“You will never be a leader unless you first learn to follow and be led” Tiorio
Recent market volatility is being attributed to many things. Some true and others are pure speculation.
The problem is not the problem, the problem is that our politicians don’t know how to think about the problem. So here is my attempt to educate them.
There are two problems that are the real cause of the recent market turmoil:
- In the United States the problem is a lack of growth and a political crisis
2. In Europe the problem is a financial banking crisis similar to what the U.S. had in 2008.
Counterparty Risk
The markets real fear stems from what is called counterparty risk. Counterparty risk is the risk to each party of a contract that the counterparty will not live up to its contractual obligations.
To evaluate the risk one institution may have to another requires one to examine both the balance sheet (Assets – Liabilities) and the Income Statement (Income – Expenses). Just like banks do to you when you apply for a loan.
The problem with the Banks in Europe and the U.S. is that no one really understands the value of the assets and liabilities that are on the balance sheets. Many of these assets or contracts have counterparty risk from the mortgage collapse and ensuing financial crisis of 2008 and early 2009. They can’t be properly evaluated and valued due to their complexity.
The U.S. addressed this problem in late 2008 and early 2009 by requiring the banks to deleverage and over capitalize. The U.S. Banks and U.S. financial system are in much better shape than the European banks. Europe needs to address their banking system, as we did in 2008.
Global Growth
The concern right now is the failure of Europe’s banking and financial system, which could slow down, the already anemic global growth. Global growth is badly needed by the U.S. and Europe.
The European problem was first brought to everyone’s attention with Greece’s debt and deficit crisis, then Ireland, then Portugal, then Spain and now Italy. As a member of the European Union (EU) France and Germany are going to have to carry the burden for an EU rescue package, much as our Treasury and Federal Reserve did for the United States.
A rescue package will be negotiated for Europe by the European Union and European Bank. They have no other choice but to take the bitter and difficult medicine of de-leveraging and austerity. When they do, markets will then focus their attention on growth and GDP again.
Good News
There is plenty of opportunity out there that is going unnoticed:
1. The high levels of cash in Treasury bills, notes, bonds, money market funds and CD’s earning negative real returns on an after tax and after inflation basis.
2. Corporate earnings are being reported above expectations.
3. Our financial system in the U.S. is on much better footing then it was in 2008.
4. Corporations are sittings on piles of cash that they need to put to use. When this happens, it will create jobs.
5. Banks are sitting on excess capital and are ready to make loans.
6. Corporate Dividends are now higher than Treasury yields. The last time that happened was in the early 1950’s. So, you can get excellent yields from AAA and AA rated companies as long as you don’t mind some volatility.
In Summary
The U.S. needs to get the right political leadership to create a pro-growth environment, which will create jobs. Europe needs to rescue their banking and financial system like we did in 2008 and early 2009.
It’s clear to almost everyone, except the politicians, what needs to be done. Leadership requires the President to call Congress back from vacation and get working on what clearly needs to be done. It requires European politicians to come to the table and together take their bitter medicine. A growing U.S. economy is good for everyone in the global economy, because we are still the world’s largest economy and our U.S. Dollar is still considered to be the world’s reserve currency. Even after Standard and Poor’s’ lowered our long-term credit rating.
