It was in March 2007, that S & P/ Case – Shiller Home price index first mentions deep trouble in Real Estate industry. To his credit, Robert Shiller made the correct call on real estate bubble back in 2005, at its peak. Over the past nine months, we moved from real estate bubble bursting to the effects of sub prime mortgage crisis to a general credit crisis, on to talk of recession and most recently about stagflation.
While there has been consistent discussion about the crisis of confidence facing the financial markets, the usual call is for the fed to lower interest rates. Television pundits like Jim Cramer went to huge lengths, literally begging for rate cuts. (It is funny listening to Cramer talk about not making a comment and do what it takes about bear stearns, and then pleading on national television for a rate cut, talking about guys loosing jobs and firms closing.)
Well, we have had multiple rate cuts since this video and the stock market hasn’t done any better. The expectation is there should be / will be more rate cuts along with fresh infusion of liquidity into the market which some how miraculously stabilize markets and save the economy. I don’t know if the Fed will cut rates further or if it will resist the temptation considering the inflation rate. That is where this new talk of stagflation comes in. If one were to believe these prognosticators, the only choice for American Economy right now is either recession or stagflation.
This is an extremely bad case of treating the symptoms and hoping the medicine will eliminate the disease. The wild gyrations of the stock market is just a symptom of the underlying crisis of confidence that plagues the economy. Rate cuts or fresh capital infusion are not going to resolve that crisis of confidence of Wall Street in Main Street.
What we face today is a crisis of confidence in the ability of borrowers to pay. We all know of that maxim, prove to a banker you don’t need money and the banker would tempt you to borrow with a great deal. The problem is, today, no one in the wall street believes there is any one on the main street capable of paying back. (Here i use the terms Wall Street and Main Street figuratively to indicate the financial industry and general society). All lending calculations by a lending institution are predicated on the ability of the borrower to pay up, along with interest. This implies faith in the ability of the borrower to improve his or her financial situation over the term of the loan. During the hey day of securitization when, all loans made at the reatil end were packaged and sold, this was not such a huge concern. Post sub prime mortgage write down, it will take real courage for a banker to do so.
This being the case, lending activity will be severely curtailed, leading to a reduction in economic activity which in turn will lead to reduction in lending further. With oil being priced at the levels it is, inflation is imminent. Thus, the choice between Recession and stagflation. Attempting to manage this crisis through rate cuts and liquidity infusion, may work at the wall street not necessarily improve the status of the main street. Given that Dollar value is falling, one likely scenario i foresee is gold moving up (good old store of value) and dollar eroding further as all the financial institutions compete to retain the value of their assets for the long term.
There is uncertainty associated with the withdrawal symptoms of binge lending and there will be flight of capital from the main street. Given this, a better option is to ensure that capital is attracted back into economy for the productivity and returns to be gained on the main street rather than to move to the next level of abstraction in financial products.
A place with a view 