“All we can do is put foam on the runway” – Tim Geithner, speaking before the collapse of Lehman

Dear Clients and Friends,

Foaming the runway, in a literal sense, is spraying a thick layer of foam on a runway in order to prevent friction and fire from a landing plane that is expected to ‘crash’ (typically an emergency belly landing) into the runway. In late 2008 Tim Geithner, the President of the New York Federal Reserve bank (who one year later would be appointed Secretary of the Treasury), was in the figurative airport control tower watching as injured planes circled the runway.  He could see that some of his district’s banks, a collection of the largest investment banks in the world, were facing insolvency.  Their assets were shrinking while their liabilities were ballooning; and one of the largest of these -Lehman Brothers, was about to crash into the economic runway.  Geithner was purported to have said that the emergency housing programs enacted by Congress would act as “foam on the runway” if a collapse happened.  If Geithner had called the FAA prior to using this phrase he would have found out that the technical practice of “foaming the runway” had not been endorsed by the FAA since 1987, and by 2008 was a discouraged practice.  As the Great Financial Crises showed, the ‘crash’ was tragic and the ‘foam’ proved useless.

The real lesson of 2008, and the Feds intervention teaches us something about our economy and it also shines a light on those who are charged with managing this economy.  The policy makers don’t always get it right, and many times the efforts used are more symbolic than effective. Over the last 3 years we have witnessed asset inflation that rivals some of the best times in history (the 1920s, 1960s, and 1990s).  All types of assets, including cars, real estate, and stocks have gone higher.  This asset inflation has a certain “wealth effect” upon our economy; essentially it makes people richer and therefore the average person tends to feel more comfortable with spending.  With the Fed raising rates and the pinch caused by inflation, many households are feeling poorer, but this change is barely perceptible when you look at the data.  This is largely part of the cycle, but cycles are typically punctuated with a crisis, and many times the crises are spawned by assets deflating after a period of strong asset inflation.  As investors we need to be aware that we are currently in an environment where asset values will come down, the question is how much, and at what rate.

Today we have an economy that is still running steady but slowing, business is still decent for most Americans.  The Fed has raised interest rates, and we have yet to experience the full effect of these hikes, but suffices to say inflation is edging down while the labor market remains strong.  Some economists are suggesting that the Fed’s mastery of interest rates will create a “soft landing” whereby the economy slows, but avoids a full recession.  There are some that would argue that a soft landing is near impossible, but sufficient evidence exists to support this potential outcome- meaning a soft landing is possible.  However, the fact remains that rate hikes are a blunt tool that work over long periods and have variable outcomes which should give all investors something to think about over the next year.

So why did I start out this missive with a quote about “foaming a runway”, you might ask?  Assuming that rate hikes have stabilized inflation, and are forcing product prices down over the coming months is a decent working assumption for this year.  Assuming that wages also stabilize and maybe even come down a bit, that too is a decent working assumption.  However, if we assume that this happens quickly and with unintended force, this creates the ‘foaming of the runway’ situation that the Fed wants to avoid.  I am not writing this piece to communicate fear of rumination for the economy, quite the contrary, I believe that the Fed has a legitimate chance at a “soft landing”.  But investors should always think about the unintended consequences of Fed action that has long and variable lags, and in doing so, figure out how they might mitigate the fallout from those risks before the foam is sprayed on the runway.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risks including loss of principal. No strategy assures success or protects against losses.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

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