The turmoil in the financial markets reached a crescendo last Thursday evening as Asian markets fell 5% in one day, following the U.S. markets’ sharp declines. As I watched the subsequent European market openings, it became clear to me that we were on the verge of a serious collapse, perhaps of a magnitude that this country has not seen for over 75 years. Apparently, Federal Reserve (Fed) Chairman, Ben Bernanke had come to the same conclusion. In panic mode, the Fed cut the discount rate by ½ percent and opened the “window” to banks in need of immediate cash to meet obligations. Additionally, the Fed promised to accept as collateral virtually any and all loans that banks were unable to sell in the open market. This historic operation was designed to instill confidence in the financial markets. After four days, the mood has calmed and confidence appears to be returning. Nevertheless, we must ask ourselves whether the structural or “systemic” risk in the markets has diminished, increased, or simply been hidden for a period of time. Unfortunately, no one really knows the answer to this question.
We do know that the amount of aggregate debt and leverage in our system has not changed. What has changed is the level of confidence based on the perception that the Fed will do what it must in order to stem a panic and restore orderly markets.
At the end of the day, we must begin to think about the outlook for housing-related employment. We expect this employment to decline as the last nails are driven by developers who have curtailed building plans because of the existing large inventory of unsold homes. Add to this picture the increasing reluctance of lenders who have been hurt in the recent mortgage crisis, and the outlook becomes murky at best. These factors, combined with the increased risk of a policy mistake emanating from a highly charged political climate in Washington, keep us in a somewhat defensive mindset. New money commitments will only be made to truly special situations. Overall, a moderate equity exposure is still the order of the day.
As we have reiterated for years, we will not take credit risk with your money. Therefore, you can expect us to continue investing in only the highest rated credit instruments…U.S. Treasury obligations. After the last few weeks, there should be few questions about the wisdom of this investment philosophy.
Enclosed is an excellent article explaining the events leading up to the recent Fed’s decision.