OCTOBER 8, 2008
OCTOBER 2008 COMMENTS
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Over the past month we have witnessed the fury of a gulf coast hurricane followed quickly by the fury of a financial category five hurricane. The decades old institutional names of Washington Mutual, Lehman Brothers, Merrill Lynch, Wachovia Bank, among others, experienced the wrath of nervous investors/depositors. The Federal Reserve and the Treasury have, thus far, been handling the crisis on a case-by-case basis while pleading for Federal relief for a larger, more comprehensive bailout.
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The recently enacted Troubled Asset Relief Program (TARP) $700 billion Federal bailout is aimed at reducing the unwillingness on the part of financial institutions to lend. The lending freeze has increased dramatically the prospects of a recession as a halt in lending has led to layoffs, and the inability of companies to fund normal operations. As structured, the bailout would be aimed at allowing financial institutions to competitively reduce holdings in so-called "toxic" securities that are plaguing their balance sheets. The competitive nature of the bidding will find a level at which these instruments can be sold to the government, increasing the liquidity of those selling institutions. The belief is that this will begin to loosen up the flow of funds through the financial system and create the ability to lend that is so necessary to the vitality of the economy. In addition, the temporary rise in the Federal Deposit Insurance limit from $100,000 to $250,000 is aimed at allaying fears on the part of some depositors that their bank accounts are not safe.
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While in past comments we have cautioned that a recession was likely, the expected quarter of negative growth was delayed by the second quarter stimulus package that revived spending and GDP temporarily. Given the capital losses sustained by investors and the current lending freeze, we believe we are in, or shortly will enter into a recession. Earnings estimates are beginning to reflect this expectation. We believe the government's plan to stabilize the financial system will begin to open the logjam in lending but that more may be needed than the $700 billion TARP program. As the value of the housing stock continues to fall, the value of the underlying securities used to finance prior house purchases becomes worth less. Certainly, as has been well advertised by the bill's proponents, the ultimate cost to the government may be well less than $700 million, as assets are sold at levels higher than the values assumed today. The cost of not doing anything is far greater than letting this situation become worse. Until these uncertainties are closer to being resolved, the more conservative portfolio posture that we have adopted is warranted. We will continue to strive to add conservatively positioned holdings with attractive potential returns.
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Another looming issue is the rapidly approaching Presidential Election which, as of this writing, is only a month away. Polls seem to be shifting toward changing the current party's hold on the Presidency. While "change" seems to be the message of that candidate's platform, change will be hampered by current economic issues. Any attempt to raise taxes as had been earlier mentioned by the Democratic candidate would only serve to worsen the economic weakness we are experiencing now. Clearly, the cleanup of today's financial problems will tie the hands of the next President for some time to come.
THIS MONTH'S FOCUS -RECENT FED AND TREASURY INITIATIVES
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The Federal Reserve
The Money Market Observer pointed out that, over the last two weeks of September, the authorities have provided more than $500 billion in incremental funding support to the markets. A major reason for this assistance is the structural shift out of diversified money funds and into government only funds. The Federal Reserve also announced a program to facilitate the sale of certain money market fund assets.
- The Treasury
The most recent Case-Shiller Composite-20 Home Price Index indicated that prices in June 2008 were 15.92% below year-ago levels. It is interesting to note, however, that the month-over-month decline was the smallest since a year ago in June 2007.
We always welcome your thoughts and opinions on this Monthly Commentary, as well as any questions or comments you may have. Please do not hesitate to contact your Portfolio Manager or e-mail info@beacontrust.com.