Wild Market Ride

Yesterday was the first trading day since the S&P downgraded their rating of US debt, due to the fiscal policy instability in our country.  The instability stems from a complete inability to compromise on Capitol Hill.  The left side of the aisle points their fingers at the right side, saying it's going to take both spending cuts and revenue increases to fix the problem that the right side won't listen to, and the right side of the aisle is throwing their hands in the air claiming a mandate from the Taxpayer to fix rampant spending abuse in Washington, then folding their arms and playing chicken with default.  But ensuring true, longterm economic health is not an overnight fix, something both sides were looking for and stood firm on.  Even with an analytical error, S&P was right to downgrade US debt, because there is a major structural issue to address.

That is a large part of what caused yesterday's massive selloff, taking the stock market under 11,000 and closer to Bear Market territory.  The other major fundamental aspect to the economy that would let the air out of stocks is that it appears that QE has ended, and the debt deal hints that it wouldn't be prudent to inject any more liquidity into the markets, artificially inflating them.  Therefore, the market is now right-sizing to what it would be sans intervention.  Of course, today we had a pop-back in reaction to the Fed leaving rates low, but once that announcement gets fully digested, I think the market will interpret the statement as I did: You're on your own, now.

Today's Fed decision was to leave the target benchmark overnight interest rate between 0-0.25% until the middle of 2013.  The bond market naturally went nuts over the news, as a 2-year T-Bill essentially became an overnight note.  The stock market went schizophrenic, unable to decide whether all of the dire ajectives about the economy overshadowed the low-rate environment or not.  The little engine that could (open-market LIBOR rates), however, has continued to chug along as it has for the last month in an upward direction.

So, based on the fact that 1) LIBOR is on a slow but consistent rising trend, 2) There were 3 dissenting FOMC members to today's statement, all which would have preferred to keep rates low for a shorter duration 3) The Fed has never set a target date horizon for a consistent rate level, leading me to believe that the decision, while probably an analyzed and educated estimate, is more of an emotional appeal to appease the market and rates may not in fact remain this low until 2013 --  We're in the full-swing of a US Treasury bubble, or an inverse bubble for rates.  Market returns must out-pace inflation, and as mortgage rates get pushed under 4% again this week (just watch), investors will begin to again search out a predictable stream of income (i.e. dividend paying stocks, corporate bonds) that will provide a more reasonable investment return.  Comparative risk appetite may increase in the mid-term, which should cause a demand decrease in US Treasuries and the subsequent and ineviable rise in yeilds.  This is the slow and healthy process of the cyclical economy, and hopefully we're disciplined enough to accept this over a quick fix as we have in the past.

With Respect to the S&P Downgrade

Back on July 29, I commented on how we would be discussing a downgrade of US debt this week, even if a debt ceiling deal was passed and adjustments to budget spending were made.  I mentioned that the politicians had already turned off market confidence that a long-term solution would be reached, and that a downgrade by Moody's and S&P was still imminent.  Well Moody's, you've got a few more hours, but I'm guessing that all of the political backlash to the S&P decision may be causing Moody's to second-guess a downgrade on their part, as well.

Monday morning will be very interesting to see how the bond markets react to this news, and what kind of risk-premium will be built into US Treasuries, if any.  Even more importantly will be to continue to keep an eye on the 1 and 3 month LIBOR rates, which over the past 30 days have slowly but steadily risen from their lows.

The Debt Ceiling: Time For a Banker to Weigh In

There's been plenty of sqwaking in the media and political posturing on Capitol Hill these past few weeks, especially as it relates to the Nation's debt ceiling, and either raising it or risk default.  I figure that, as a lender who deals with credit and risk management on a daily basis, it's time for me to weigh in.

I had a client sent me a panicked email today, asking if it would be okay if they sent in their Q2 financial reporting on Wednesday the 3rd instead of Monday the 1st.  The client felt horrible about being late, but had been bogged down by an increase in business this year, and needed a couple extra days to finish reconciling the books.  Why am I telling you this?  Because this is an example of not a good, but a GREAT client that is managing its reputation around the full faith and credit of itself as a business-- with flying colors.  We're not talking about payment delay or default, or even any substantial risk change in the business, and they are reacting with great sensitivity.  Side note: Of COURSE I granted them the extension to report their financials!

Take the opposite end of the spectrum.  For a large institution like the US, reporting statistics has become almost an automated process, and gaining the info within these reports is not such a chore, as can be with middle-market banking.  BUT...this institution has been running red ink (a budget deficit) for far longer than any credible business would be able to sustain prior to a credit downgrade.

This is why I can say with almost complete certainty that at some point next week, we'll be discussing the downgrade of US debt from AAA by both Moody's and S&P.  Risking delayed payments to any debtors has negative implications, and increasingly leveraging the country with budget deficits only protracts those risks.

Spending is out of control, and the waste inherrent in that spending has increased over time as more people have become keen on how to play the game.  I'm all for important social progams, but you have to instill a slapping mechanism for when the beneficiaries of these programs bite the hand that feeds them.

Washington is playing politics with our country's credit rating hanging in the balance, and this is sure to have a negative affect on the interest rate environment.  While I'm sure there will be a deal to increase the debt ceiling next week, it appears that there is still plenty of posturing on the right to make the deal a 6-9 month fix, and posturing from the left to close tax loopholes.  And why can't they compromise?  Because this is a game to politicians, and the Republicans 'win' if the debt problem comes back before the next election, and Democrats 'win' if they can close tax loopholes so that they don't have to cut spending as drastically.  It's disgusting, and all of us ordinary Americans are going to pay a price for their game of chicken, but most likely not to the extent that the media is hyping it up.  Remember the lessons from Carmageddon on this one!