To begin with, I believe FPA Capital Fund and FPA New Income are well structured to weather this credit-crisis storm. FPA Capital stands with nearly 43% in liquidity that we believe should help it withstand the crisis and provide us with the necessary capital to use at the appropriate time. FPA New Income’s credit quality has never been better, and with over 66% of the Fund invested in short-term government/Agency securities, it too is well positioned to both protect and grow your capital.
This letter will provide a background as to what policies and procedures have been taking place at First Pacific Advisors and within your Funds as this credit crisis developed.
The general hope is that the Fed, along with regulatory changes and fiscal policy stimulation, will be able to contain and soften this credit contraction. Given that this crisis was not a function of high interest rates or restrictive monetary policy, it seems like an optimistic view that lower rates and a few changes of regulatory policy, along with a potential $100-150 billion tax cut, will save the day. This crisis is a function of a credit bubble that financed an asset bubble that is now in the process of deflating. Until overpriced assets, as well as excess and unsound leverage, are allowed to clear the system, the recovery from this credit crisis should be delayed. As I wrote in the September FPA New Income Shareholder Letter, “future Fed policy actions may prove rather ineffective in dealing with these challenges.” The word “challenges” was referring not only to the credit contraction but also to high oil prices and a weak dollar. I also referred to Chairman Bernanke as “Greenspan Lite” because his initial rate cuts were examples of what an Alan Greenspan policy might have been. Again, this crisis is not about the level of interest rates but of excesses in lending and borrowing on inflated assets. The process of clearing these unsound practices is analogous to allowing a body fever to run its course, when appropriate medication is unavailable. The Fed’s medication is likely to be ineffective in dealing with this economic fever. Misguided policies could make the situation better in the short run but worse in the long run. This refers to short-term fiscal policy stimulation that was referred to in a recent Wall Street Journal opinion piece as “feel good economics.” Our problems and challenges that we are witnessing currently are the outgrowth of similar unsound monetary and fiscal policies of the past.