Wednesday, March 4, 2009

Economists find silver lining in fear

Visiting economists offer optimism, opportunity

Express Staff Writer

A bustling downtown Ketchum nonetheless hosts lots of nervous economy watchers. A trio of speakers at the Sun Valley Inn on Monday advised the audience not to wait until it was too late to take advantage of the downturn in the economy. Photo by Willy Cook

"The economy will take off like a rocket, and you can't wait for it to turn around because it will be too late."

That was the advice doled out by economist Brian Wesbury during a presentation at the nexStage Theatre in Ketchum on Thursday, hosted by the Boise and Ketchum branches of the Royal Bank of Scotland.

In a separate lecture on Monday, a trio of investors from Wells Fargo's private banking operation proffered a similar but slightly more tempered view of the economy at the Sun Valley Inn.

Wesbury, chief economist at the Illinois-based financial services firm First Trust L.P., has gained national recognition through his bullish views of the economy, frequently heard on CNBC and Bloomberg, and read in the Wall Street Journal.

Using historical data and analysis of past economic recessions, Wesbury said similar downturns had been experienced before in the U.S. and that a rebound can be expected shortly.

Wesbury said the housing crisis, compounded with the failure of Lehman Brothers and the government's Troubled Asset Relief Package response, were all large factors in precipitating a panic that sent investors into hiding.

That led to a collapse in the "velocity" of money—the number of times a dollar is cycled through the economy. Wesbury said that as spending dries up, the flow of cash decreases, leading the Federal Reserve to print more money to counteract the drop in liquidity.

"Food sales fell for the first time in 50 years," Wesbury said to a nearly full theater. "This means people were scrounging in their pantries for cans of soup they'd been holding onto since college."

While he might have been exaggerating to make his point, Wesbury said that with an approximately zero percent Federal Funds rate set by the Federal Reserve, stocks' having become undervalued and checking account balances "going through the roof," the circumstances are becoming ripe for reinvesting.

"We're at unsustainably low levels of economic activity," he said. "We could be in line for an explosion with huge wealth creation."

Wesbury said that while tight credit markets are making it difficult to borrow money, this too is bound to change, especially as more and more people have chosen to put money into banks rather than the stock market.

"Banks make loans. That's what they do. They don't make hamburger or widgets," Wesbury said.

He also said that people spend money, and once that begins again, the excess supply in the market will drop, allowing production to resume.

However, Wesbury wasn't as upbeat when it came to the federal stimulus package, explaining that the government is traditionally less efficient than the private sector, thus slowing the velocity of money.

Wesbury said "toxic" mortgage-backed securities, which have received plenty of press during this economic slide, could lead to further problems if their purchase prices fall too far below face value. To create those securities, banks packaged mortgage loans into one instrument that could be sold. The problem came when a proportion of loans in those securities defaulted, making it difficult to value the entire package.

If the prices are set too low, Wesbury said, that could slow economic recovery as banks would not be receiving enough from their sale to provide them with the cash needed to make more loans.

Wells Fargo Senior Economist Gary Schlossberg also spoke about those securities, saying they will likely be purchased at a sizable discount, possibly by a partnership between the government and private investors, and could return an excellent profit in the future.

For Schlossberg, Wesbury's loss of capital is not nearly as important as merely figuring out a pricing mechanism and showing the world that there is a plan in place to handle these securities.

"Confidence is the glue that holds the capitalist system together," Schlossberg told the approximately 50 people who attended the Wells Fargo discussion. Indeed, as he spoke, The Dow Jones Industrial average dropped to levels not seen since 1997.

Schlossberg said removing the uncertainty about the future of mortgage-backed securities will help catalyze a recovery.

Whereas Wesbury spoke of a potential rebound in the economy this summer, Schlossberg, and his colleagues Jeff Savage and Hank DesJardins, said the turnaround is more likely to occur next year.

Schlossberg said the delay would be a result of lingering restrictions on credit, as well as the nation's growing budget deficit and a depressed housing market.

"This is gut-check time," said DesJardins, a senior investment manager for the bank. "When fear is at its worst, this is when you find opportunity."

Like Wesbury, Savage, a senior director of investments, said that when the recovery comes, it will do so over a short period of time.

"The return will be quick," Savage said. "If you are holding only cash, you will miss it."

To take advantage of the opportunities presented by the economic downturn, DesJardins recommended municipal bonds issued by cities where the housing market hasn't hit as hard. As well, he said "blue chip" stocks—those of large companies with stable cash flows—can bought for relatively low prices.

"People get so caught up in the stock market going down every day," DesJardins said. "But if you dig through the rubble, you can find a few gems. AT&T and Pfizer are definitely not going out of business. There's an opportunity to buy high-quality stock and build a strong portfolio right now."

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