The Titanic was carrying lifeboats with capacity that exceeded government
standards by 22%.
The vision I have of the night to remember is based on the movie, A
Night to Remember, and of course Titanic, which I regard as the most
profitable chick flick in movie history.
I am not sure what I would have done, had I been a passenger on that
ship. But as an entrepreneur, I know one thing: I would have been the
first person to line up at a lifeboat. In high school, when a fire alarm
sounded, by the third ring I was at the door. By the fourth, I was outside.
I do not recall a single instance when I was not the first one out the
door. With poor eyesight, I always sat near the front. However, there
was never anything the matter with my legs.
If I had been refused access to that lifeboat – "Women and
children first!" – I would have headed rapidly to another
lifeboat, on the assumption that the same rule did not hold for every
lifeboat. That was in fact the case that night. A lot of men got into
lifeboats. I would have been prepared to offer my seat to a woman or
child, but once the crewman said "lower it!" I would have
Assuming that I got on deck late – highly unlikely – after
all lifeboats had been lowered, I would have immediately gone to the
closest side of the ship. I would have looked down to see if there were
any empty seats in any visible lifeboat. Had I not seen any, I would
have gone to the other side.
I would have seen plenty. At that point, I would have had two decisions
With seats empty, I probably would have headed for
my cabin. These seats are probably going to stay empty. Why? Because
people are creatures of habit. As soon as most passengers who were left
behind saw that there were no more lifeboats, they would have adjusted
to the new conditions: "No exit." They would have prepared
to die. Why? Because most people in a crisis think "lifeboats,"
not "empty seats." They think of the big picture as "no
lifeboats here," rather "empty seats out there." They
see no lifeboats, so they don't go looking for empty seats.
As for me, I'm an empty seat guy. If there were a commodity futures
contract on the last train out, I would go long.
The water would be painfully cold. But since I was going to wind up
in the water anyway, I would have decided to go swimming sooner rather
than later. The longer I waited, the longer I would be swimming toward
Time was of the essence. The water was close to freezing. I would probably
suffer spasms in swimming – maybe near paralysis. I would probably
need a life preserver. I would have asked a crewman how to get to a
lower deck. Then I would have gone to my cabin. I would have grabbed
my life preserver and headed for a lower deck. I would have traded time
for a lesser impact. My key to survival would be to keep my senses after
In the water, I would have swum toward where I thought most of the
lifeboats were clustered. If they had been moving away from the ship,
then I would have tried to guess where they would be when I arrived.
Upstairs, passengers were listening to the band playing songs, although
not "Nearer My God to Thee," contrary to legend. Those people
were imitating the British by keeping a stiff upper lip. My approach
has always been to get my lip as far away from avoidable trouble as
I can, fast. Stiffness of lip offers no lure for me.
"Look out below!"
FEDERAL RESERVE POLICY
From that groaning sound, I have concluded that the Good Ship Bubble
Economy has hit a monetary iceberg.
The question now is this: Is the scrape long enough so that it has
punched a gaping hole in all of the watertight bulkheads?
Before a recession, there are conflicting opinions on this crucial
question. One of the signs of this conflict is increasing volatility
of the various stock markets. Wild swings take place like the one on
October 24: 200 points down for most of the day, the Dow closed down
0.98 point. The bulls and the bears fight for supremacy. The market
goes nowhere, wildly.
Alan Greenspan took over as Chairman of the Board of Governors of the
Federal Reserve System in October, 1987, just days before the legendary
508-point decline: 22%. His response, like the FED's, was to pump in
fiat money – "liquidity." That kept the economy from
falling into a recession. Only in 1990–91 did the recession finally
hit. The FED's response was the same: increased fiat money. For the
next decade, there was no recession.
The NASDAQ's collapse began in mid-March, 2000, which followed the
peak of the Dow and the S&P 500 in January. This did not persuade
the FED to lower the target federal funds rate. At its March 21 meeting,
the FOMC raised the target rate from 5.75% to 6%. Then, incredibly,
at the May 16 meeting, it raised the rate half a point to 6.5%. How
could the FED in March, 2000 hike the FedFunds target rate by .25 percentage
point, two weeks after the stock markets had peaked? How could it do
it again in May? Didn't they see what was coming? Obviously, they didn't.
Investors also did not see. The Dow was above 11,000 all through 2000.
Only at the January 3, 2001 meeting did the FOMC lower the target rate
to 6%. On January 31, it lowered it to 5.5%. At the March 20 meeting,
as the recession was beginning (we learned two years later), the rate
was cut to 5%. This was a major cut, as were the cuts that followed.
In the spring of 2001, the recession began. The Dow fell briefly to
9,000. It immediately rebounded above 11,000, as the FED began cutting
rates. But 9-11 caused a decline to 8,000.
By November 6, the month that the recession ended, the rate was at
2%. On December 11, it was cut to 1.75% – simply unheard of. One
word suffices to describe what happened in 2001: panic. The FED was
in sheer panic mode. On November 2, 2002, the rate was cut again to
At first, the stock market responded positively to these rate cuts.
It went from 8,000 after 9-11 to well over 10,000 in the spring of 2002.
But then it fell. It bottomed at just above 7,000 that fall. It began
its long-term recovery in the spring of 2003.
By then, the FedFunds target rate was 1.25%. Then it was cut one last
time: June, 2003. There it stayed for a year.
The increases, rising by .25 percentage point at each FOMC meeting,
continued until June 29, 2006, when the target rate peaked at 5.75%.
There it remained until the September 18, 2007 meeting, when it was
cut by half a point.
