Friday, February 13, 2009

Michael Farrell - Annaly: Just Save, Baby, Just Save

As we sit on the precipice of the greatest fiscal stimulus package in our nation’s history, the question we are asked most often during our discussions with market participants is “When will it end?” Well, we can’t tell you the exact date, but I believe that a precursor will be the stabilization of mortgage cash flows. I can say that with certainty because from where we sit the current instability in the economy began showing its teeth in the mortgage market in 2002 and it will ultimately end once those cash flows stabilize again. When this occurs—at some uncertain future date—property valuations will have found a bottom and new run rates in GDP will have been established.

The sooner this happens, the better; but in the interim, we as a nation will be faced with policies designed to maintain the consumption-driven force of our domestic economy. My view is that this is what got us into this problem in the first place, and it runs counter to what Americans are now doing as rational economic beings—we are reducing consumption and increasing savings. The following is a construct of Newton’s principles. For every action, there is an equal and opposite reaction. We are witnessing the reaction of America’s primary Gross Domestic Product component, its consumers, as they retrench and repair their own balance sheets.
We should set a national target personal savings rate of 15% to provide the balance required to properly value and control our domestic economy. The increase to 15% amounts to a diversion of about $1.2 trillion in personal savings away from consumption, or a little more than the size of the proposed stimulus package. Our national security interests are at stake here, not simply the price of our standard of living. We all sense that higher taxes are coming at the Federal and municipal levels. Entitlements are going to be renegotiated. Social Security will be reformatted to reflect the fact that we are living longer and the pool of payers is shrinking. Medicare/Medicaid and healthcare will be restructured to a socialist model. But, we still need to pay for it. At this point in the economic cycle, savers are the key to survival, not consumers. With this in place, the America of the immediate future will look, at best, a lot like the America of the 1950’s. If we truly think that there is a short term solution via consumption then we deserve our fate. The long term view and solutions are much harder to take in the short run, but if Americans are incentivized to save their stimulus checks rather than spend them, it would help provide structurally sustainable fiscal health in the long run. This would position the country to win the economic war rather than the current battle.

The answer is that we need to swallow the full tablespoon of medicine or, to paraphrase Al Davis, the legendary owner of the Oakland Raiders, “Just save, baby.”


Related book:

The Richest Man in Babylon (also available in an Audio Book)