The commentary below was taken from our quarterly market letter that was published in April 2009 at the end of the financial crisis. I thought it would add some perspective to the current situation.


On March 6, 2009, the Dow Jones Industrial Average traded at 6,470, which will likely turn out to be the bottom of the current Bear Market that began in October of 2007 when the Dow peaked at just under 14,000. In just 17 months, the market had lost 54% of its value, and many investors had lost more than that.

The worst Bear Market of our generation had wiped away 10 years of gains and sparked a level of despair not seen since the Great Depression. We had lost faith in our Government, our banks, our insurance companies, and for the first time in my thirty years as a financial advisor, I began to field calls from clients asking about the safety of our currency.

The economic data at the bottom of the current economic cycle is about as dismal as I have ever seen. Economic activity as measured by the Gross Domestic Product (GDP) contracted at an annualized rate of 6.2% during the fourth quarter of 2008, primarily due to a severe reduction in consumer spending, which had been the backbone of the greatest economic expansion since the “Roaring Twenties”. Unemployment registered a dismal 8.1% in December, its highest level in 25 years. The unemployment numbers are usually the last to recover, and I suspect we will see 10% before all is said and done.

The housing market appears to be searching for that elusive place where prices and the cost of financing are both low enough to coax buyers back into the market and force a bottom in prices. Meanwhile, those Americans who spent all of those years tapping the equity in their homes to finance their country club memberships and flat screen TV sets have either successfully deleveraged themselves and learned from their excesses, or they have paid the ultimate price of foreclosure and personal bankruptcy. Either way, the world is a fundamentally different place than it was just 17 months ago.

I have mentioned many times over the years that things are never as bad, or as good as they seem. This tired expression has never been more relevant than it is today. If we can get past the doom and gloom and assume that the financial markets and the world economy are built on a solid foundation, then common-sense dictates that at some point, the markets will find “fair value” based upon reality as opposed to the perceptions that abound at the extremes. In other words, when things are bad, the common belief is that they will get worse, just as the positive momentum that has carried our economy to unsustainable heights created the assumption that fortunes would keep on rising. Therein lies the basis for what our new President calls a “Boom and Bust Economy”.

The key to any analysis of investment opportunity is a clear understanding that “fair value” resides somewhere between the extremes of prosperity and depression. While this concept may sound elementary, the boundaries of prosperity and depression can only be determined in hindsight, and those boundaries are almost always determined by emotional extremes. In short, we never know how bad things got until they start to improve, which has started to happen already.

The financial crisis of 2008 involved a “perfect storm” of events that had the potential to completely derail the US economy. The factors that led to the storm involved greed, misguided strategy, and an assumption by those who should have known better that the party in the real estate market would never end. Rather than throw daggers at those who pushed us off the cliff, it is important to first determine how we got to the edge in the first place.

Historically, banking regulations in this country dictated that a commercial bank was required to maintain a reasonable asset base to support its loan portfolio. In other words, for every dollar the bank loaned out, they were required to secure the risk of the loan with somewhere between 20 and 40 cents in assets. Typically, those assets had to be in cash deposits, US Government bonds, or similarly guaranteed liquid investments. During the last decade or so, a couple of things happened that, in retrospect, started our economy on the road to the abyss that nearly swallowed our collective future. All of the events in question fall under the umbrella of complacency brought on by deregulation.

It will undoubtedly be argued by future economists that the passage of the Gramm-Leach Billey Act of 1999, which relaxed the boundaries between banks, investment firms and insurance companies that were originally established by the Glass Steagall Act of 1933 was the primary reason for the current crisis. The bigger picture on this subject is the simple fact that politics and economics are strange bedfellows and when politicians feel the need to meddle in the economy, bad things are almost a certainty.

From 30,000 feet, if one is to argue that the deregulation of the financial services industry in 1999 is responsible for the economic crisis of 2009, it then follows that the politicians were terribly misguided when they felt compelled to meddle in the workings of the American economy. In fact, the regulations they sought to unwind were put into law at the end of the only other crisis of this magnitude in history. By unwinding those important boundaries that kept bankers out of the market, traders out of the banks, and insurance companies out of the mix entirely, the politicians started an era of unbridled greed among the leaders of the most powerful financial institutions in the world. At the same time, nobody in Washington seemed concerned as these institutions grew to unsustainable size and garnered enough financial clout that if the house of cards were to fall, the financial stability of the greatest nation in the world would be threatened.

The entrance of major banks and insurers into the financial services business was meant to provide competition in the industry and a wider array of choices for investors. However, when politicians who are motivated more by perception than consideration of the consequences of their actions begin to meddle in the workings of the financial system, there are always consequences that they neither anticipated nor cared about after the elections.

While Congress was pushing legislation to fuel the rapid expansion of the mortgage industry, and allowing “no-doc” mortgage lending and “liar loans” that allowed for loan approval simply on the basis of a borrower’s “stated income”, the bankers and insurers that they allowed into the securities business were creating bonds to finance these bad loans and selling them to each other!

The bottom line here my friends is that a person who can afford a home and finance it with a mortgage that he or she can afford the payments on is a person who is a worthy borrower. Lending money to people who are worthy borrowers is the foundation of the housing industry and the strength of the banking industry. When lack of regulation and effective oversight create an industry where those fundamentals are ignored for the sake of ever-increasing underwriting fees, commissions and profits, something had to give, and it did. When a politician embraces the noble idea of “making home ownership affordable to every American”, he or she must then understand that there are consequences to these noble promises. The reality is that every American may not be able to own a home, and no matter how the figures are fudged, if he can’t afford it, he can’t afford it.

Looking forward, beyond the doom and gloom that sells advertising time in the media, the evidence now suggests that we have seen the worst of the current crisis, and that the “bottom” has been reached in terms of the economy and the stock market. Out of the carnage created by perhaps the worst financial crisis and recession since the Great Depression will arise perhaps the greatest opportunity to buy stocks and bonds in a generation. The opportunity is at hand, and the time is now.

Joseph C. Paul
President and CEO