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Farr: Two Main Problems With The Economic Landscape

Markets began the week nervous about a large supply of US Treasuries to be auctioned. The main worry was of higher rates if demand for the new debt proved thin. With so much riding on the level of interest rates right now, it should come as no surprise that the markets worry about these monthly auctions. But low and behold, the Treasury auctions were over-subscribed! Investors piled in en masse to purchase these abundant and historically low- yielding securities. Stocks, of course fell on the news.

Stocks fell because the unexpectedly strong demand for Treasuries led investors to surmise that the economic recovery may be in trouble. The demand for “risk-free” investments must be evidence of a lack of confidence in a return to economic growth and the evolution of investment propositions containing some modicum of risk. Isn’t Wall Street a great place?!

There are two main problems with the economic landscape: 1. deficits are immense, causing record debt levels to increase at a record pace, and 2. there is no political will or plan to provide anything other than short-term, politically expedient patches.

There isn’t a plan or a strategy for the future architecture of the US banking system.

Uncle Sam and money
Uncle Sam and money

Institutions deemed “too big to fail” have since expanded at the government’s encouragement and with taxpayer dollars.

Treasury bill, note, and bond issues have become incredibly short-term, so much so that an increase in rates will create a significant impact on the governments interest expense.

The net effect of the government’s actions has been the creation of more systemic risk than existed before the crisis began.

The federal government has gone infinitely more into debt while we remain glaringly exposed to the failure of a handful (albeit a smaller handful) of huge banking institutions.

No political will to address painful economic problems has a compounding effect.

David Einhorn of Greenlight Capital says it well:

Paul Volcker was an unusual public official because he was willing to make unpopular decisions in the early '80s and was disliked at the time. History, though, judges him kindly for the era of prosperity that followed.

Presently, Ben Bernanke and Tim Geithner have become the quintessential short-term decision makers. They explicitly "do whatever it takes" to "solve one problem at a time" and deal with the unintended consequences later. It is too soon for history to evaluate their work, because there hasn't been time for the unintended consequences of the "do whatever it takes" decision-making to materialize.

The author, and my great friend, P. J. O’Rourke deliciously warns, “if you think healthcare is expensive now, just wait ‘til they make it free!”

Winterizing Your Portfolio - A CNBC Special Report
Winterizing Your Portfolio - A CNBC Special Report

The market’s reaction to strong Treasury Auctions this week is symptomatic. The resurrection of the US consumer may be more anticipated than a Yankees World Series victory and far more costly should the consumer go 0 and 4. The short term recovery is fragile, and the long-term deficit and debt being created by near-term political pandering are already unimaginable and perhaps unmanageable.

My politically moronic solution is to reduce government spending, insist on a schedule to produce a balanced budget, formulate a strategy and timeline for a return to surplus, and refuse to push dire consequence into the next election cycle. We must take our economic problems head on and deal with them and the painful consequences of dealing with them now, because ignoring them ultimately threatens the fabric of American Society.

America has a great history of taking the hard responsible steps to insure the American lifestyle and preserve the American Dream. Our elected officials are stewards of these great traditions, a rich, vibrant history, and hope and possibility for future generations.

David Einhorn has a more troubling conclusion:

For years, the discussion has been that our deficit spending will pass the costs onto "our grandchildren." I believe that this is no longer the case and that the consequences will be seen during the lifetime of the leaders who have pursued short-term popularity over our solvency.

If Einhorn is correct, our political leaders should pay attention to solving rather than patching problems. These chickens may, in fact, come home to roost.

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Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.