Interest Rate Cut – Sleep it Off!

What?!?! You loaned money to people that could not afford it and now you want someone to bail you out? Big shocker. ME, ME, ME is all I hear – similar to a 4-year old in a candy store when it comes to the well-publicized events of the sub prime mortgage ‘meltdown’ and the debate of whether the Fed should cut interest rates.

I will be the first to say that I am not a heavily trained economist and I have no advanced degrees in the subject. Furthermore, I must admit that I do not have access to a fraction of the information that these people do – and in the event that I did, I would be hard pressed to make any sense of it.

However, that does not stop me from running my mouth on the issue – everyone else seems to be doing so, so why not join the party?

First, there is no doubt that things have been tough out there. We have seen a couple of Wall Street’s more adored lenders, banks, and mortgage REITs take monster hits on people. From declining stock price, to wiping out lots of net worth, to companies going under and leaving thousands of people with out jobs – it is rough. The situation is further exacerbated by the real estate market slow down – leaving many related professionals (realtors, mortgage brokers, developers, home builders, etc.) without income or a much smaller source of such. Living in South Florida, which was arguably the hottest real estate market in the country during the boom has provided me some very basic, observational insight on the situation.

It seemed that everyone here in the area became a realtor – everyone was looking to flip homes – everyone was writing big-ticket mortgages. For a while, things were good, but then the inevitable happened – things slowed down. Why did things slow down? Simplistically, let’s be honest – people ran out of money, especially in the area I come from. If people had more money, people would still be buying the flipped homes, realtors would be earning commissions, builders would still be building to sell to the masses, and mortgage lenders would still be madly filling out applications. But, it stopped? Again, people ran out of money. I do not want to hear that all of a sudden the mass population of Americans suddenly started subscribing to value investing and changed their financial tone. There was literally no more money left.

I would always wonder when the lack of top-quality paying jobs in the area would finally catch up with the real estate marketplace here. I could not compute the math on how people were affording high-priced homes on mediocre salaries. I was always wondering at what point does this behavior trickle into the overall local economy? Well, it has – and it is showing up here in the area. Restaurants are slower and waitresses I speak with are telling me this past winter season was the slowest in a while, the summer was slower than usual, and this upcoming year is also supposed to be slow. Membership applications to golf clubs have slowed – and in some cases, many want out but cannot sell because there are no buyers. Small businesses – especially one-man shows that do business with other one-man shows – are complaining about clients taking longer to pay them – rather than getting paid within 15-20 days, checks are showing up 40-50 days after the invoice and a phone call. It all adds up.

Next, do not kid yourself that this issue is restricted to a small, non-metropolitan area in South Florida. The signs are all there and are showing up nationwide. Some examples:

All of the major cable companies are reporting slowdown in subscriber growth for their high speed Internet and digital cable TV services. Charter, for instance, had great additions of their digital phone product, but flat growth in their cable TV subscribers. DISH Network flat out blamed the slower home market for slower sales;

Home Depot, Nordstrom, and even Wal-Mart said they are seeing weaker consumer spending. The first two also cited that payments on their company-financed credit cards to customers are coming in slower and we are seeing more late payments.

Foreclosures are up – everyone knows this.

Apple iPhone sales appear to have slowed since they first exploded onto the spot. I do not have the numbers to back this up, but think about yourself or your friends that got one. They all got them the first week they hit the market – not a lot of new iPhone buyers since then. Personally, I am not sure where people are coming up with the $600 for this device. Actually, I take that back – I know one person that actually padded his mileage on his expense report to be able to foot the bill. Harmless to a big company, right, but it comes out of someone’s pocket.

The biggest news item I have seen that overall, the average American savings rate is in the negative numbers. That is, on average, people are spending more than they are making. Eventually, the well runs dry.

Previously, Greenspan saw what was going on and warned that a recession by the end of 2007 or early 2008 was a distinct possibility. I hate to also sound like a psychic, but many of my past writing from early 2007 cited many of the above reasons and that at some point, it would have to filter into the overall economy and hit the marketplace. Of course, I had no idea on the timing of such, the absolute freezing of the mortgage paper marketplace, and the extent that albeit it for a short time, the stock market actually endured a correction (10%+) on an intra-day basis.

So, what is the source of the above issues? Since nobody is flat out saying it, I will say it. Why is everyone so surprised about this? For years, banks and credit cards have been loaning money to people that frankly could not afford it. I am not merely singling out those that are classified as sub prime. People with 750+ credit scores were being loaned boat loads of money, often unsecured, to do whatever with. Buy a bigger house, invest in a half-baked business idea, buy new cars, go out to eat all the time. Nobody is saving this money and investing it – if they were, the savings rate would not be negative, right? So, now that banks have loaned money to people that could not afford to pay it back, they want someone to bail them out.

