Bear Streams

| February 17, 2023

I first heard about the run on Northern Rock bank in September 2007, while playing ping-pong on a terrasse high on a hill overlooking the Mediterranean Sea. A British physician said to me “you’re the financial guy, should I be worried about this?” I did not really know. We sat on a bench and read together an article in his UK newspaper. I ultimately decided that since the Bank of England guaranteed liquidity, depositors had no cause to worry. That was true.

I am reflecting on this because of the related questions facing us today. I learn from my experiences and know that I need to keep hammering away at the long time that can pass between cause and effect. Northern Rock is a great example. The Fed hiked rates to 1.25% on March 7, 2004. Because of an overheated real-estate market, the Fed continued to hike rates until it peaked at 5.31% on August 31, 2006. The Fed did not cut rates again until August 10, 2007, right before the British bank run. Even then, the Fed rate returned to 5.11% by August 20.* A picture is attached below to make it easier to visualize, the shaded areas are recessions.

I am boring you with this series of obscure statistics because they teach us an important lesson. Government officials, politicians, leaders of finance, journalists, and pretty much all the world missed the many signs leading up to the Great Recession. On April fool’s day, following my return to America, I walked past the line of limousines waiting in front of Bear Stearns’ Manhattan office.  The sun had not yet risen, and the dark and cold added to the melancholy scene of executives taking turns putting their possessions into cardboard boxes. Nobody at the three-day conference I was there for talked about a recession, not even the many celebrity speakers. Yet, the Great Recession had begun five months earlier. Even when Fannie Mae and Freddie Mac collapsed on September 7, most market participants expected a Fed bailout and remained bullish. Not until the Lehman Brothers collapse did it dawn on global leaders that we were already in the midst of a terrible recession.

Today, rates remain below where they were in August of 2006. They will not stay there for long. With the current CPI inflation rate still at 6.4% rates continue to stimulate the economy. Not until rates are higher than inflation will the economy slow down. The two numbers will cross as inflation continues to decline and the Fed continues to hike rates. Short-term, speculative investors are likely to drive markets higher. We are at the musical chairs stage in the business cycle. For movie buffs, maybe I should say that we are on the Chicken Run. It could be a long run when we consider that more than three years passed between the time that the Fed began hiking rates and when Lehman Brothers failed.

I do not anticipate another Great Recession. I do anticipate a recession either later this year or early next year. In 2007 we had the opportunity to invest in many high-quality and low-risk securities when others chased risk. We have a similar opportunity today. We remain fully invested but are also taking advantage of the current opportunities in fixed income. We know from experience that early investors look foolish, right up until they don’t.

Federal Funds Effective Rate (DFF) | FRED | St. Louis Fed (