Since the stimulus plan was first proposed, there has been a growing chorus of pundits chatting up the likelihood of a second-half boom in earnings.
Or maybe it will just be a second-quarter blip. While some of those $1,200 checks will be wisely used to pay down debt, most will probably be used to buy things. Nothing like a spending spree to take away the pain and make it seem like everything is better.
But when it’s done — it’s done. Sugar rush over. Ain’t no more stimulus packages on the horizon. Then it’s back to business, which won’t be like the business of yesteryear until this mortgage mess, and its residual ramifications, get hashed out.
“Well see whether those election-year fiscal stimulus checks change consumer confidence,” is the way Mike Farrell, CEO of Annaly (NYSE:NLY), put it in a letter to his investors, “but my guess is that $600 or $800 or whatever the package provides to consumers will be a transient event for the economy.”
That leaves us with the Fed, which is in a damned-if-they-do, damed-if-the-don’t situation. Cut and there’s a risk they overstimulate and create inflation. Don’t cut and risk the economy sinking into the abyss.
One guy who has gotten this right is the Northern Trust’s (NASDAQ:NTRS) Paul Kasriel, who has been a long-time worrier over debt. In the end, he says, it’s about consumer spending, and he doesn’t believe that is about to pick up with permanence any time soon, stimulus package or not.
Although the Federal Reserve has been quite aggressive in reducing the fed funds rate and will likely continue to be aggressive, we expect an anemic recovery. Why? Because the financial sector is likely to incur some large losses in this downturn. The losses will not be confined to securities related to residential mortgages, but will involve credit card debt, auto loans, commercial mortgages and high-yield securities (known as junk bonds in a less politically-correct era).
The financial sector, especially the banking system, is the transmission mechanism between the Federal Reserve and the private sector of the economy. If the financial transmission is not functioning properly, the Federal Reserve can mash on the monetary accelerator but little power gets transmitted to the wheels of the economy.
Credit losses can lead to capital inadequacy of the financial system. Capital inadequacy means that the financial system cannot extend as much credit to the private sector as otherwise would be the case. So, even though the Federal Reserve is offering to extend credit to the financial system at relatively low interest rates, the financial system, because of capital inadequacy, cannot, in turn, extend as much credit to the private sector.
This was the situation that prevailed in the United States after the economic recovery began in April 1991. The Federal Reserve continued to reduce the federal funds rate through September 1992 with little to show for it. It was not until the second half of 1993 that the financial sector had rebuilt its capital to the extent it could step up its lending to the private sector in earnest. That is when economic activity began to behave in a more normal cyclical fashion. So, a good model for the 2008 recession might be the 1990-1991 recession.
You can read his full report here. Click on the Jan/Feb report.
The beat goes on…