Keep It Between the Ditches

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.

 A young boy, two hands on the wheel
I can't replace the way it made me feel
And I would press that clutch
and I'd keep it right
He'd say "a lil' slower son,
you're doin' just fine."
Just a dirt road with trash on each side
But I was Mario Andretti
When Daddy let me drive
- Alan Jackson

If you've ever been in a car crash or other traumatic sequence, you know the feeling when everything seems to happen into slow motion.

I was t-boned once while commuting home on a Friday and this frame-by-frame effect began before I even entered the intersection (with the green light, of course). It continued until I had pulled over and even seen the culprit pull her car to the curb behind me. Thankfully, no one was injured, but I was quite groggy for 10 minutes or so as we exchanged information.

As we struggle through today's economic challenges, I think more and more of this experience, which seems quite the corollary.

Mortgage underwriters, analysts, salesmen, executives, and even investors were not paying attention for some years leading up to the liquidity crash of '08. But the slo-mo effect began much earlier in 2007 when Household Finance announced dismal first quarter earnings due to write-downs from their subprime unit. By summer of that year, more than 100 mortgage brokers had gone belly up across the country and hedge funds — included two run by Bear Stearns — had disclosed enormous losses in the sector.

As the Wall Street folks slowly recognized their mistakes in this sector, end investors stayed put for awhile in the riskiest of securities, including very short-term debt that had to be refunded quite frequently. It wasn't until early 2008 until cash investors began to realize their principal invested in short-term holdings of SIVs, ARS and ABS commercial paper was solely dependent on the "next buyer" as opposed to true quality collateral.

A "throw the baby out with the bathwater" effect ensued as all short-term investments became suspect, regardless of collateral quality. This brought down the ARS market in rapid fashion — even though the collateral behind many of the securities remained AAA.

Company funds became locked up, CFOs were fired, and the contagion continued. Bear Stearns then collapsed in March 2008 as overnight investors (through the repo markets) pulled massive amounts of funding away within a two-day period. The government bailouts ensued and collateral damage continued to spread everywhere.

By the time the next big challenge arrived in September, the government thought that letting Lehman go bankrupt would be accepted by the markets as they wanted to avoid treading too far into moral hazard territory. Obvious in hindsight, they were wrong and have had to overcorrect toward government support since.

The effects of investor pullbacks were felt across the globe and one could confidently posit that all of the economic troubles worldwide can be traced back to this movement toward the sidelines.

But the original cause — not the car crash per se, but the cause of the crash — was a poorly formed mortgage market.

The problem, in other words, was not that liquidity dried up or that a car crash occurred. The problem was that Wall Street and investors did not understand their own transactions – first in the mortgage market and then elsewhere. The problem was that they did not know how to drive.

We have been addressing the symptoms ever since the government's first action in the fall of '07. Not once since the downslide began has there been a serious debate regarding the cause of the crash. Perhaps we are finally moving out of the slo-mo phase and will be able to address the structure of the mortgage market in order to get the economy moving again.

Last Friday, the Executive Branch unveiled their suggestions for what to do with Fannie Mae and Freddie Mac. If this debate continues and decisions are finally made around how the government will interact with this $13 trillion sector of the economy, please be happy we are finally addressing the true issue and learning how to drive once again.

Key Developments
University of Michigan preliminary index of consumer sentiment for the month climbed to 75.1 from 74.2 in January. This is the highest level of consumer confidence in eight months. The increase is attributed to an improvement in unemployment numbers. The sentiment data showed that households perceive the economy and the job market to have turned a corner in February and signaled that consumer spending may continue to contribute to the expansion.

The U.S. trade deficit widened for the second month in December as the cost of oil climbed to the highest level in two years. The gap grew 5.9 percent to $40.6 billion. For all of 2010, the trade gap surged 43 percent as the recovery in spending helped lead record imports of consumer goods.

Consumer credit rose by $6.1 billion to $2.41 trillion in December. This was the third consecutive month of increase, led by the first increase in credit-card charges in more than two years as holiday sales improved. Borrowing, however, remains below the peak of $2.58 trillion in July of 2008.


The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or SVB Asset Management, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.

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