The Economy and Free Money: Too Late to Play it Straight?

Includes: DIA, QQQ, SPY
by: Craig Jones

Though we long ago took the fork in the road that veered away from Adam Smith’s invisible hand, one would hope that, as a democratic and ostensibly freedom loving society, we would endeavor to hold on to some basic tenets of a laissez-faire economic model. As in most election cycles, this year’s cadre of candidates, especially the Democrats, are promoting ideas to “fix” our economy that would make even Lord Keynes roll over in his grave.

There is little doubt that our economy has suffered systemic damage due to the sub-prime crisis in the mortgage industry. As an economy moves from growth to recession, there is almost always some dramatic event to point to as a catalyst and the meltdown in CDOs can claim that fame in this instance. To say, though, that this is the cause of our economic woes would be naïve. Nevertheless, Obama and Clinton have made it loud and clear this week that, if elected, it is their intention to provide some type of direct stimulus to those disenfranchised homeowners, or, might we say, previous homeowners, who have been adversely affected by the terms of the mortgages that they signed to purchase said homes in the first place. Mr. McCain does not go so far as to offer direct aid to individuals, but seems to be satisfied with the Federal Reserve’s moves towards backstopping JP Morgan in their buyout of Bear Stearns, the sub-prime poster child, as well as offering relaxed lending arrangements for financial institutions, both bank and broker alike.

It may be, at this point in our development, too late to play it straight. Our financial system, and by association the major financial systems of the world, have become dependent upon a framework of a de facto insurance policy that has and will assume all risks beyond the threshold of our corporate infrastructure. Perhaps this began with Chrysler so many years ago, but whatever the precedent, it has surely become standard operating procedure going back to the Resolution Trust Corp., the Latin American Debt bailout, LTCM and, now, Bear Stearns (NYSE:BSC). The Greenspan Put has, apparently, been exercised, and not only is the Fed now taking marginal paper as collateral, but it looks as though some form of governmental stimulus will be directed towards individuals who did not read their loan documents (this latter point makes it quite difficult to apply the “too large to fail” doctrine to this scenario.)

In their never ending quest for appeasement, the elected official who seeks office for self rather than societal good (read as “all politicians”) can not help but to pander to the public and promote policies which, more than economic meddling, often prove quite harmful to the health of the system. Would we have, years ago, let a few large, name brand, weak institutions collapse in spectacular implosions, we would, today, likely be blessed by a financial system built upon granite rather than sand. On both Wall and Main, and from the top down, our tolerance for risk has grown out of proportion with our abilities to manage risk. We reach and reach and reach for yield and forget the timeless principles of investing or borrowing that are supposed to maintain equilibrium. Should our governments and regulatory institutions, who, by the way, are peopled and not monolithic, computerized entities, continue to add drams to the scale, it will become harder and harder, and much more painful, for market forces to ever work things out. By the sound of it, our new leader, whoever it may be, has a pocket full of drams.

As a final note, as you listen to the candidates rail against the mortgage industry, take note of how much that industry is contributing to their campaigns.

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