In Need of a Long Term Fix

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. 

It feels like we're swimming upstream
It feels like we're stuck in between
A rock and a hard place
We've been through the heartaches
And lived through the darkest days
- Will I Am 

In "normal" times, investors and traders use economic and market data to drive their decision-making process. When the economy is growing, inflation and employment are stable, and earnings are solid, investors look primarily to data that would show any sort of stumble in these three measures.

I've spent the better part of my investing career focused on these three areas and largely ignoring legislative action. The Fed, being focused on the economy in a non-political manner, would simply offset any action from the rest of Washington as the effects of new legislation began to come forth. If Congress enacted laws that would slow overall growth, the Fed would simply hold rates at a slightly lower level. If policy was too loose, creating the potential for inflation, it would hold rates at a slightly higher level than it would otherwise.

These days are a far cry from "normal," of course, as the volatility seen in market levels clearly demonstrates. Today, instead of investors focusing on growth, inflation, employment, and earnings, investors are primarily focused on the next action out of Washington.

As the crisis played out in 2008 and 2009, government activity took a prominent role in shaping the course of investment prices. First, the knee-jerk reaction toward safety, including a multitude of bailouts and dropping of interest rates, helped to quell the terror-level of fear that permeated investors at the height of the crisis.

Then came a number of "stimulus" projects. I define "stimulus" here as any action by government to promote growth in the economy; including the publicly labeled stimulus packages under Bush and Obama, these actions total somewhere around $1 trillion.

In addition to, or as part of, those direct stimulus packages, the "Cash for Clunkers" program got the most play in the media and turned out to be quite a dud assuming the objective was to promote an overall economic recovery. Sales for cars were simply pushed forward one month causing, if anything, a short-term disruption in the supply chain. Looking at auto sales over a longer period, there is no evidence of increased auto sales.

There were many other programs, of course, particularly in the housing industry. The $8,000 first-time homebuyer incentive is interesting when you consider some quick, back-of-the-envelope math that reveals participants have seen their home values drop around 6.5%, negating this credit.

All of these stimulus ideas have led to $1.1 trillion in GDP growth since the bottom in the second quarter of 2009. Stripping away the $1 trillion or so of "stimulus" projects, we find a net zero effect on the remainder of the economy.

If the goal was to get us to the other side of the riverbed – where the economy operates on its own - it's clear these short-term "boosts" are not working.

In my well-worn metaphor describing our economic experience as "crossing a riverbed" these programs were designed to smooth out the bottom while we waited for a longer term solution that would get us to the other side. We still wait.

In the last month, we've seen a focus on another round of short-term solutions, still with no discussions of a long-term strategy for our economy.

These include:

• A soft promise from the Fed to keep rates low into 2013
• Talk of a QE3 or other manipulation of the Fed's balance sheet
• A push for easier home refinancing, targeting those who are current on their mortgage, but under water
• Temporary alterations to the tax code or potential tax holiday
• New infrastructure spending
• Extension of unemployment benefits

All of these programs may be worth pursuing, but let's not kid ourselves that they will lead to a long-term recovery. Instead, these are designed as short-term stimulus projects that will provide a further smoothing of the riverbed.

In 2008 and 2009 this was clearly the correct goal of government policy. But here in 2011 we should be more strategic in our approach to the economy.

One approach I have long advocated is to rebuild the way credit is provided to the typical homebuyer. This is where our current struggles began as the old system imploded in spectacular fashion. Unfortunately, debate around the economy has oddly ignored this important function. In the past, I have somewhat simplistically referred to this as "fixing" Fannie and Freddie, but that's really only the first step.

Today, as a result of the mortgage market implosion, homeowners – or, really, consumers – are left with enormously volatile exposure to an asset that may not be worth much on a net basis. This new massive increase to their wealth volatility has encouraged them to delay or cancel many marginal expenditures that have become a part of the overall economy in favor of savings. Add to this a struggling global economy and there is no solid consumer that the world's producers can rely upon.

Removing this barrier to recovery will not drive growth alone, but it seems clear this wealth volatility remains a tremendous obstacle between us and the upslope on the other side of the riverbed.