Rational Speculation

Speaking of Warren Buffett..

According to the Reuter’s article “Buffett says Fed avoided chaos in Bear bailout”, WB is to have said:

“I think the Fed did the right thing in stepping in on Bear Stearns,” Buffett said at the annual meeting of his Berkshire Hathaway, Inc. insurance and investment company. “Just imagine the thousands of counterparties around the world having to undo contracts.”

Of course WB is going to say that because the fallout from such a crisis would have severely and immediately affected Berkshire’s businesses and investments. But, was this bailout really good for everyone?

Remember, for every action there’s a reaction.

Who do you think is eventually going to pay for the Fed’s economic stimulus and bailout of the fat cats on Wall Street? Right, it’s ALWAYS going to be the average American taxpayer. Those especially hit the hardest will be in or near retirement age, whose savings are allocated to income investments (e.g. bonds, money-market funds) or are used to generate income for daily living expenses.

How’s that?

1. In order to “stimulate the economy”, in just a few months the Fed has quickly lowered the federal funds rate from over 5% to a recent low of 2%, which is now much lower than the 4% rate of inflation. After accounting for the rate of inflation, it will now “cost you money” to keep your savings in a savings account, CDs, money-market funds and bonds, all which many retirees depend on for “safe” monthly income. I believe Wall Street refers to this as “negative growth”.
2. On May 1st, the treasury announced their semi-annual earnings rates on the I-bond savings bond (government-issued inflation-protected savings devices). The fixed earnings rate, which continues for the life of that bond, is 0%. Yes, that’s ZERO PERCENT. Are you encouraged to save yet?
3. The government can’t issue money without incurring some sort of consequence. The main consequence of lending (or giving away) money it doesn’t have is called “inflation”. Just as income from our “safe” investments is being lost, the cost of living for the average American is starting to skyrocket. As inflation kicks in, it’s going to cost you more for food, gas, and other goods just when your income to buy them is reduced.

So, how does the government expect to get out of this mess it’s created?

Well, lo and behold, the Bush administration has recently announced that it will be re-instituting one-year treasury bills, something they did away with after the Clinton administration responsibly balanced the budget and created a surplus when they were running the country. According to a Yahoo! Finance article:

The government is looking for various ways to borrow the billions of dollars in extra cash it will need to cover a budget deficit that is expected to jump to an all-time high this year, surpassing the old mark of $413 billion set in 2004. Private economists are projecting that the deficit for this year could surge as high as $500 billion.

It seems as though the government is outrageously expecting the average American to bail them out. They’ve even targeted us middle-class huckleberries by lowering the minimums to only $100.00. But this plan may have also have unexpected consequences.

Where’s the incentive to buy these treasuries?

The fixed rate on I-bonds is now at zero percent, 3-month T-bills are yielding 1.5%, 6-month T-bills at 1.68% and 2-year notes at 2.45% - all well-below the inflation rate. Only the very long-term bonds are offering any type of half-way decent yields, but they’re all still yielding far under 5%. If inflation continues to rise, even the long-term rates won’t have any appeal.

Unless the Treasury offers some kind of unprecedented yields on 1-yr T-bills, this plan will backfire too.

So, after you recognize that you’re experiencing difficulties in your activities of daily living, remember to ask yourself: Was government bailout of Bear Stearns the right thing to do? I don’t think so.