In the Wake of Poseidon

Who voiced the following allegation?

“I believe that banking institutions are more dangerous to our liberties than are standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation and then by deflation, the banks and the corporations that will grow up around them will deprive the people of all their property until their children wake up homeless on the continent their fathers conquered.”

Want to guess who stated this? Alan Greenspan? Warren Buffet, or some other 21st century sage? Nope! You’ll see at the end of this article.

In antiquity, Poseidon was a major civic god of several cities: in Athens, he was second only to Athena in importance. Poseidon was seen as offering calm seas. However, when offended or ignored, he supposedly struck the ground with his trident and caused chaotic springs, earthquakes, drownings and shipwrecks. Like the people of ancient Greece, we in the 21st century found ourselves in the wake of Poseidon in September – today’s Poseidon being the financial markets.

There will be books written about the recent events on Wall Street, and possibly even more books written about the long-term implications. The developments in September changed so fast -- and the stock market was so volatile – that there was no time to catch our breath. Other asset classes—bonds, currencies, gold—also made historic moves. For the record, I sent four e-mail blasts to clients during the events of the last weeks of September. In this commentary, I will consider the current state of the stock market, and review the major developments that occurred.

What went wrong during the end of September:

• Mortgage giants Fannie Mae and Freddie Mac were poised to collapse.
• Investment banker and brokerage firm Lehman Brothers filed for bankruptcy protection.
• The world’s largest insurance company, American International Group (AIG), nearly collapsed.
• Merrill Lynch became vulnerable and was quickly acquired—shotgun wedding style—by Bank of America.
• The commercial paper market seized up (froze in fear with a “deer-in-the-headlights” response), which impacted many corporations’ ability to raise short-term funds.
• The multi-trillion dollar mortgage derivatives market began to unravel.
• Institutional investors began to withdraw cash from money market funds -- assets that have
  always been presumed safe.
• Funding costs soared for giant investment banks (Goldman Sachs and Morgan Stanley),
  which put their viability into question. They eventually will become F.D.I.C.-regulated banks,
  marking an end to the Wall Street investment banking business as we have known it.
• The Treasury Department (taxpayers) bailed out Fannie and Freddie.

The Government, Treasury, and Fed Responded with The Mother of All Bailouts...

• The ultimate liability is unknown, but it could cost hundreds of billions of dollars – up to $700 billion according to the proposal made by U.S. Treasury Secretary, Hank Paulson.
• The Federal Reserve loaned $85 billion to AIG at a high interest rate to allow for a more orderly liquidation of distressed assets and a sweeping restructuring. The loan is backed up by AIG’s insurance assets, and the U.S. government receives an 80% equity stake in AIG in return.
• The Fed led a coordinated effort among global central banks to flood the financial system with hundreds of billions of dollars. Loans were offered to commercial banks.
• For the next year, the Treasury Department will now guarantee money market funds up to $100,000 in a similar way that FDIC bank deposits are insured. The program will be financed with up to $50 billion in taxpayer dollars and fees from money market firms.

Of all these “fixes,” some will work, and some will fail. Some problems will be corrected over a few months, but many will take years to resolve. Our simple advice: live prudently, spend less than your make, save at least 12% of your earnings for your future, and never forget this axiom:

“When you are in a hole, rule #1 is to not dig another one.”

I will continue to comment on last-minute market conditions through e-mail. If you did not receive those e-mails, please call our office. I assure you, Chris, I, and our team are closely monitoring your accounts daily as we evaluate how to best serve each of our client’s investment objectives. Please feel free to call or write (cbrown@weg1.com) with any questions or concerns.

Remember that quote at the beginning of this essay about banking institutions becoming dangerous to our liberty? Thomas Jefferson stated that over 200 years ago!

Until next time,