What I propose to chat about tonight is the crisis on Wall Street. First, just a brief review of how we got into this mess and our attempt to locate the broader themes in our society that are responsible, which will not focus on a particular person or regulator. We believe it’s often instructive to review how we got somewhere to better estimate where we’re heading. Secondly, an attempt to review some of government’s attempts to address the crises and why there is some, albeit modest, cause for optimism.

I’ll also briefly address the portfolio implications of events over the past 9-12 months. Most of the news has been grim, as we all know, yet there have been some encouraging developments that deserve mentioning.

First….who is to blame. Above all, deregulation. For over 25 years, the orthodoxy dominating economic and political thought, has been the less regulation, the better. An open and free market is the best source for efficiency and prosperity. This paradigm has taken the ultimate hit as a Wall Street virtually unhindered by any regulation has crashed and burned. The problem is that it’s unclear where the market failed and what if any regulation could be a remedy. Our belief is that the culprit is absence of regulation, certainly, but that this became particularly risky because it was in conjunction with government – make that, taxpayer, insurance. If we were insuring the risks, we should have been kicking the tires. Culprit #2 is the consumerist-spending culture that permeates America. It seems like everyone wants to spend more more and then some more, and if you can’t afford it, borrow borrow borrow. Now we all know consumerism has been a staple of our society since after WWII, but this has accelerated and galloped out of control this decade. President Bush’s call to a nation to spend rather than save and sacrifice during the week after September 11th epitomizes just how ingrained this had become. And we listened to our leaders and spent. And borrowed. The demand for borrowing was relentless. A pliant Federal Reserve Chairman cut interest rates to 1% to facilitate the binge. But this still wasn’t enough to satisfy the demand for spending. So Wall Street did what Wall Street does, particularly an unregulated wall Street. It innovated. Thus were born subprime mortgages, stated income loans (better known as liar’s loans), option ARMs and all the rest. There were very few voices of sobriety. And the 3rd culprit is ourselves. We have consistently rewarded the “see-no-evil, live-for-today, cut-taxes” politicians. Those who encourage spending are rewarded, those who take a longer-term view are punished. Thus we find ourselves in a political environment today where the candidates are debating who will cut taxes the most while simultaneously leaving the budgetary sacred cows untouched. We cannot blame them for everything, we have set the standards for the debate.

And how has government – the Fed and Treasury Dept – been addressing the crises? It appears we are transitioning from what has been direct intervention – nationalization – to something a bit more subtle and perhaps more insidious. For the first segment of the crisis, the problem solving method consisted of hasty weekend meetings during which a handful of elders would decide which companies would live, which would die, which taxpayers would take over, which we wouldn’t. Thus, without any public debate or hearing in Congress, the federal debt has exploded. It is as yet unclear if any of these actions have “stabilized” the markets, nor by the way was there ever any public debate about what that means and what value should be assigned to that stability. And now with the latest Treasury proposal we have …what exactly. At this point, it is still early to tell, but what initially proposed seems little more than corporate welfare at its worst. Taxpayers will take the worst of the worst assets off the banks (and hedge funds??) balance sheets, pay at face value, and …wait….wait…for housing prices to “recover”. Buying virtually worthless assets for full price…if that isn’t a bailout, then someone help me out with the proper word. And what are the taxpayers getting in return? Yes, those assets might appreciate over time. And yes, there will be “stability” if that means that several large financial institutions will survive. But again, at what cost? And where is the penalty for the institutions? Regulations? Maybe that will come..but it’s not on the table now. Restriction of pay? Possibly, but this will be managed today and will be gone in 2 years at the latest. I don’t think this is the proper forum, but it would be an interesting exercise to speculate what would happen if we simply let the market..yes, the market, sort this out without the taxpayer taking on trillions of dollars of liabilities. WHAT WE CAN SAY UNEQUIVOCALLY IS THAT THE TREASURY PLAN REPRESENTS A MASSIVE BAILOUT OF WALL STREET BY THE TAXPAYERS. The “business-friendly/we must support the stock market at great cost” paradigm is still alive and well.

Finally, a quick word about the portfolios themselves. As I noted, most of the news has been grim. Our own stock market is down by close to 20% over the past year and most foreign markets are down more. This is sadly more the norm that the exception; the world’s stock markets are highly correlated with each other. Natural resource stocks and commercial real estate are suffering under strains of their own. Health care stocks seems to be the only sector that is holding up fairly well. The most encouraging development recently has come from the economy and that is the dissipation of inflation risks. Commodities are down dramatically, wages are not accelerating, headline inflation is falling, and thus, government bonds are still retaining value. For us, this is extremely comforting as it is providing us a major asset that continues to display negative correlation with the stock market and risky assets in general. It is this negative correlation that enables portfolios to weather steep declines in the equity asset classes.

We welcome your observations and questions….