For the last few weeks, decision makers all over the world have been grappling with the far-reaching implications of the current credit crisis. Today, the narrative took a decidedly turn for the worst as the US House of Representatives failed to pass the legislation that would have set up a $700 billion loan to shore up the weak mortgage security market. In our view, the crisis has morphed from a financial crisis into a leadership crisis. Those representatives who voted against this legislation appeal to have done so out of some bizarre notion that their constituencies did not back the plan because it was a “Wall Street Bailout.” Not only does this concept underscore a totally lack of understanding of the plan by the average “man of the street,” (ultimately we think this plan is in every possible way a “Main Street Bailout”) but shows a complete rejection of the fiduciary responsibility Congress has to provide leadership and make the tough decisions the “man in the street” is ill-equipped to make.
The fact that partisan politics has also raised it ugly head in the midst of this critical time for the US economy and its capital markets is also a grave concern for us. We are loathe to lay blame for any decision anyone makes in good faith, but this lack of leadership in this time of crisis is unforgivable. We think that those who voted against this plan will have a lot of explaining to do, if fundamentals quickly deteriorate.
While we are in the mood to lay blame (against our better nature), let’s review the guilty parties of this financial crisis:
1. Anyone who bought a home with no money down or without documented proof of income and who expected to “flip” it quickly to make a short-term profit. Guilt is multiplied by the number of homes bought and sold this way.
2. Any bank or mortgage lender to who loans to any home buyer without an adequate down, payment, adequate documentation and/or proof of income. Loan officers share the blame with their managers who were likely encouraging this behavior.
3. Any bank who sold these mortgages to someone else. This has been standard practice for a long time – if banks had to keep the mortgages they made, we would expect that the lending standards might have been kept more reasonable.
4. Any investment bank or financial intermediary who then packaged bundles of these mortgages into CDOs and other like securities and sold them to investors.
5. Any bond rating agency who rated these securities “AAA” (best quality) knowing that some portion of the mortgages in these bundles would go bad as the home buyers (see #1) eventually would begin to default.
6. Any investor who bought these securities – this huge list would include mutual funds, banks, investment banks, hedge funds, pension funds, 401k advisors, corporations, etc.
7. Any manager of firms included in #6 who pushed their fund managers or treasury staff to “get more yield” on fixed income securities. The admonition to “get more yield” pushed many decision makers to buy these bundles of mortgages.
8. Anybody who thought one could receive a higher yield on a security without a higher degree of risk.
9. Anyone who said (after the fact), “Hey, I thought it was rated ‘AAA'” (see #5).
10. Anyone in the government who encouraged home ownership as an unalienable part of the American Dream.
11. Anyone who might call into question the urgency of the this crisis for political gain.
Clearly, laying blame is a non-productive activity at this point in the crisis, but for many talking heads featured in the media, it seems to be only important thing.
At this point, we think the market is being driven purely by fear (nothing fundamental changed for the economy today) and this is often the tell-tale sign of a selling climax. Very often, the end of a bear market is marked by a dramatic event that creates a huge vortex a negativity that overwhelms all reason and objectivity. Today’s market action has that feel about it.
We cannot quantify the impact this kind of fear can have on the markets, but we are confident that when this fear abates, the markets can resume their normal path to recovery. We continue to think that the market is offering a vast quantity of very high-quality stocks at massive discounts to their fair value. We, like most long-term professional investors we know, are using this market turmoil to upgrade the quality of our holdings, use cash to buy equities and in some cases, move from bonds to stocks.
In our view, economic fundamentals have not changed today. The US economy continues to face a number of challenges, but one of the more troubling challenges (the credit crunch) could be largely addressed by the simple passage of the Paulson/Bernacke proposal. When this happens, we expect the global stock markets to response very favorably.