Friday, May 20, 2005

Bill Cara: Capital Markets & Social Equity

Bill and Chairman Greenspan are correct to call for the elimination of the Freddie and Fannie subsidy. However, the 40 basis point subsidy is not the cause of soaring real estate prices. There is speculation in the real estate market but for the most part prices are being driven by an old reason called supply and demand.

Besides, long interest rates are in line with where they should be. The rates on TIPS, Ten Year bonds and inflation measures such as the PCED all forecast moderating inflation. Many big ticket items are offered at lower prices today than were available a short time ago; everything from computers to airline tickets.

Take a look at what IBM is doing with computer time. After paying a $5,000 retainer, companies of all sizes can now rent time on a super computer for a small fraction of the costs of last year. Consumers are dropping land based phone lines and newspaper subscriptions. They are substituting "free" services such as on-line instant messaging and on-line news.

Forty years ago, stock market newsletters of lower quality than Bills blog were available by subscription. They were typically delivered once each week, first thing Monday morning, and often cost more than $5 per letter. So far, Bill hasn't charged me a nickle to read his letter.

It is really hard to pump a tank of gas in today's market and believe inflation is tame. The rule that applies is "out of sight out of mind". Most of us do not buy an airplane ticket once a week or a computer once a week but the savings are large relative to the extra cost of the gas. Five hundred gallons of gas in a year cost maybe $350 more than last year. The savings on a lap-top computer might be $1,500. The interest savings on today's mortgages save the increase in price of a lot of hamburgers.

Greenspan is likely to continue to push congress to deal with Freddie and Fannie. I doubt that anything will happen as the congress is doing battle over judges. A republican win on this issue will save consumers and businesses billions if not trillions in the years ahead.

In the mean-time, investors have to deal with inconsistencies in the economic numbers. A case can certainly be made that economic growth is slowing and that oil prices will continue to fall. This argument would imply that the fed does not need to raise rates more. A case can also be made that the economy is stronger than perceived. The latest retail sales, unemployment claims, corporate earnings revisions, productivity growth and more suggest that GNP will grow at better than 4% this quarter! If this is true, the fed may need to snug a bit more.

History has shown that money is made by staying in the market much more than sitting it out on the sidelines. The conventional wisdom of three steps and a stumble is not born out by the data. Stocks tend to move up during periods of moderate rises in short interest rates.