December 2008

Time is All We Need

By Brad C. Stewart, Senior Vice President/Chief Investment Officer

The saying is, “time heals all wounds.” Time is the key ingredient the economy needs to heal its problems. One of the biggest problems facing our nation’s economy today is a credit crisis brought on by a lack of confidence in the system, and in our fellow financial institutions.

The Federal Reserve and the United States Treasury have done almost everything they can to address this crisis. Even still, there is a feeling of more bad news to come. While that is not a very pleasant thought, unfortunately the doubters are correct. I for one am glad to see 2008 coming to an end. But I have very few delusions about what 2009 might bring. Although 2008 has been a strange year, earnings for some have been quite good and yet the reason to celebrate is missing.

Why is that? Because of the dichotomy of accounting rules that allow a company to report strong earnings, while at the same time requiring them to report unrealized losses. Keep in mind that these losses are nothing more than the mark-to-market of securities in the investment portfolio. If these securities are still performing as advertised, you do not have to sell, if you choose not to. If these securities were not performing as advertised, you would not be allowed to mark-to-market. Instead, you would be forced to list them as, Other Than Temporarily Impaired (OTTI).

The original purpose of mark-to-market was to give shareholders a “clearer” financial picture, in the event of a forced liquidation of those securities. There are other reasons, such as giving insurers like the FDIC, FSLIC and NCUSIF, what is referred to as a “liquidation value” of the financial entity. However, in stressed times such as now, if an entity needs to sell in this “buyers” market, the resulting price is not the true value of the security. One main reason to voluntarily sell is to raise liquidity. Liquidity is king. This is where the Fed and Treasury have been working over time to inject as much liquidity into the system as needed. This injection of liquidity, which is not readily recognizable by a user friendly lending environment, is certainly in the system. It is however, very evident if we look at the overnight federal funds rate. The overnight rate has been trading somewhere between .25 and .50 percent. A full 50 basis points below the official fed funds target, because by design, there is a ton of excess liquidity in the system.

The Federal Reserve and the Treasury will continue to propose more stimulus programs, and to lower the funds rate, even as we approach zero. Don’t forget Japan’s experience in the 1990s.

We continue to hear this current crisis compared to that of the 1930s. I recently read an interview in BusinessWeek in which the Chairman of Wells Fargo, Robert Kovacevich, said it best, “This is the worst financial crisis since the Great Depression, but it is far from the worst economic crisis.” There are many reasons why that comment is true. There were many programs put in place after the Great Depression, but as I have said before, Chairman Ben Bernanke and Secretary of the Treasury Henry Paulson, are very much involved in addressing this crisis before it morphs into something much worse. Their “hands-on” approach is very different from the one used in the 1930s. While this crisis is certainly upsetting and down right scary, with time this too shall pass. Time really is all we need.

Finally, it is time for our Mid-Atlantic Corporate family to wish you and your family a very Happy Holiday Season and a healthy and prosperous New Year.