Lehman, Fannie and Freddie

Wow!! Yesterday (Monday 15th Sept 2008) the FTSE-100 fell from Fridays' closing price 5,416.70 to 5,204.20, nearly a 4% drop in a day, some markets falling even harder. So what can we identify as a reason for the drop. Well, the fourth largest investment bank - Lehman Brothers has filed for bancrupcy, Meryll Lynch is getting ready for a takeover and AIG has some problems too. However all this didn't come quite too unexpected. We were in huge trouble since the Subprime crises erupted 14 months ago. What we've seen since then, was a lot of patching and quick-fixing. Banks, such as Bear Sterns or Northern Rock among others being rescued, inflation targets beeing ignored for the price of cheap cash and the highly controversial rescue of Mortgage Giants Freddie and Fennie Mac http://news.bbc.co.uk/1/hi/business/7603946.stm.

The problem with pumping money into these companies are numerous-fold. First off, tax-payers are paying for something they should not be be paying for in a fair economy. The system is shaken up already, consumer confidence is very, very low!! Nobody knows how much more real estate will fall, people are more likely then ever to put off home buying in the current climate. Another real problem, when the government steps in to rescue a private financial firm it encourages other firms to engage in risky behaviour too [see http://biz.yahoo.com/ap/080915/paulson_markets.html].

Most people knew a time would come when the patching becomes unbearable. Untill now all that was done was simply putting off of a crisis further back that cannot be avoided anyway. Jim Rodgers explains this nicely in his August 2008 interview for CNBC:


Jim Rodgers - CNBC video (August interview)
http://www.cnbc.com/id/15840232?video=835801384


Even the biggest of the biggest Bulls now see that we are going into a pretty hard recession. A recession always happens in one of two possible ways:

1. Markets fall hard and painfully, but the recession tends to be shorter
2. A crisis is put off by government intervention for so long, that when eventually a recession happens it takes much longer for it to come to an end.

The second point is obvious if one thinks about the idea a little bit. There is something inevitable about rescuing badly managed businesses, were management was incapable of adapting to shrinkage in consumer spending and minimising loses responsibly. In situations such as these, responsible companies survive and the badly managed ones will not. In a democratic society maybe we shouldn't let them. Anybody can do well in a healthy economy, however when hard times come around, the bad ones need to go and they eventually will. The question is how long it will take for them to go away; long vs. short recession?!?!

For those on the left side of political spectrum I will say only this, I am too, but saving badly managed businesses is not right, not right, not in a free economy! We should have and many countries (not all) do have enough social nets to take care of people who lose their livelihoods.

To Conclude

There are three things I would like to conjure from this little Tuesday post :-)

1. In capitalistic economy we should be socially responsible to people, however not to badly managed businesses even if they are in a recession. There is no reason we should all pay for mistakes and incompetences of a small group of people.
2. Recessions are inevitable in the free markets.
3. We are currently in a very recessive economic environment, and I am certainly bearish on the UK stock market and I have been for a while. That does not mean there are no mid-term opportunities, what it means is that short selling is now the way to go!!