I FEEL LIKE A WRESTLER
Over the last week, I have started to feel like a wrestler for the WWF (World Wrestling Federation). I thought, here I am, a 170 pound weakling being thrown into the ring with a 300 pound guy. After the gorilla beat me up for about 10 or 15 minutes, I realized that I had survived and I was about ready to leave the ring. Then the 300 pound wrestler tagged up with his partner, who was a 320 pound guy, and just when I thought I was getting a reprieve, he came in and pounded me again, mercilessly.
Iâ€™m sure that is how we all feel after a few months of this market pounding. It is like we have been pounded mercilessly by the markets with a few daily reprieves of a 900 point up day, a 700 point up day, and two 400 point up days; then without notice the market takes back almost everything it gives us.
What I would like to do at this stage is bring you up to date on a few occurrences with regard to the markets and what is happening.
Secretary of the Treasury Henry Paulson gave a speech on October 21st, and his key points were as follows:
1. The current challenges in the credit markets will continue for a number of months.
2. The U.S. Government will do whatever is necessary to strengthen the banks and the financial institutions.
3. World governments must continue to take individual and collective action to stabilize the financial markets.
4. The 20 largest countries are supporting the stabilization process.
5. The recent actions of the government and the FDIC are powerful and will unlock the credit markets.
6. China (despite the slowdown) will remain an important engine of financial growth.
7. The world financial markets are undergoing the most serious financial stresses in recent memory.
New stimulus package
Yes, Congress has proposed a NEW stimulus package and Fed Chairman Bernanke endorsed the package when he testified before the House Budget Committee earlier this week. The package could cost between $150 and $300 billion and â€śseems appropriateâ€ť according to Bernanke.
Nancy Pelosi suggested the bill should include new spending on infrastructure, aid to cash-strapped states, extended jobless benefits and possibly a tax cut. President Bush wants a plan that would â€śactually stimulate the economy.â€ť
The Democratic leadership is considering calling lawmakers back to town after the election to vote on this package.
My note: Where is all this money coming from? The printing press must be running overtime.
The Credit Markets
In order to understand the credit markets, you need to understand LIBOR.
London Inter-Bank Offered Rate. This is the interest rate that banks charge each other for loans (usually in Eurodollars). This rate is applicable to the short-term international interbank market and applies to very large loans borrowed for anywhere from one day to five years. This market allows banks with liquidity requirements to borrow quickly from other banks with surpluses, enabling banks to avoid holding excessively large amounts of their asset base as liquid assets. The LIBOR is officially fixed once a day by a small group of large London banks, but the rate changes throughout the day. It is for non-collateralized loans.
This global inter-bank market provides a means for financial institutions with excess capital to earn higher rates of return by lending liquid assets to those in need of the funds.
LIBOR is important because it is often used as the base for variable-rate government and corporate loans, mortgages, and derivative-based products such as credit swaps.
The Discount Rate
The Discount Rate is the interest rate banks are charged when they borrow funds overnight directly from one of the Federal Reserve Banks. When the cost of money increases for your bank, they are going to charge you more as a result. This makes capital more expensive and results in less borrowing.
The Federal Funds Rate
The Federal Funds Rate is the rate that banks charge each other for overnight loans. These loans are backed up by the Fed; LIBOR based loans are not.
â€śWhy would one bank borrow cash from another?â€ť you ask. The Fed can require banks to keep a certain percentage of assets in the form of cash on hand or deposited in one of the Federal Reserve banks. From time to time, The Fed will establish a required ratio of reserves to deposits; when this ratio is increased, more cash must be kept in the vault at night, making it more difficult (and expensive) for funds to be acquired. When the reserve requirement is lowered, the money supply is loosened; because less cash has to be kept on hand it becomes easier to acquire capital.
There is one positive development in the last week. The frozen credit markets are slowly showing signs of a thaw. The three month LIBOR rate on Wednesday the 22nd had dropped to 3.54%, while the Federal Funds Rate was 1.5%. One week ago the three month LIBOR was 4.64% versus a 1.5% Federal Funds Rate. This is a very important credit indicator.
Type of Rate
3 Month LIBOR
(lowest since 9/24/08)
Federal Funds Rate
The narrowing of the credit spread between the three month LIBOR and the Federal Funds Rate shows that credit is starting to loosen. You will hear more and more on the news stations, especially CNN and MSNBC, about the LIBOR rate. If the LIBOR rate continues to decline, this is a very positive sign with regard to credit loosening. It is also a very positive sign that the governmentâ€™s plan is beginning to work.
~ ~ ~
In the weeks to come, we will bring you more information with regard to what is happening in the markets, what is happening in the economy and what is happening in the credit markets. We expect the equity markets, as well as the fixed income/bond market to continue to be bumpy for the next several months. However, there are some positive signs developing, even though the earnings reports of corporations currently are disappointing.
~ ~ ~
Warren Buffett of Berkshire Hathaway fame wrote in the New York Times recently that he has been buying U.S. stocks. â€śA simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.â€ť
Edward J. Kohlhepp, CFPÂ®, ChFC
Edward J. Kohlhepp, Jr., CFPÂ®, MBA
Note: Several people have been asking if we would mind if they forwarded our emails to friends and family. Not only do we not mind, but we appreciate the fact that you value the commentary enough to do so.