Today, I am envisioning myself in Rome in year 64 A.D watching it burn as Nero is fiddling away, oblivious to the havoc he is wrecking and totally indifferent to the suffering around him. 

Return to September 2008 and this reality and unfortunately the scene are familiar.  Rather than creating a bipartite piece of legislation that both the legislature and executive branch can claim is best for the people, we have a show.  We might as well be Romans sitting in the Coliseum.  On one side we have the Treasury proposal:  It is a three page statement authorizing the spending of $700 billion as the Treasury Secretary deems necessary and take whatever action the Secretary deems appropriate.  On the other side we have a legislature who is holding televised hearings rather than sending the document to Congress' legislative aids who actually draft documents.  Both branches are more into the drama and show than committed to solving the problem.  So we have better than 500 elected Senators and Representatives and Cabinet Appointees fiddling while our economy is burning.  The market retreat over the past few months is more about the emotional disappointment in our political leaders, who are more interested in thinking about how good they look rather than providing the assistance our economy requires, than a further deterioration in the actual economy.  To me, the economy is playing second fiddle to politics. 

In my last report, I made it clear that the serious problems in the investment banking and mortgage system would result in the demise of the independent investment banks, just as the Savings & Loan Crisis ended the Savings & Loan industry.  I did not expect that the investment bank demise would occur the weekend after you received that email. 

As I said in my last discussion, I do not like betting against the stupidity of our government and the current behavior in Washington is best described as STUPID.  There are two things that more than anything else fuels our economy. 

First, is integrity.  Currently the United States banking and investment system fails the integrity test.  If the system was working, there would be enough transparency so that we could reasonably make decisions about what is safe to buy and what is risky to avoid.  At this juncture, investors and consumers do not know what is safe to buy and what is not.  The direct result is no action which means the economic activity is slowing more and more daily.  Even outside of our empirical evidence, we know the system is not working since the government proposes bailing out companies and the market to a tune of about $1 trillion in a few months time. 

The second is certainty.  Certainty means that the rules of the game are clear; we know how to play the game; and that the rules won't change in the middle of the game.  We fail the certainty test.  One day money markets are safe and the next day some money market accounts are not paying a dollar for dollar redemption.  The Federal Reserve is now loaning mutual fund companies money to cover money market accounts.  Another example is our government (both the executive and legislative branches) announces that there will be a $700 billion bailout and that the bailout is urgent.  Then days are spent arguing between the two sides regarding the final result.  My guess is that each day the government dawdles, we potentially lose thousands of jobs and tens of billions of dollars in GDP.  I cannot think of any government response more stupid than what is currently happening.  

In the recent past, there have been two economies that have experienced what we are experiencing right now, Japan and Iceland. 

The Japanese economy of the 1980s imploded.  The country's banks were saddled with worthless debt from a real estate bust that rumbled through the economy until unemployment exploded (for the Japanese) and the economy contracted for approximately ten years.  Eventually the Japanese worked out a plan to recognize the losses and recapitalize their banks.  Unlike the Japanese, I cannot imagine our electorate tolerating our current situation continuing and worsening for ten years.  So far, our current administration has followed the Japanese model of denying the obvious and acting only when the system fails so badly that even they know denial is not an option.  By the way, the Japanese at that time and up to the new millennium ran up public debt of about 5 trillion dollars.  Since their population is about a third of ours, that amount is comparable to the debt we currently are looking at with our current bailout.  Since 2001, when Japan instituted economic reforms to their tax and banking systems, their economy has expanded despite the debt.  So, I am less worried about the debt issue than I am about the Integrity of our system and the Certainty of our economic system.  Both of which have been woefully lacking during the last year, if not longer!