This rate cut would seem to indicate a shift in monetary policy. So
far, it hasn't. The adjusted monetary base has risen at about 1.6% per
annum since mid-March. From August 15 until October 10, the adjusted
monetary base fell by 1%. That's right: fell. This was during a crisis
in the subprime mortgage market. [Note: This chart is updated frequently,
so it loses relevance.]
There is no evidence of monetary inflation in the one monetary aggregate
that the FED controls directly. In response to the surfacing of the
subprime mortgage crisis, which created a panic-driven sell-off of brokerage
shares in mid-August, the FED adopted a policy of monetary deflation.
Got that? Deflation.
In response, the major brokerage shares soared. You can see this in
the following chart of an index known as the XBD, which is published
by the American Stock Exchange.
So, in summary, in the three-year period from mid-2004 to September
18, 2007, the FOMC raised the target rate for the FedFunds market from
1% to 5.75%, and the stock market rose from 7,000 to over 12,000. That's
"rose." As in "went up a lot."
Then, in response to the subprime crisis in August, the FOMC did two
things: (1) it reduced the monetary base; (2) it cut the target rate
by half a point.
If there is some economic theory or technical investment strategy that
explains all this, let me know. What happened was not intuitive.
NOT SO SMART AFTER ALL
On October 24, a report hit the financial wires that Merrill Lynch
– bullish on America – has lost an estimated $8 billion
in its subprime mortgage-related investments.
The Dow fell 200 points in response. But then the rumor came: "The
FOMC will reduce the FedFunds rate target at its next meeting at the
end of the month." The market then rose by 200 points. It closed
for the day down by 0.98.
What was the verifiable news? That the geniuses at the nation's largest
brokerage house have lost $8 billion in the unfolding disaster of the
subprime mortgage market. What was the rumored news? That the FOMC,
which 98% of forecasters had already believed would cut the FedFunds
target rate, would in fact cut the FedFunds target rate.
This conveys the following information to me: (1) the best and the
brightest hot-shots in the financial brokerage industry never saw the
subprime mess coming; (2) the best and the brightest stock fund portfolio
managers believe in the FOMC as the equivalent of the tooth fairy.
As of October 25, 2007, 174 mortgage lending firms have either gone
out of business of have merged with solvent firms since December, 2006.
This is tracked on www.ml-implode.com.
The FED under Greenspan lured lenders and home buyers into what have
now become visible disasters. But for most of this period, 1991–2005,
the policy seemed to create great wealth: rising home prices. That is
a long period of success. So, when signs appeared in mid-2005 that the
housing market had peaked, and some of us hard-money writers began warning
about this, nobody paid attention. But the reality is here.
This brings us back to something that Ludwig von Mises warned against
in 1912: when central banks manipulate money in order to lower market
interest rates, the entire capitalist class is deceived into believing
that more capital is available. Today, almost a century later, this
deception is not only still widespread, it is worse. Investors believe
that the central bank's ability to lower a target overnight rate enables
it to raise stock prices by fiat – not by creating capital, but
merely by making a public announcement of a target rate. What Mises
described as an error regarding the actual supply of capital has descended
into something bizarre: faith in the ability of a central bank to increase
the value of capital (stocks) merely by making an announcement –
with or without a change in monetary policy. On the basis of this announcement,
investors redeploy money from debt to equity. They will do this even
in response to a rumor about the announcement.
And yet . . . Merrill Lynch really did lose $8 billion. Very smart
people did some very foolish things with investors' money. This capital
has now gone into the land where the tooth fairy lives, the land of
broken teeth and broken dreams.
Nowhere are dreams more broken than in central California. This is
the hot, dry part of the state where most people did not want to live
in my youth, the place where Okies and Arkies arrived in 1935. Then
came the housing boom. CBS News (Oct. 10) reported on the recent economic
carnage. Home builders are walking away from half-completed developments
and half-completed homes. They cannot sell anything at yesterday's retail
In every mania, a few emotion-driven people buy at the top. This now-deflating
housing mania was debt-funded. You could still get jumbo loans (above
$417,000) last July at fairly low rates. Today, you can't. There is
no indication that anyone will be able to do so in time for these now
debt-burdened people to get out from under their upside-down mortgages.
They must now make mostly interest payments for the next 15 years just
to pay off the equity that they have lost in one year. They are prisoners
in their McMansions. They will not be able to move out. If a better
career opportunity comes up more than 150 miles away, they will have
to skip it.
For what? To live in an uncompleted subdivision that will not be completed
for many years.
This is the price of central bank policies designed by very smart people.
They are very smart people who think that they are wiser than free markets.
The U.S. housing market is down – on paper – by over a
trillion dollars, CBS News reports. But who knows how much? The report
cited one forecast that says it will be down by another $3 trillion
in a year. I think this estimate is plausible.
Median prices are down by about 4%, year to year – the first
national decline since 1933. Sales are down by 8% nationally, and by
25% in the Southwest.
Why are prices not falling faster? Because sellers think this decline
is temporary, that in a year, their homes will be worth what they were
a year ago. Sellers learn slowly. Their homes will not rebound just
because sellers think they are special, that they can beat the market.
In a year, there will be real fear. Sellers will not be able to sell.
Inventories will be much higher. Sellers will be stuck in their homes,
or worse, paying the mortgage on their now-empty houses and rent on
the one in the new location.
Contracts that are contingent on the sale of a home by the buyer will
fall through. Reality will set in.
Some sellers will run out of bargaining room. That is when you should
be there with cash.
If you are seller, think "Titanic." Lower your price now
and get out while the ship is still afloat. The water will be just as
cold next year. Put on a life vest and jump, before the lifeboats float
out of swimming distance.