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Final Thoughts on 2008
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Well, it was a quite a year. The stock and bond markets had perhaps the most volatile year in their existence. From the surge in commodity prices to its’ deep plunge, from the collapse of major financial institutions to perhaps the biggest Ponzi scheme in history, most investors took a significant step back financially. There were very few places to hide. Even with a 20% rise in the S and P since November 20, the broad index still closed down 38.5% which was the worst performance since 1937. The Dow Jones did slightly better, closing down 34%. Although the declines cut across almost every segment, the financials were clearly the hardest hit. Lehman, Bear Stearns and Merrill Lynch no longer exist, and AIG, Fannie Mae and Freddie Mac are only barely hanging on. Most of the other large banks like Citi, Morgan Stanley and Bank of America have needed massive bailouts in order to stay afloat, and they are hardly the picture of financial health. The auto industry is in deep trouble, and only an eternal optimist would believe that GM and Chrysler will continue to exist in their current state. As the recession deepened, retailers and the rest of Main Street began the painful process of lowered revenues, layoffs and increasingly difficult access to capital. As we close out the year, we are looking at substantial declines in corporate and municipal bond prices, and anemic treasury yields. In order to get a yield of even 1 per annum, you would need to lend your money to the US government for more than three years. Even 30 year treasuries yield only about 2.6%. At that rate, it will take you only about 27 years to double your money. On the other hand, your funds should be safe as long the US government honors its’ obligations as they have for the past 232 years.
The US government has increased its’ borrowings significantly. Contrary to popular opinion, US dollars are not backed by gold. Instead they are backed by the full faith and credit of the US. Although I am not predicting a default, it is clearly problematic to me that the US has increased the deficit over this time period. To use an analogy, imagine yourself getting your first job coming out of school. Although your salary is low, you can manage and even save a few dollars. As your career progresses, your salary continues to rise. However, instead of increasing your savings, you start spending more and more and even use credit cards to buy even more. Eventually, you are earnings substantial sums of money, but you continue to spend and borrow at a rapid rate. Then, the recession hits, and you lose your job. Unfortunately, instead of saving in the good years, you are actually in worst shape financially than you were at the beginning of your career! This, unfortunately, is not far from the position of the United States. Although we have gone through a 25 year period of growth, we have continued to spend and borrow at even faster rates. In other words, instead for using our growth to reduce the deficit, the US actually increased it rather dramatically. The federal deficit was $930 million in 1980, and comprised about a third of our Gross Domestic Product (GDP). As of 2008, the deficit has risen to over $10 trillion and is now over 70% of our GDP. Although it is still unclear how high the deficit will be for 2009, considering all the bailout money in use, it is almost certain this number will be at least $11 trillion. With GDP decreasing, these is a real possibility the national debt may actually comprise over ¾ of our GDP. I will try to talk more in detail about this over the weekend. However, rest assured that this increase is not a positive situation. Stay safe, and lets hope for a better 2009!
For Your Reading Enjoyment
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Please click this link from New York Magazine detailing some top analysts’ investment choices at the start of 2008. My favorite is from Elaine Garzarelli, who first achieved fame from supposedly calling for a steep decline prior to the market crash in October 1987. She was a bit off the mark this time:
“Garzarelli is advising investors to buy some of the most beaten-down stocks, including those of giant financial institutions such as Lehman Brothers, Bear Stearns, and Merrill Lynch. What would cause her to turn bearish? Not much. ‘Our indicators are extremely bullish.’”
Here’s a link to the entire article:
Happy Holidays!
Where Did the TARP Money Go?
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Imagine you meet some guy who’s down and out. He used to be a major player on Wall Street, but now he’s facing hard times. He begs you for a rather substantial loan. He tells that if he doesn’t get money soon, he will be facing bankruptcy and he hints that this could severely hurt lots of your friends who invested with him. On the other hand, he tells you that if you would just grant him this rather huge loan, he will not only survive, but will actually help lots more of your friends so that everyone benefits. Although he’s sort of vague about both how he will pay you back and what exactly he will do with the loan, you are persuaded to give it to him. He thanks you profusely and then goes on his way. A few months later, it seems that your friends are still in bad shape; in fact, they are worse then before! So, you go seek out your loan recepient and ask him very simply, “What did you do with the money I so graciously lent you under such favorable terms?” Imagine your surprise when he absolutely refuses to tell you what he did with any part of the money!
Apparently, the Associated Press decided to question 21 banks who received at least a billion each of the $350 billion in TARP money. Not a single bank would provide a specific answer. Here’s a link from Yahoo: http://news.yahoo.com/s/ap/20081222/ap_on_go_ca_st_pe/meltdown_secrets
Of course, I can think of a very good reason why the banks refuse to answer. Thanks to the incredibly generous and highly speculative ratios that the government allowed these banks to leverage their balance sheet at, (along with some poor investments in creative mortgage financing) most of these banks have lost the great majority of their equity. Many of them could very well be bankrupt right now save for the governments’ (read:taxpayers) largesse. You think any of them want to admit their that? I don’t. In addition, thanks to Paulsons’ and Bernakes’ high pressure efforts, there was absolutely no requirement that the banks loan out even a penny of their TARP bailout money. My guess is that they have actually lent out very little, preferring to shore up their own shaky balance sheets. Will anyone actually demand some accountability?
