Wednesday, January 23, 2008

A Lap of Victory is in Order

I nailed the Fed rate cut, right down to the minute. Markets cannot go down in a straight line without the regulators intervening. So there was a massacre, as I thought earlier this month ( , and there is a rebound. I know all this timing etc is more luck than anything else. But let me be happy and gloat for a day.

Funnily, some people think Fed rates are useless. That it is somehow morally wrong. That it shows Fed panicked - so there is trouble. That, we are now entering Armageddon etc. I dont think they have really thought this through.

The biggest variable in the world right now is the value of a US home. As I mentioned here,(, the Fed and the US govt will need to ultimately stem in to prevent housing price declines. Otherwise, even prime borrowers with little equity in their homes will walk away. This is also what Wachovia mentioned in its conf call yesterday - "people are chosing to hand in their keys".

With yesterday's action, Fed has moved decisively in that direction. As housing prices stabilize, a lot of pessimism surrounding housing, structured finance and US economy will disappear. There might be some more pain left and some financial institutions might still go bankrupt in the US. There will be slow growth/mild recession. But some securities that are pricing in Armageddon scenarios might give 7x returns from here, especially MBIA.

In economies as dependent on asset price inflation as the US and the UK, asset price deflation is dangerous. So both US and UK will reduce interest rates. Low interest rates lower discount rates and push up asset prices.

Fed should now stop its bull of "we can't predict bubbles till they have burst." If you can't, dont get in the way of market forces when they burst.

1 comment:


Great take on the financial crisis.