Monday, October 27, 2008

Is the Age of Prosperity really over?

I won't go into the details, but for various reasons the WSJ has lost much of its clout as of late as the paper of record in the financial world. Today, however, they hit one out of the park with a great guest opinion piece by Arthur Laffer.

Mr. Laffer is a former Reagan staffer so you've got to cut through a good deal of supply-side bs to get to the meat of the story, but it has several themes which are interesting. I applied a fairly heavy hand to the edit button (cutting out much of the political nonsense he spouts), but the economic discourse is valuable.

"When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.

No one likes to see people lose their homes when housing prices fall and they can't afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house's value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple.

But here's the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy.

These issues aren't Republican or Democrat, left or right, liberal or conservative. They are simply economics, and wish as you might, bad economics will sink any economy no matter how much they believe this time things are different. They aren't.

Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was -6% per year for 16 years. That, ladies and gentlemen, is a bear market. And it is something that you may well experience again. Yikes!

Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity."

Cheers!

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Final note on yesterday's action - at 8,175 we've set another closing low and that will be the talk among the tarot card rea..., I mean chart readers.

The end of the month might be strange because mutual funds will probably do more window dressing than usual. Mutual funds usually only report their holdings quarterly to investors, so for 89 days in a quarter a mutual fund could be daytrading penny stocks but on 10/31 they can go out and buy GE, Microsoft, Google, and JP Morgan to have some pretty names to put in their brochures and regulatory filings. These stocks are "window dressing". Any stocks that have been severe underperformers, in the news or just plain dogs might be sold hard this week, while the outperformers should see higher demand.

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