Money makes the world go
around,
The world go around, the world go around
- John Kander, Cabaret
Money may make the world go round, but it is confidence that moves
money. There is no doubt our financial system operates, or fails,
based on the level of confidence placed in the system itself,
causing self fulfilling prophecies to wreck havoc in times of
stress.
Take, for example, the simple model of a bank. Depositors open
direct deposit and other accounts that allow them easy and full
access to their funds at any time. Because the bank has a broad
depositor base and, on any given day, many people make deposits and
withdrawals, there is a core base of these accounts that is assumed
to be long-term. There is no need to figure out exactly which
accounts will exist over the long term, as long as we can have
confidence a certain percentage of the deposit base will remain.
Given this confidence, the bank can make long-term loans which are
normally at higher interest rates than it is paying on deposits.
The difference - less expenses, of course - is the profit. Most
bank risk is assessed based on the strength of its loan portfolio
since the deposit base is assumed to have some level of stability.
Indeed, if there were no stability, the bank could not operate.
Broaden this simple bank model, and you have the design of our
entire financial system. Credit card loans are easily available
because they can be funded by issuing debt securities in the
marketplace. The same is true for auto loans and, until recently,
mortgage loans.
But infuse a significant amount of fear into the equation, which
decreases the confidence level of investors, and a potential house
of cards is revealed. If enough investors pull their funds from the
markets, funds stop flowing through the system and contagion
effects take hold. This is what we are experiencing today.
As the bulk of investors rush to the sidelines, prices plummet and
capital structures collapse. Fear begets fear, leading to new
downward momentum as the decline spreads throughout the economy.
The government's solution is to lead everyone to believe that
everything is government guaranteed, tipping the scales back toward
greed. If they can accomplish this, there will be a mad rush out of
the safer markets and into the risk markets, getting funds to flow
through the system again and rebuilding investor confidence.
The trick at that point will be to pull government support and
liquidity in order to avoid hyperinflationary activity as the
pendulum swings hard from fear back to greed. But that is a problem
for another day.
Weekly Review
Treasury rates continued to fall last week due primarily to
continued negative news on the economy. Good news, however, came in
the form of an agreement on the Treasury's Temporary Liquidity
Guarantee Program (TLGP) as well as newly developed programs to
support credit card and auto loan creation.
- Third quarter's GDP growth estimate was revised down from -0.3
percent to -0.5 percent. Lower revisions to consumer spending were
the primary culprit along with a wider net export deficit. Slight
inventory stabilization helped to offset these negative effects.
GDP in the fourth quarter will likely be significantly lower given
the slowdown in already seen in October.
- Durable goods orders fell more than twice the expected three
percent contraction at a -6.2 percent pace in October which
followed a downwardly revised -0.2 percert move in September. Over
the last twelve months, orders have fallen 10.6 percent, the
largest such decrease since 2001. Weakness in the report was
widespread indicated an economy-wide slowdown is in progress
- Weekly initial unemployment claims have gone parabolic over the
last several months coming in at 529,000 for the week ended
November 22. Expectations for November's change in non-farm payroll
have hit -320,000, far beyond typical recessionary levels and
implying a new batch of forced home sales is on the way.