets by cutting the discount rate “temporarily” from 6.25% to 5.75%. The markets cheered on the open roaring up with great relief. As the day rolled on the intial exuberance moderated a bit, as averages dropped back from opening heights. And volume on today's rally has been low.
Today several commentators (the same ones who weeks ago said sub-prime was a contained, non-issue) are quick to pronounce that the serious economic consequences caused by the “non-issue” are now behind us thanks to the Fed stepping in.
Facts must be faced. The truth is that there is no extreme-makeover solution to the present problems of over-levered consumers and markets. An emergency cut may help with emergency relief but it is really the equivalent of dropping a bed roll and food rations from the rescue helicopters. It may help the most critical casualties to buy some time, but it does not restore a nation to healthful habits and a robust recovery. This will take a bit more work than that. As Bloodier and Bloodier points out in New York magazine this week, the current imbalances are vast and wide-spread they have come from years of abuse and consumption at all cost. The health of the US ecomony (and thereby feeder-fish like Canada) are all compromised at present. Lipo-suction-like intervention by the Feds may smooth the surface for a bit, but restoring real health will take longer. There will need to be systemic and life-style changes. Consumers will need to stop spending like million-aires just because they could borrow, and start living within their actual means. This means inevitably slower economic growth for a while. We have borrowed a lot of consumption from the future months through goods bought on credit in the past couple of years.
I am hopeful and optimistic that better habits and policies will be the positive outcome of these painful lessons learned about credit-abuse (at least for a while anyway, I acknowledge that people have short memories).
Sorry to be the party-pooper, but at some point it really is not just how things look on the surface that matters. True health requires real work and rehabilitation of the foundation underneath.
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The Fed stepping in certainly looks like a quick fix, a band-aid solution. This kind of action is not sustainable, and it will be only a matter of time before the real market inertia shows itself once again.
I agree with you Danielle.
I must admit I am taken aback by the Canadian response to the enveloping storm. Too many people seem to think it is just a case of US sub prime borrowers defaulting on their mortgages. At least this debt has a collateral aspect (albeit damaged). What happens if the US economic downturn gathers pace and the rest of the asset (debt) backed comercial paper and collateralised debt instruments come under real pressure? I hate to think given the extremes these derivatives have been exploited.
We are in a very serious situation; the economic, market and financial relationships are well beyond their mean relationships and pure physics suggest a nasty outcome.
I also think the current situation is beyond most people's ability to comprehend. Few people understand commercial paper, ABCP, bank conduits (SPVs) and monolines, CDOs (synthetic or otherwise) or indeed the massive growth of these debt instruments. It is an altogether different universe from that which most people think currently exists.
Andrew Teasdale
The TAMRIS Consultancy
PS Did you see the following Morningstar article?
http://www.morningstar.ca/globalhome/Industry/News.asp?articleid=MStarUS204278_2007-08-20_17-00-00
Hi Andrew, thanks for stopping by. I had a look around your web site too.
Critical thought and self-control are not that popular with the masses I fear. And yet, trying to teach people these tools is what made me write the book and what gives me a sense of larger purpose in my work. Thanks for the Morningstar article link, it is this type of “all is well, buy first and worry second” stuff that really gets my blood up. Why do we tolerate so many non-money managers throwing around glowing recommendations in the marketplace? Why do so many people listen to non-fiduciaries, salesmen and journalists for advice on their money? I know adults choose, and perhaps they deserve to suffer the consequences, but I still hate to see regular people get hurt time and time again.
Keep up the good work.
By the way, I do not see financialsense.com on your list of favourites. I wonder if you had seen it.
No but I will take a look. D