As for Iceland, earlier this year, European countries, mostly Denmark, Sweden and Norway's Central Banks, had to shore up the Icelandic's Central Bank by providing a line of credit of $1.9 billion Euros.  Iceland's currency, the Krona, had been dropping even more than the dollar in comparison to the Euro, and the Central Bank of Iceland had raised the prime rate to a whopping 13.75% in February.  It also has $97 billion in debt for a country with a total population of approximately 600,000 (the same population as Boston proper).  To compare, the US debt per person is about $40,000, the Icelandic debt person is $160,000 per person.  The large debt by Iceland has resulted in the European Community calling for Iceland to cut back on its health care spending which is the equivalent of us cutting back on Medicare and Medicaid spending.  In other words, it is a big deal, and this problem explains why their currency has been dropping during the last couple of years.  To quote European Pensions and Investment News (EPN), "...Iceland was already "in trouble" in February 2008.  Its currency is in freefall and the credit markets have dried up," ... Furthermore, Iceland's Central Bank was steadfastly maintaining "startling" interest rates of 13.75 percent.  A fund manager speaking anonymously to EPN blamed Icelandic politicians for the crisis.  "They are idiots," he said.  "Instead of finding an answer, the politicians claim that nothing is wrong and that things must continue as they are."  To me this sounds very similar to President Bush and Secretary Paulson saying that fundamentally everything is sound, when we know it is not! 

The above are two examples of dealing with the problem and both point to the benefits of facing the fundamental problems directly to result in a greater clarity and decisiveness for the economy.  So far, our politicians have chosen to "fiddle while Rome (our economy) burns". 

Today, the fear in the market is palpable.  We and many of our colleagues have had more clients calling for reassurance.  I am not surprised by this reaction due to the irresponsible behavior of our politicians.  Past experience indicates that creating a fund to bail out the system works.  But we all know that past experience does not always relate to the present experience.  It is important to minimize damage which includes the ability to renegotiate many of the outrageous terms of these sub prime loans.  This ability would reduce foreclosures, reduce the number of homes being sold and reduce the loss our government (read: WE) will suffer from buying these bad mortgages as they have been doing with each of these bailouts.  The actual strategy our government should follow is simple; the sad part is that I am uncertain our political leaders see that simple strategy in their quest to look good.  To quote Gayle:  "Striving to look good drains a person from being real."  Real from our perspective is being authentic and full of integrity. 

Eventually the politicians will put together a bail out plan.  Our pattern in history, from the 1920's to present, is to ignore the obvious until the problems are so great and in our face that we are forced to fix it and then we react.  A great example of this behavior is President Bush decided to speak on national television last night (September 24th) now that the bailout bill is in jeopardy rather than weeks or even months ago, when the crisis first became undeniable.

The following is a list of some of the more spectacular economic crises we faced in the past and the government fix that solved the problem.  The economic crisis of the Great Depression resulted in the Federal Deposit Insurance Corporation (FDIC); the massive failure of large corporations and with them their pension plans in the late 1960's and early 1970's resulted in the creation of the Pension Benefit Guaranty Corporation (PBGC) in 1974; and the massive collapse of insurance companies and brokerage houses in the 1970's resulted in the creation of Security Insurance Protection (SIPC).

Using non-financial examples, remember when we as a nation did not deal with pollution as it worsened between the 1930's through the mid 1960's until there were fires on the Great Lakes, when one day spent breathing in New York City damaged the lungs as much as smoking two packs of cigarettes a day and when Love Canal, New York had to be evacuated because living there was deadly to the homeowners.  We are witnessing our national pattern and at some point our national leaders will solve the liquidity issue confronting us which will allow credit to flow more normally again.  The United States economy is too important for the rest of the world to allow it to fail, so even if the rest of the world must step in and lend us funds like they did for Iceland or we buy up the bad loans and start unraveling the mess ourselves like Japan, this crisis is drawing closer to a conclusion.  Fundamentally we know that as investors with a long term perspective, remaining invested with solid companies is the best investment course in these troubled times.  And unless we see the underlying economic conditions deteriorating much further than they are now, we do not plan on changing that philosophy.

Our intention for sharing is to support your understanding of what is happening now in the context of what has happened in the past.  Underneath all of this chaos and financial volatility, we need to be grounded in places of truth that override all of these instigators of fear.

The truth is financially we are in neutral and the economy is running on inertia with a strong headwind causing it to slow further.  During these periods it is best to allow the system to reset and focus on non-financial issues.  This period of time is a prime opportunity for reflection of what really matters in your life.  What do you most value – your relationships, your health, creative-contributions and so on?  As we know, these aspects of life are priceless and what inspires us to live fully and move forward with conscious actions for a better world.

We hope this note helps you to better understand where we are financially and why the market is so erratic while the government fiddles with the bailout plan.  Despite the frustrations to date with this bailout proposal, we remain hopeful that the legislators and the administration will draft a legislation that will avert further financial chaos and fairly balance the needs of the financial institutions and WE, the taxpayers.