Don’t try to make too much out of today’s activity. I am going to take a break from trading the market for the next few days. My trading relies on using chart patterns to make entry positions and with the market gapping down as much as they did today the charts are broken. By the end of the week they’ll be back to normal and I’ll resume trading. But there is no reason to step up and try to be a hero now. All the markets are out of whack. I’m talking about just the stock market, but the bond, gold, currency, and dollar markets also. After the dust settles from today we’ll be able to take a careful look at them and see what they forecast for the economy and the market. So don’t take too much out of today’s action. Of course we will still follow the action on the market window and make comments. That said I am worried. The reason is two words: moral hazard. Moral hazard is an economic theory. It states that if someone insures an individual against risk of loss their incentive for trying to prevent further losses from occurring is reduced. If someone tries to repeatedly prevent their losses then when a loss finally does come it will be worse than any of the previous losses would have been. This applies to Greenspan and our entire economy. Over the past 10 years every time there has been a financial crisis or threat of a market downturn Greenspan has bailed us out. In the early 1990s he bailed out international bankers who made some bad loans to Mexico. They didn’t learn and a few years later they made some bad loans to several Asian countries. He bailed them out again by lowering interest rates in 1998. The stock market boomed as a result.
Every time he bailed someone out he was successful and every time his reputation and stature grew. People got over confident and took more risks. The boom in junk stocks, like the Internets and biotechs came as a result. So did the obscene P/E of “safe” stocks in the S&P 500. Regular consumers got overconfident and took on large amounts of credit card debt. The final result is now we are in a recession in which there cannot be a quick recovery because people and companies have to work off their debts first. The problem with a moral hazard is that one cannot bailout the economy and investors forever. Eventually a bailout will fail and result in a total panic and market collapse that will be worse than any of the other previous crisis. The opposite of trying to bail people out every time they make a bad investment is to let them lose their money and learn a lesson from their mistakes. They would then they make wiser decisions and economic growth would last longer and be steadier with less volatility. Instead over the pat 10 years Greenspan has run his Federal Reserve policy on the principles of bailout. And today he tried it again and failed. Today is a turning point in our nation’s history. We have a Federal Reserve Chairman who has blown the financial system up. He cut interest rates before the market opened and took every measure he could to make the market rally today and failed. The terrorist bombing did not cause today’s decline in the markets. It would have happened eventually anyway. It was caused by a decade of flawed economic policies on the part of the Federal Reserve and the Federal government that benefited a few wealthy Wall Street interests at the expense of the national economy.
Several thoughts and images cross my mind as I write this. 1)This morning after the announcement that Greenspan cuts rates before the market opened Mark Haines, the head anchor of CNBC, pounded his fist on the table and laughed as he proclaimed that the market would go up; a symbol of the wild optimism and reckless behavior created by Greenspan’s moral hazard. 2)Back in 1998 when the Asian economies were in trouble I remember reading a newspaper article about a meeting that took place in Davos, Switzerland called the World Economic Forum. The reporter interviewed bankers at the meeting who acted as if they were in a state of shock, by wearing long faces and walking slowly. They thought they would go bankrupt if their loans in Asia went bust. Greenspan bailed them out. A year later the same meeting took place. I then read about how these same bankers were talking about how we were now in a new economy that would grow forever because of the genius of Alan Greenspan and other central bankers. 3)At the time the Nasdaq was at 4,000. A few months later it went to 5,000 on the back of a rally technology stocks. Warren Buffet said they were overvalued and would crash. People said he just didn’t understand the benefits of technology. George Soros, the most successful financial investor in history, said that the world economy was on the verge of a financial crisis because of the problems of moral hazard. Lawrence Kudlow of CNBC, who claimed that the internet had made the business cycle obsolete, said that Soros just didn’t understand the new era. Look this isn’t the first time the United States has gone through financial collapses. Each collapse came from a speculative bubble that burst and each bubble came as a result of excess monetary stimulus that fueled reckless investment activity. Let’s count some of them.
Speculative instrument Year of Collapse Source of Hyperinflation
Cotton & land 1837 small western banks
Railroad stocks 1857 gold discoveries, credit from English banks
Railroad stocks 1873 lax credit from English banks
Stocks & real estate 1929 margin, banking/loan deregulation
Stocks & real estate 1974 eurodollars flooding the market
Technology stocks 2000 Federal Reserve Like all of the other financial collapses the US will survive this one too. Like the others this collapse came as a result of reckless investments fueled by easy money. In this case from the Federal Reserve which hyperinflated the money supply in 1998 to bail out bankers and in 2000 due to fears of a run on banks because of the Y2K computer bug. The only thing that compares to this current collapse is the 1929 stock market crash. Like the 1929 crash this current crash is not going to be fixed suddenly. We are in for some hard economic times and some major changes and reforms are going to have to be made in regards to economic policy in order for us to get out of this. This is not going to easy. And we are going to need some leaders to stand up and tell the truth. To tell the American that everything is screwed up and we are going to have to take some measures to fix things. Pretending like everything is ok or that everything will be fixed painlessly tomorrow is not going to cut it. Alan Greenspan is going to have to go. He has done nothing but lie about the economy for the past year and his failure today is telling evidence that investors have lost their faith in him. We are going to need a Federal Reserve Chairman like Paul Volker. Someone who isn’t afraid to tell the truth and isn’t afraid to take measures which are unpopular, but necessary. Paul O’Neill, Bush’s Treasury Secretary is going to have to go too. He has been Bush’s main economic advisor and is sending him down the wrong path. O’Neill's eeconomic strategy is to basically sit and do nothing, but appear on TV every few days and say everything is going to be fine. After today’s market crash he got on CNBC and said that the DOW will make a new high in 12-18 months. This is bullshit. We don’t need financial leaders to get on TV and say the stock market is going to go up. We need some leaders to get on TV and say we have a plan to fix the economy right now. We’ve had a decade of misguided policies and excess which we are paying for. It’s not my fault, but it’s reality and we have to deal with it. It won’t be easy, but we’ll come out of it. Bush is doing this in regards to the terrorist bombing. I’ve had my doubts about him. I didn’t vote for him nor Gore. But I am happy with the way he is handling himself with the terrorists. He and his administration are going to have to use the same blunt talk in regards to the economy. They are going to have to remove some people and roll heads. If they don’t the bill the country will pay will just be larger.
Greenspan’s policy of trying to stop the bubble from bursting by re-inflating it is not going to work. Policy makers are going to have to just let the market collapse and make a real bottom. Anything else will only prolong the economic downturn and make it worse. This is the lesson of moral hazard. Unfortunately as long as he and O’Neill make economic policy this is the destructive path the nation will stay on. Franklin Roosevelt shook up the national power structure and the government of the United States when he got in office. In the next few months Bush will have to do the same thing. It is going to be more politically challenging and risky for him then waging war against terrorists, but just as important. |
