FOMC Day - September 18, 2007

September 18, 2007
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FOMC Day

We expect the normal lateral pre-announcement track for the indexes today. We still believe that the FOMC will not change rates, but if Fed Funds is lowered we would prefer a 25 basis point cut.

Credit Liquidity Crisis - Rate Cuts Are Not the Way Out

Let's repeat a lesser known fact. The Federal Reserve does not regulate banks. It regulates bank holding companies. It uses an indirect tool, interest rates, to attempt to control the supply and availability of money and credit in this economy.

The Federal Reserve does not control or regulate the investment banks, like Goldman Sachs, or brokers, like Merrill Lynch. National banks, investment banks and brokers created this financial bubble. They loved it when their bubble was growing and glowing. Now, they just don't want to use their own capital to clean up their mess when the bubble burst.

They want to use our Federal government's capital mop and bucket.

Big Cut - Big Bear?

If the FOMC lowers by more than 25 basis points, then we may have to re-evaluate our view of a continuing Bull market. If you wonder about what would make me turn neutral to bearish for the longer term, it is a big rate reduction. The financial credit/liquidity seizure is a normal event in cyclical markets. It just occurs that this year's event is in the CDO market. Same story but different economic sector.

The "cleansing" must and will come, with or without a rate cut.

In past decades, the American economy was self-sustaining and self-fulfilling. The gradual change to its economic influence on other global economies today took about 50 years. Current domestic economic and federal policies affect significant changes around the globe in foreign domestic economies.

The British Northern Rock Bank story is a minor example of the ripples that come from this country's economic events. The credit crisis will not be solved by rate cuts, nor by a change in Federal Reserve monetary policy. The financial creators of these debt instruments must resolve this problem by publicly purging or writing down these assets. The investors in these credit vehicles will have to take their losses, and then make their way into the future.

Capitalism is not a panacea of endless profitable gambits.

Capitalism renews itself by shedding excess and, that shedding comes packaged with pain to those who invest in risk that fails. The shedding produces a leaner and more innovative, more expansive economy. The expansion filters deeper and deeper into the lives of all who live under the tent of a free economy. The benefits to the individual as well as to the economy, must be measured against the risk taken to achieve those rewards.

The perceived risks in the CDO investment market turned out to have a severe penalty measured against the modestly higher rates of return that are available in a U.S. Treasury risk free investment. Investors believed the creators and promoters of the fancy financial exotica. Most investors could not explain the risks nor understand the consequences of those risks becoming real.

Rate Cut Mania

Which has been hyped more, the credit crisis and the imminent collapse of the U.S. economy, or, that a Fed Funds rate cut of any amount will solve all of the financial and CDO market pricing problems? The two lies are Big Lies.

Big Lies shrouded in mystery, preached by latter day sainted economists and other media pundits who are believed by the masses, if they are heard often enough without counter arguments. Attitudes and behaviors are changed. People begin to wonder if disaster awaits them in the near future.

Isn't it a bit unusual that the creators of the problem are announcing the problem and its severity, while in the same sentence demanding the solution they have devised?

Nobody asks, "Who wins and who loses, if we do what you say to do? Who wins and who pays if your problem is solved?" These global financiers will answer questions only after you pay to fix their problem. It's the least they can do right.

Repeat - "It's a correction in a Bull Market."

If the FOMC cuts rates today, I believe that the correction may last longer and may drive index prices deeper than necessary. It doesn't automate the end of the Bull, but it might.
What does a rate cut really mean? It doesn't mean that real interest rates are too high. A rate cut does not mean that this economy has suddenly turned from growth to contraction in just 8 weeks.

A rate cut today will be seen as a concession to those who are unwilling to help themselves, but are able to take their own measures to solve their problems. "It is too painful!", they say. They want the Fed to kill the American economic goose that's been laying golden eggs, because they are sure the goose has a reproducible gold factory in its gut, instead of a gizzard.

The Federal Reserve will be seen as weak.

What a big rate cut will mean to the global markets is this: Sell U.S. dollar-denominated assets now! The $US will take a hard hit. Then the Asian carry trade adds to the slide in U.S. equities. The Yen goes home. Then, the perfect storm is waiting for the first real misstep by the Fed or the government to launch an out of control spiral downward.

This economy is not dying.

The U.S. economy is still slogging along quite well. Don't believe it? Then you don't know the American economic mystery or Americans themselves. Nothing stops them. Nothing. Some regions of the country aren't doing well like Michigan and Ohio. Some regional construction is well below the rates of 2005, like in parts of California and Florida. All are victims of their recent excesses and successes. Recovery for those in trouble depends on how they correct the causes of their troubles.

If Americans or their economy appear to be slowing or stopped, it's because they are down shifting to climb the next mountain of adversity. The only effective adversary the American people have is their own apathy. "We have met the enemy. It is us."

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I hope for no rate cut before the correction ends. Let the market's nature takes its course. After the correction, a rate cut will be okay but irrelevant to the American markets. Currency markets and foreign investors will still sell $US denominated assets, but it will be into a rising bull.

Forgotten lessons have to be re-learned don't they.

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As with any outcome today, we will be trading it.

We continue to expect 10-year Treasury Note yield to touch at least 3.94% and potentially 3.80%.

Let's see what reaction the P.P.I. brings before the opening.


W. B. Busin