April 2008

Of course they are different this time, mainly because the times are different. However, while some of the circumstances may be different, if we look back over the history of this great country, we will be able to find situations similar to what we are going through right now. The United States is going to be 232 years old in a few months. We have experienced a great deal during those years. History does repeat itself and if we are in or about to go into a recession, it certainly will not be the first, or the last. We have had ten since 1947.

One of the biggest differences in the circumstances of our current dilemma is the fact that we are now part of a global economy, and many other countries are also being affected by the housing debacle and the credit crunch. How is it possible that a decline in housing prices in the United States affects the global economy? Simple! The mortgages used to finance the purchase of those houses have been securitized and sold all over the world, creating huge write downs in mortgage backed securities. The estimated write down thus far is just under 200 billion dollars.

While some of these write downs are unrealized (created by the mark-to-market accounting method) they are still creating a great amount of concern. As you know, under FASB 115 we are required to classify our securities at the time of purchase as one of three categories: held to maturity, available for sale, or trading. For liquidity purposes, many securities are classified as available for sale. The accounting rule states that if a security is available for sale it must be marked-to-market every month. The results show up on the financial institutions balance sheet, but not on its income statement. 

One of the most devastating side affects of this housing debacle is the credit crunch. As we discussed earlier, financial institutions are unwilling to lend money to each other because of an unwillingness to accept the collateral that is being offered. This is a huge problem that has curtailed the flow of funds and credit. In an attempt to get the markets to function properly, the Federal Reserve’s most recent action was to introduce the Term Security Lending Facility. This will allow the primary dealers community to borrow up to $200 billion U. S. Treasuries from the Federal Reserve for 28 days at a time and pledge agency debt, agency Mortgage Backed Securities (MBS), and non-agency AAA rated private label MBS. The plan is to make this facility available until September of this year. This will then give the primary dealers acceptable treasury collateral to conduct their own transactions with the hope of getting credit moving again. 

As this credit crunch has unfolded and the fear of a recession has become a reality, gold has traded just over $1000 per ounce, oil has traded at $111 per barrel and the price of food is rising. In other words, inflation is not going to go away and monetary policy will be influenced by both. 

So, are things different this time? The answer is yes. Are they similar in many ways? The answer is also yes. 

P.S. With the recent “purchase” of Bear Stearns by JPMorgan Chase, there is an obvious effort by the Federal Reserve to calm the fears of the markets. History does repeat itself, and things will work out. It’s just a matter of time.