Monday, August 20, 2007

Is the sky really falling? Sequel No. 1

Despite the "crisis" of the past three weeks, I continue to contend that the financial sky really is not falling. Yes, the Fed has had to inject significant liquidity into the banking system due to some significantly irrational behavior by a number of "players" on Wall Street. Yes, there was a temporary crunch in the commercial paper market. Yes, the stock market has declined in sympathy to difficulties in some credit markets. Yes, people with bad credit now have trouble getting mortgages. Yes, people trying to buy expensive homes (mortgage over $417,000) are finding it expensive to indulge their financial fantasies. Yes, people do have to get used to saving up a down payment to buy a home. Yes, the whole subprime mortgage market is in the process of being "rationalized." Yes, there will be more ARM resets and foreclosures over the coming year, but so much of this has been priced several times over into mortgage debt. Yes, to all of this and a lot more, but a resounding No to the idea that all of this constitutes a major financial crisis (ala 1987 or 1998), and a resounding No to the idea that this "crisis" is sending the economy down into a recession.

Expect the Fed to maintain its vigilence to the ongoing misbehavior of various players in the financial markets and to continue to inject liquidity into the banking system, as needed. This process won't instantly restore Wall Street's confidence in the banking system overnight, but each day that passes adds incrementally to longer-term confidence.

Then Fed is standing by and ready to give the banking system as munch money as it needs to stay on an even keel, but that in no way suggests that the Fed is likely to cut the fed funds target rate any time soon. We would have to see some convincing evidence of substantial economic deterioration, which we are not, before the Fed would actually cut the fed funds target rate. Yes, it could actually happen, but it is still very unlikely.

The Fed really is a lot more capable of dealing with "challenging market conditions" than many so-called  "professionals" on Wall Street give it credit for. Do not bet against the Fed. A number of unscrupulous players on Wall Street may have managed to outmanuver the Fed and engineer this "crisis", but they made a big mistake by managing to awaken this slumbering giant. The Fed is very capable and very vigilent, but even they cannot guard against every  single financial "pothole" that may arise (or be engineered by the profiteers on Wall Street.) But now that the Fed is solidly on the case, watch for some significant moderation of the shenanighans on Wall Street.

There are plenty of unscrupulous players on Wall Street who will continue to try their best to take down more hedge funds, try to take down some major banks, and even try to take down the Fed itself. Their hubris knows no bounds. But, sooner or later they will have reached a bit too far and find themselves to be the next and final victims of this "play."

The other major factor in this crazy "crisis" is that old saying "When the tiger is away, the monkeys rule the jungle", meaning that with a lot of the heavy-hitters off enjoying their summer vacations, you have a lot of second and third-tier players "messing around." Wall Street is never truly dead in the Summer, but the pace does slow down dramatically and usually many operations are simply on auto-pilot. But, of course, auto-pilot cannot handle very many curve balls, so a situation which might have been handled rather easily in the Fall, completely overtaxed the third-string players manning the trading desks and those playing caretaker for absentee executives.

Is it a good time to jump back into the stock market? Hard to say. I'll make an effort to avoid trying to time the market. You'll need to figure that out for yourself. The best advice I can give you is to focus on fundamentals and look for companies with solid earnings growth potential selling for a discount.

The stock market may or may not be poised for a decisive rebound. Worst case, give it another two weeks.

-- Jack Krupansky


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