Sunday, August 19, 2007

Worst is not over, more cleansing needed in financial markets

The credit bubble has not been cleaned out yet. A couple of bad weeks and the meltdown in the subprime market are not enough to clean out the years that created the credit bubble.

I think that the bottom is a long way off. We have only seen the tip of the iceberg of the coming credit problems. In the next several months, many mortgages are going to reset and many families will find themselves with higher monthly payments that they can not afford, liquidity will start drying up, and money will start flooding out of markets.

We have not seen any major market correction since 2002. Not only have markets corrected but US consumers and the government have borrowed so much to fund spending the last several years that they fueled global real estate and emerging market growth. While I hope I am wrong, I think this is only the beginning of more problems to come.

The market reaction to the Fed cut on Friday does not surprise me, but it is a short term bounce and not sustainable. The Fed cut is an attempt to reverse psychology which affects liquidity. At best, the cut is only going to postpone things for several months. I would argue that it would be better if the Fed managed the correction not tried to reverse it and let the system clean itself out.

The Fed rate cut is short-sighted and foolish. The market is only down 8% from an all-time high. I am surprised of the lack of perspective that people have on what is going on. After years of irrational growth in certain markets (ie real estate) and US consumers spending more than they earn, everyone knew this was coming and it would be healthy. I respect Ben Bernake, but I do not think the Federal Reserve should be worried about bailing out institutions and individuals who lack financial discipline. As Jim Rogers said, "The Federal Reserve was not founded to bail out Bear Stearns or a few hedge funds. It was founded to keep a stable currency and maintain its value."


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