Financial Crisis 101 - 10/17/08

PHILADELPHIA - October 17, 2008 - For several weeks, it's been public knowledge that the CEO of Berkshire Hathaway has been buying stocks. In today's New York Times, the so-called Oracle of Omaha, known to be perhaps the most successful investor of all time, explained why. "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors."

Buffet acknowledged that the near term economic outlook is scary, and the headlines will confirm that. But, "fears regarding the long-term prosperity of the nation's many sound companies make no sense. Most major companies will be setting new profit records 5, 10 and 20 years from now." And this may be the essence of Buffet's philosophy, "Bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price."

There are those who might say that advice from Warren Buffet is priceless. Here it is for free. Thank you Mr. Buffet and the Times. And need I say it again, I'm not saying anyone should act on that advice, but I thought it was worth mentioning that a guy like Buffet has confidence in America's long-term economic health.

Having said that, the short term prospects of the housing market seem to be in tatters. This morning's report from the Commerce Department has housing starts plunging in September for the 3rd month in a row, and housing starts are now at a 17 year low. The construction level of 817 thousand units was the lowest since January of 1991. Seen in a much shorter time frame, construction activity was down 31 per cent compared to September of last year. Now that is a burst bubble. The numbers for new home sales are even worse. August '08 to August '07, sales were down 34.5 per cent. Some economists are criticizing the government bailout plan for failing to specifically address the housing crisis. What follows is from the October 15th Wall Street Journal:

But some economists say the government needs to do more to address the underlying problems that triggered the credit crisis. "It's very disappointing" that the plan doesn't do anything "to stop the spiral in home prices," which is reducing net worth and creating a falloff in consumer spending, says Harvard University economist Martin Feldstein. He proposes that the federal government offer low-interest loans to replace 20% of homeowners' mortgages.

But the Journal also presents another view that the bailout plan's responsibility has a wider arc of responsibility.

At the heart of the rescue plan is an effort to keep the credit crunch from sending the economy into a tailspin. "If the financial system doesn't get working again, then the economic downturn is going to be much worse, and that means the housing market will be a lot worse than it otherwise would be," says Frederic Mishkin, a Columbia University economist who stepped down as a Federal Reserve Board governor in August.

The more I read for this blog, the more I understand that many of the best known and most accomplished economists have fundamental disagreements over what course the government should or should not take to get the country out of this mess. Really, it's more comforting to read what Warren Buffet has to say, and he has the billions of dollars in his bank account to back it up!

By the way, did you read that the big banks that are each getting billions of dollars from the government for the purpose of loosening up the credit markets aren't legally obligated to lend that money to businesses, consumers and other banks? Presumably, it's in the banks' interest to use the money for the purpose for which it's intended, but if a bank wants to hoard the cash, it can. The government, in buying the banks' preferred stock, has no voting rights on the governing Boards of Directors, and therefore no say in how the banks use our tax dollars. Come on banks, do the right thing!

And finally, some people are wondering if the financial crisis is hurting the terrorists. Has the financial free-fall actually made us safer, albeit poorer? One theory is that terrorists are being hurt because Middle East countries that sponsor terrorism are feeling the pinch of the global slowdown and will suffer sharp declines in their revenues from the plunging price of oil. With less money in their coffers, wouldn't the leaders of Iran, for instance, be less willing to subsidize people who would do us harm?

But the other side of the coin says that Al Qaeda and the Taliban get much of their money from the opium trade in Afghanistan and that business should be largely immune from the problems associated with more conventional commerce. There's another thing. Terrorists in the Middle East don't use banks to move their money. They actually deliver money in person, or use informal networks called hawalas. Hawalas are sort of a financial honor system for terrorists. They are far less efficient than the worlds' banks, but they're largely untraceable, and in this time of crisis for banks around the world, Osama's savings may be safer than yours. Despite that, have a great weekend. No Phillies, no Eagles. Go Penn State, beat Michigan!

Jim Gardner

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