Essays on Rebuilding America: Efficient Markets or Irrational Pessimism

Columnist : Jonathan Williams

by Col. Frank Ryan, USMC Ret.

The markets have gyrated wildly over the past few months.  Commodity prices have skyrocketed, real estate prices have plummeted, financial services stocks have declined precipitously, deficits have soared, inflation and deflation are running rampant, and this is the good news.

I have been amazed, however, about the almost complete hysteria impacting the markets.  In my experience, few things are as good nor are they as bad as is first assumed.   Markets discount information by the second, both correctly and incorrectly.

Unfortunately, major governmental policy shifts are being recommended due to short term market dislocations which will have very long term consequences upon our markets.  The unintended consequences of those policy shifts will far exceed the costs of the dislocations we are facing today.  For example, one presidential candidate has recommended a five year “freeze” of certain interest rates.  What a way to scare the daylights out of a financial services market.  Just the mere mention of that freeze from a viable presidential contender could send the markets reeling.

Warren Buffett mentioned recently that, despite the technical definitions, we are, in fact, in a recession.   His assessment mirrors the sentiments of most Americans.  The psychology of markets will bring such pessimism to fruition resulting in the very thing we are trying to avoid.  But, then again, markets are about psychology and there is absolutely nothing wrong with that.  What is wrong is when we try to interfere with those very markets.

This is not to imply that our problems are not real.  Nor is it to imply that by preaching optimism all will be well.  The problem comes when neither pessimism nor optimism are reflective of reality.

If you look at actions of markets, you will see that exuberance frequently causes prices to rise and pessimism causes prices to decline.  That is what markets do.

From the tech stock boom and bust of the late 1990’s to early 2000, to the real estate boom and now bust, we are merely seeing the normal workings of markets.  Each person is free to participate or not participate as you so desire.  You can believe the optimism.  You can believe the pessimism.  If you guess correctly you will do well.  If you do not guess correctly, you will lose.

As an example, are gold, silver, or platinum at today’s price reflective of value or due to the current market exuberance?  If the prices are reflective of value, the buyers will be rewarded.  If the prices are reflective of exuberance, prices will decline.

Real estate is being discouraged today since values are falling.  This is perhaps an example of irrational pessimism. Yet many are buying real estate and they will reap significant rewards if the markets rebound.  Conventional wisdom implies that demand goes up when prices come down.  I think I read that somewhere.

Oil prices should return to $70 to $75 per barrel.  Most oil industry managers will tell you that the current prices are because of speculators and not necessarily of supply and demand for petroleum in the market.   Irrational exuberance perhaps?

Financial service sector stocks will yield significant returns from the middle of 2008 for the next two to three years.   When fears set in about the sub-prime loans and asset quality, shares are sold and prices decline.  I think I read that somewhere as well.  When the market stabilizes, intrinsic values should become apparent resulting in higher stock prices.

The markets are unstable today also because of the presidential elections and perceived government intervention in our markets based on various candidates comments.  The effects of increased spending, increased taxes, and market intervention on the value of investments are clearly known.   When candidates mention these alternatives, markets react and it is appropriate that they should.

Government should provide the framework or rules for markets, the rule of law as Alan Greenspan would say, but certainly not interfere in the markets.  Interference will fail. To properly minimize the impact of market dislocations in the long run we need to focus on productivity, industrial capacity, maintaining a rule of law, and sustainable private sector growth.  Only one of these factors is a role of government.  To do otherwise will merely put a feel good solution to a problem that will not feel so good in the long run.

Frank Ryan is a member of the Lincoln Institute Board of Directors and lectures for the AICPA and BLI on management related topics. He can be reached at [email protected].