We Get By With A Little Help From Our Friends (in Congress)

Let there be no confusion: we are in the thick of an economic slowdown. Wall Street seems to be reacting very emotionally to all the doom-sayers and their recession dirges. Today marked another 300+ point drop in the Dow Jones Industrial Average, coming on the coattails of other triple digit losses earlier in the week.So why all the hub-bub, Bub?

Ben Bernanke gave a strong speech on the economic outlook of our country to members of Con­gress today. In this speech, he cited a disappointingly weak report on the job market and wage growth from December, but qualified that by saying we shouldn’t place too much credence in a single month’s data. He also mentioned that inflation was being driven up (although it has slowed its growth as of last month) in part by high oil prices percolating into all consumer goods. He passed off rising gold and commodity values as false specters of inflation on the horizon by saying gold prices are being driven by geo-political supply-side pressures and commodities are receiving a growing demand due to emerging nations being able to afford them.

bailout Merrill Lynch and CitiGroup both posted huge losses, underscoring this precipitous drop in stock values we have recently experienced. Countrywide, in lieu of going under completely, was re­cently bought by Bank of America, dealing a substantial psychological blow to the mortgage mar­ket. If the big enchilada of the industry is hurting that bad, how can we ever recover?

So that’s the bad news.

The good news is that Ben Bernanke described the American economy as “strong, resilient, and diversified.” I echo this sentiment. When we stiffen our necks and hunker down, we can get a ton accomplished as a nation. Ben is still not forecasting a recession. Actually, only 4% of profes­sional economists are willing to forecast even a mild recession publicly. Slow growth, yes, but not negative.

However, as an added insurance policy against downside risks of slow growth, Chairman Ber­nanke advocated some sort of fiscal stimulus (i.e. tax code reform and easing) to accompany his monetary stimulus (i.e. cutting key interest rates). While he wouldn’t get into details (because the Fed needs to stay staunchly non-partisan and not favor one tax code over another), he did suggest that the fiscal package have multiple angles to it so as to comprehensively thwart economic decel­eration. The changes, he stated, need to come quickly and should be “explicitly temporary” in order to not compromise fiscal discipline.

Translation: if the government bails out the country, we’ll put ourselves right back into a similar heap of trouble before you know it. This is known as the ‘moral hazard’ worry of cutting rates too quickly. In that case, we’d see another big bubble created with an even nastier pop at the end.

Wall Street bloodhounds are sniffing around for an emergency rate cut from the Fed. I don’t see it happening. Emergency cuts evidence panic from the higher-ups, and maintaining a veneer of con­fidence is more important than ever. If the investing populace isn’t convinced that the Federal Reserve has a handle on price stability and growth, mob mentality will set in and bad things will result.

Tax increases at the top tier would clinch supply. That along with loose monetary policy will leave too many dollars chasing too few products. In that case, stagflation (simultaneously rising unemployment and inflation) would rear its ugly head. Ben suggested we run up the deficit to cover the cost as opposed to taxing ourselves. That approach certainly rings true to me as the lesser of two evils.

Bottom line: Bonds are improving as the stock market tumbles, meaning that mortgage rates are becoming all the more attractive as this mess continues. Expect a 50 basis point cut at the end of January to the Fed Funds Rate (which would bring the Prime Rate down to 6.75%) and no emer­gency meeting between now and then. If the stock market catches tread and starts rocketing up­ward, mortgage rates will suffer.

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