Reward bad business decision making? That is what it sounds like, but it may be too aggressive. Consider this perspective. I have read, cover-to-cover, a big book called Responsibilities of Corporate Officers & Directors Under Federal Securities Law. It was the most boring thing ever, but the biggest thing I took with me was the discussion on what you can get busted on, for lack of a better phrase, when it comes to the collapse of a business. Obviously, anyone can sue anyone for anything these days, but realistically, what qualifies as an event that can genuinely be prosecuted? Specifically and simplistically, if you have a business plan and it appears you put thought into it with the intent to turn a profit and reward shareholders, you are in the clear. Translation, you cannot be punished for a bad business idea. Not all businesses work – that is a reality. If your intent is to defraud or steal, well, then you have problems. But, you cannot go down in flames if the business idea, with some analysis showing it might work, simply did not pan out. Even a chance of a business panning out is enough, considering that most small businesses fail. I have heard a slew of statistics from 75% in the first year to 90% within 5-years – who knows – but the reality is, most business ideas do not make it to profitability.

As for how this impacts the banks and lenders. Well, again, very simplistically their take was to loan as much money as possible to pretty much whoever. For a while, this was making the banks a lot of money – there is no question. The business plan showed that it could work in theory and for a while it did. So, all is well. Honestly, the system could have continued to work and drive things the way it did, but people stopped paying their bills. That is where we are today. Businesses, lenders, banks, and many more engaged in the practice of turning a profit and the business idea simply just did not work out.

So, with the writing on the wall, why is everyone now calling for an interest rate cut and whining to do so? I think it comes down to wanting someone to bail them out. The now famous Jim Cramer meltdown video basically saw him whining and crying about ‘how tough it is out there’ and that the Fed should come to the rescue. Remember – the Fed is not the enemy here – the practices of America as a whole is what caused this blip.

Overall, at least to me, things look good. Sure, growth has slowed in some cases, but revenues are up, profitability is up (even if at slower rates), people are employed. Business has not ceased to exist and continues to function very well. Some in the credit markets might claim exception to this, but how is this different from technology consulting companies facing the Internet Bubble collapse or travel companies facing the events of 9/11? It’s not – it is just part of doing business and there is absolutely no reason to be bailed out.

How many of you still reading this article (sorry for the length) have run into tough financial times? How many of you have had businesses you owned fall apart or have slow year? Who was there to bail you out? Nobody. Sure, clients help and the government has programs to facilitate the development of business, but nobody was just going to write you a check to cover your losses. And in the event they did, what are the odds of you tightening the belt and just walking away? Slim to none – as more often than not, people that are bailed out of their credit card debt by a family member or bankruptcy often return to the same fate. Forget statistics – I would venture to say we all have a handful of friends that are in over their head, were able to get out of it, and then fall right back into the precipice of debt.

The stock markets are pushing for a rate cut – and it very well may happen. The stock markets, though, want it now it seems and do not feel like waiting until the September 18 meeting. Many economists are now saying one will happen, and it very well may. Should such a cut happen, it will be interesting to see how that actually affects the stock markets. It makes one wonder if some of the upside is already getting priced in by the markets expecting such activity. Note today’s (August 22) climb in the major indices.

So, what happens if the Fed does not cut rates and leaves them the same, as they have been saying for a while. The panic returns and the markets continue a downward decline. Honestly, that does not seem like a horrible idea. Nobody likes their stocks going down, but it has been up-up-and-away since Fall, 2006. It may be time for a breather. Additionally, we have seen the U.S. Dollar strengthen against the British Pound and the Euro in the past few weeks suggesting that this may be a good path to go down. Overall, this is good news for the Dollar and for our economy as a whole. Sure, $1 is $1 here, but the more liquidity added, the more it is going to hurt our country’s economy in the long run.

Also, all things are possible. Explain how the interest rates in Europe are lower than ours here in the USA and yet, their respective currencies have strengthened, and their countries have avoided much of the debacle of the mortgage fall out. Honestly, I think the Fed would be amenable to lowering the rate if they were convinced that banks and Americans would change their ways somewhat and practice fiscal responsibility. However, as mentioned above, adding more liquidity would likely just contribute to the same poor spending practices by consumers and loose lending guidelines by banks.

I really believe that we need to let this situation filter out naturally. It is not some Force Majeure event – there is a very direct, logical explanation for such. Additionally, consider that the markets have yet to endure an actual correction on a closing price basis. The markets are down about 7% since their highs (less than the 10% required to officially call it a correction) and are still up about 6% YTD, despite the steep recent decline. Further consider that September and August, historically, are the stock markets two weakest months of the entire year – and the closing months of the year tends to be strong.

I am not suggesting maliciously punishing anyone, but we cannot just let the effected companies off of the hook at the expense of our entire economy – only to create a situation that will most likely spawn an even more severe situation in the future. This is a storm that must be weathered – and frankly, it is not that bad of a storm. The interest rate cut needs to be restrained until it is really needed – when inflation does start to spiral out of control or business becomes universally stagnant. Like antibiotics, you do not want to take them to much because each time you do, it makes them that much less effective when you might actually really need them.

Also, do not take me for a bear – I want things to go up, up, and away all the time myself. In fact, I have a couple of positions that I would like to see go through the roof as soon as possible. Why? Well, and I embarrassingly say this, but to ‘bail me out’ of some issues. As much as I would like that happen, I am well capable of bailing myself out and having someone bail me out now frankly would not help me for the long-haul.

So, this horrible malady that we are effected with is really not all that bad and there are intelligible, logical steps that can be done without waving the magic interest rate wand. Sleep it off.