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Warren Graham's Legal Blog: Irrational Exuberance Redux
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Location: New York, New York, United States

I am a practicing lawyer who lives and works in Manhattan, and specializes in Bankruptcy, Corporate Restructuring and Creditors' Rights, Commercial Litigation and Real Estate Law. I grew up in the New York City Area, and am a graduate of the University at Buffalo (B.A. 1976) and Fordham University School of Law (J.D. 1980). I have a wide variety of interests, but am particularly interested in history, politics, economics/finance and religious affairs, and am a frequent writer on a variety of those topics, and others. On a personal note, I'm a 54 year old man, married for 27 years, with two daughters, ages 24 and 20, respectively. Legal topics of interest may be found on my blogsite,, while non-legal commentary may be found at The content of these sites will be centralized and easily accessed locations for both legal and non-legal analysis and commentary, as well as a description of my legal practice for clients and potential clients. Keep checking back, as I expect the content to change and grow regularly.

Monday, October 01, 2007

Irrational Exuberance Redux

Well, it’s official. The traders (mostly large institutions and funds) who move the Stock Market have now lost all touch with reality. This morning, after new of an enormous write-down and profit warnings by Citigroup, UBS and many economists, near panicky price-slashing by Wal-Mart in anticipation of a lackluster holiday season, the cancellation of several high profile deals, and a public statement by Greenspan expressing concern that a housing meltdown in the U.S. might well hurt the entire global economy, these traders reacted by blowing the Dow right through the previous 14,000 level, and as of the time of this writing, taking it up over 200 points.

The reason, say the generally clueless Wall Street analysts employed by various media outlets is the prospect of lower interest rates to come; perhaps much lower. And they’ll probably get it, now that Ben Bernanke has proven himself unable to stand any pressure from the banks and the hedge funds. The markets, in fact, have been bubbling with pie-eyed optimism nearly every day, since the recent interest rate cuts.

It follows, they say, that with fixed income securities becoming less attractive, and real estate in trouble and generally illiquid, equities will continue to be the only place to be. Never mind oil prices heading up to $100 a barrel. Never mind the increasing prospect of recession. Never mind that stocks are trading at near historically high multiples, and that is based on profits that are nearly guaranteed not to increase, but to decrease in 2008. Never mind that the U.S. Dollar is in free-fall, with no apparent end in sight.

The reason for this buying frenzy, however, is much more basic than a reasoned analysis of the benefits of easy fiscal policy. It is, quite simply, mass hypnosis, short covering hysteria, and outright denial. “Buy now, or miss the party!” “Buy tech, it’s a safe haven.”

Tech, a safe haven??! Have we really gone so off the rails, that the term “flight to quality” now means that widows and orphans should stake their retirement nest eggs on the prospect of endless good times at Cisco, rather than U.S. Treasuries? Is Red Hat the new Municipal Bond?

Apparently so. And, to use a hackneyed metaphor, the financial world is “fiddling while Rome burns.”

Lower interest rates (and remember, we’re talking only about short-term rates. The Federal Reserve has little or no control over long-term rates, which are actually trending higher) cannot, by themselves, enhance home values. They cannot induce lenders to lend to non-creditworthy customers anymore, at least in the near term (presuming that those lenders have learned some kind of lesson from the sub-prime crisis). They cannot really spur consumer spending either. Credit card rates rarely go down much with the Fed Funds Rate, and Americans are already drowning in a sea of unmanageable credit card debt. In fact, the falling dollar is likely to substantially increase the cost to consumers of goods, especially those imported from abroad. Foreign banks and investors are already reducing investment here because they are losing money every day, as the dollar declines against their own currencies. They also do not want to hold dollar denominated instruments for the same reason.

If lower rates do somehow turn out to stimulate the economy meaningfully (a dubious proposition, to be sure), one likely result is, of course, renewed inflationary pressure. And while we are all told that food and energy should be stripped out of the inflation measure, very few of us can get by without food and energy. Food prices have gone up dramatically in recent months, and the suggestion that gasoline and heating oil prices will continue lower notwithstanding $80 a barrel oil is just plain mendacity. Nothing spooks the Fed like inflation. And at the first sign of it, the trend will start to tightening, no matter how much the markets recoil at it.

It may be that lower rates will have a beneficial effect on the Merger and Acquisition business and may reignite the crazed “urge to merge” mania of the last year or two. That remains to be seen. The beneficiaries of those deals, of course, are not Mr. & Mrs. John Q. Public. They are, rather, the same (very few) folks who made tens or hundreds of millions in the last couple of years, in an era of almost cost-free money, charging their clients whopping fees, and paying low taxes. Even for an unabashed capitalist like myself, there does seem a certain excess and decadence in all that. The clients, of course, never complained, so long as their returns were high. Only when the quality of some of these investments came into question, and investors started pulling their money out, did these funds scream for Bernanke to ride to the rescue. Which he has, thus far, done, in spades.

Meanwhile the markets go on in a gleeful upside rampage, blissfully ignoring all bad news, or worse, interpreting all bad news as good, because financial weakness leads, they suppose, to easy money.

Hey, how about those Mets, eh?

Warren R. Graham
Copyright 2007


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