Enhanced Authority for the Fed Proposed

Later this morning, Henry Paulson will announce the proposed enhanced authority for the Federal Reserve. The purpose of this enhancement is to update now antiquated laws originally passed some 70 to 90 years ago. Upon first review, the increased authority makes sense, but as always the "Devil is in the Details". Attached is a link to a Bloomberg article highlighting a few of the proposed changes.

http://www.bloomberg.com/apps/news?pid=20601103&sid=aQ8Jdn1leDss&refer=news

Putting the Sub-Prime Crisis in Perspective and the Risks that Remain

Below is a link to an interview with Carmen Reinhart, a Professor of Economics at the University of Maryland. The interview touches on the following important points:

1. Sub-Prime Financial Crisis Recovery - A historical perspective.
   
2. The US dollar decline - Is it really all that bad for us?
3. Inflation and Commodity prices - Are they the next bubble?

On the historical perspective: Professor Reinhart points out that the recovery period for the current crisis will take two to three years, with the good news being that we are already six months into the recovery. Unlike past financial crises, we are addressing the problem aggressively though without a full understanding of the magnitude of the problem.

For the falling US dollar: She notes that the US dollar decline is required and "the best thing that could happen." It will correct our current account deficit and ignite growth of exports.

Commodity prices the next bubble: Professor Reinhart states that commodity prices are in a secular (long-term) downtrend but cyclically (short-term) have done well. She noted that the commodity prices will come down as Asian markets slow down. This slow down will have its biggest negative impact on emerging markets.

Her final words regarding investing: " I have a long term outlook, and we will ride this (crisis) out."

http://www.advisorperspectives.com/pdfs/newsltr08-2-13-3.pdf

What makes Bershire Hathaway tick?

The following link is a case study on why Berkshire Hathaway ticks. The study, performed by the Focus Consulting Group, points out the intangibles that make Warren Buffet and Charlie Munger so successful. As they brand it, the "soft skills" are leadership and culture development; Buffett and Munger possess these. These soft skills allow for speed and accuracy and empower the decision-making abilities of the organization's "number one asset": its people.

In addition, the case study highlights key behaviors observed in successful organizations.

We at Crew Capital look for these types of organizations when we invest. They have proven to offer the best long-term results.

http://www.focuscgroup.com/Portals/_Rainbow/Documents/High%20Performing%20Investment%20Teams%20A%20Case%20Study.pdf

Could Talking About a Recession Create One?

The following article addresses that very question: could talking about a recession actually create a recession? The author focuses on behavioral finance and how it can blur one's judgment. In this article, he points out one of the most common Decision Traps we see - that of basing decisions on one's recent past experience rather than careful analysis.

At Crew Capital (CCM) we specialize in educating our clients about these common Decision Traps so that together we can avoid them, especially in the process of making investment decisions.

http://www.predictablyirrational.com/?p=183

How the Federal Reserve Works

The following link provides a basis illustration of how the Federal Reserve works.

http://money.howstuffworks.com/fed.htm/printable

Fed's interest rate cut spurs fear of inflation

The recent interest rate cut has increased the fear/chance of inflation, as discussed yesterday. If the Committee mismanages and pumps too much into the economy, demand will increase and so will prices (i.e. inflation). On the other hand, if the US economy is in a Recession (Shhhhh) then the threat of inflation should subside. The recovery pattern will be key. Crew Capital is projecting a U-shaped recovery, based on current data.

Fed Rate Cut Announcement

The Federal Reserve cut interest rates .75%. The market anticipated a full 1.0% cut, which puts the Fed Funds Rate at 2.25%. This additional rate cut will not impact the market for a full 12 to 18 months. The Federal Reserve stated that the continued pressure of the credit crisis and the eroding housing market continues to put downward pressure on economic growth. The Committee did have two dissents, both are considered Fed inflation hawks: Fisher and Plosser.

Ideally, low inflation is good for the economy and the financial markets.

The Fed is clearly focused on stimulating economic growth today at the expense of potential inflation down the road (long-term).

Federal Reserve Comments - regarding inflation today and January 30th.
January 30th:
"The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully."

March 18th:
"Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."

Fed Rate Decision

Federal Reserve May Cut Rates by up to 1%
from Bloomberg

The Federal Reserve could cut interest rates by as much as a full percentage point when it meets Tuesday. Investors are worried that investment bank results could trigger a full-blown market crisis. The Fed has reduced interest rates by 2.25% since mid-September.

Confidence in the Market

We continue to review the strategies of our investor role-models and were struck once again by Warren Buffett's confidence in the equity market. In his most recent Shareholder Letter, Mr. Buffett states:

"Last year I told you that Berkshire had 62 derivative contracts that I manage. (We also have a few left in the General Re runoff book.) Today, we have 94 of these, and they fall into two categories. First, we have written 54 contracts that require us to make payments if certain bonds that are included in various high-yield indices default. These contracts expire at various times from 2009 to 2013. ... The second category of contracts involves various put options we have sold on four stock indices (the S&P 500 plus three foreign indices). These puts had original terms of either 15 or 20 years and were struck at the market. We have received premiums of $4.5 billion, and we recorded a liability at yearend of $4.6 billion. The puts in these contracts are exercisable only at their expiration dates, which occur between 2019 and 2027, and Berkshire will then need to make a payment only if the index in question is quoted at a level below that existing on the day that the put was written. Again, I believe these contracts, in aggregate, will be profitable and that we will, in addition, receive substantial income from our investment of the premiums we hold during the 15- or 20-year period." (Berkshire Hathaway shareholder letter dated February 2008, page 16).

If you would like to read the letter in its entirety, I refer you to the Berkshire website at http://www.berkshirehathaway.com/letters/2007ltr.pdf

Special Market Alert - March 13, 2008

Bravo!

The Fed is proactive and creative. Besides lowering interest rates to ignite the economy over the past 6 months, it has created a new program, the Term Securities Lending Facility, which will lend up to $200 billion in US Treasuries to banks for 28-day periods in exchange for other securities used as collateral currently, held by the banks. In other words the Fed is swapping US Treasuries for mortgage back securities (MBS), which no one wants. This creative plan by the Fed will not add money to the system, so it should not contribute to runaway inflation that has been developing. This action will ease the credit crisis and entice banks to lending money.

The Fed is addressing its near-term issue of igniting economic growth. The interest rate reductions of 2.25% have had little impact to start economic growth. Rate reductions on average take 12 to 18 months before they are felt in the economy. This additional creative step is a temporary fix until the rate reductions have had time to take affect.

The Fed’s traditional method of lowering interest rates to promote economic growth has negatively impacted the dollar’s value against other currencies. As a result, commodity inflation is significantly higher than normal. The Fed needed to take this additional steps to reduce the pressure of Stagflation (no economic growth with high inflation, ala late 70’s) the lowering of interest rates was causing.

The Fed steps may cause inflation sometime in the future. But inflation is better than Stagflation.

This action by the Fed was received well by investors, as they noted its proactive and creative steps. This confidence building step is the catalyst the market needed to turn the corner. Bargain Hunter season started with the Fed’s action. The market is still calling for an additional rate cut of .5 to .75% in on March 18. Though CCM focus is on long-term investing, we believe this is a time for equity investing.

Be sure to check our website at http://www.crewcapital.com for more insights on the market. We welcome your ideas and comments, as always.

Thank you,
Robert F. Jung
Managing Director, Crew Capital Management