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Trust Department Quarterly Newsletter 4th Quarter 2007
Sub Prime – How Many Times Do We Hear That Word? It’s not easy to be optimistic about the investment world and the economy when the headlines continue to include “Real Estate Prices Decline”, “Foreclosures Increase”, “Credit Tightens”, “Companies Writing off Billions of Dollars Due to the Sub Prime Crisis”. Why did this current problem in the marketplace happen? Whenever there are big dollars being made in short periods of time, excessive risk taking and greed take the place of sound investment principles. We saw this in the latter part of the last century when the Y2K scare drove technology prices too high. Many of those responsible for the sub prime upheaval are now becoming the victims. Mortgage salesmen wrote loans based upon the borrower’s ability to refinance rather than on the ability to repay. If the borrower defaulted the salesmen still got their commissions. Many of the salesmen are now out of jobs. Borrowers bought homes and took out equity loans they couldn’t afford. That didn’t matter. As home prices kept rising they could always refinance, creating more costs they could not afford. Some of these borrowers will lose their new homes or in some cases homes they have had for years. Financial organizations bought loans to turn into securities that gave them high yields. If the borrower defaulted, the organizations still got their fees. Now the losses are piling up. Several firms worldwide (it did not happen just in the U.S.) are collectively expected to write down about 90 billion dollars in sub prime losses by the end of 2007. And they probably are not done with the write downs. To this point, the government has not stepped in to bail the problem out and hopefully they will keep our tax dollars out of it. Over the last nine to ten years our economy has faced numerous “economic crises” that were going to devastate our economy and the markets. These crises run the gamut from the Enron problem, the previously mentioned Y2K, and the tragic 9/11. The economy has recovered from these crises and we will rebound from the sub prime mortgage problem. Some firms have or will go out of business. The Citigroup and Merrill Lynchs of the world will write off billions, but they make more than that in other areas. The Stock Market There were no presents under the tree in the stock market this holiday season. Eight out of the last 11 years the market has seen a significant rise in the last 15 days of December. It appeared the markets were moving more positive and then the assassination in Pakistan took place with blame being put at an Al Qaeda group. The equity markets, like our Minnesota lakes, are perched on very thin ice; too much weight and we go down. The year 2007 has been very turbulent with many days where the market has moved by 1% or more either up or down. On October 9 of this year the Standard & Poors 500 Index peaked at 1,565. This was an increase from their average of 777, which took place exactly five years prior to that. This is after the index had dropped 49% over the two and a half year period prior to October of 2002. Since October 9 of this year we have subsequently experienced a 10% correction in the market, which is basically where the market closed at the end of the year. We anticipate 2008 to be another volatile year from an overall trading point. Our expectation would be for somewhere between a 5% and 8% increase in the market by year end. The Bond Market Interest rates continued to decline during the quarter with the rate on a 10-year treasury note dropping a little over ½ of 1%. During this same period of time the Federal Reserve also dropped the Fed Funds rate by ½ of 1%. The Federal Reserve continues to balance their decision making process between the problems with inflation and the concern of the country slipping into a recession. Most economists feel that we most likely will avoid a recession; however, this too is on thin ice. Our expectations and the projection of the economists is that there probably will be another quarter point decline in the Fed Funds rate prior to the end of the first quarter. We do not see much movement in the overall interest rates for the year 2008. Bumper Sticker: Aging is inevitable --- Acting your age is optional |
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