Income Strategy September 7, 2007:

The economic news this past week has not been very encouraging; the US economy has been showing increasing signs of slowing. The August Non Farm Payrolls report showed a decline in jobs of 4,000 the first decline in over four years. The unemployment rate remained at 4.6% for the second month as fewer people entered the job market.

The decline in employment should not be a major surprise when one looks at what is happening in the real estate sector. The housing market in the US is falling fast especially in the areas where there was excessive building activity over the past few years in states such as California, Florida, Nevada and Arizona. The problems in the sub prime mortgage sector is are now spreading to all mortgage sectors as lenders pull back and generally refuse to lend.

The delinquency rate on sub prime mortgages is escalating very quickly as borrowers realize that the new roll over rate on their mortgages makes owning a home unaffordable. Unfortunately many recent borrowers bought at very high prices and now do not have any option except to go in to a foreclosure situation.

The increasing expectation of an economic slow down in the US has created a global concern and the central banks are holding firm on rates until the uncertainty regarding the credit markets is clarified. The Bank of Canada decided not to increase rates in the midst of the turmoil. The Bank of England and the European Central Bank followed with similar announcements this week holding rates at current levels sighting uncertainty regarding future economic growth.

There appears to be a lot of pressure on the Central Banks around the world to lower rates in an effort to soften the blow from the fallout in sub prime mortgage and Asset Backed Corporate Paper markets. Unfortunately many observers will view a rate reduction as a bail out of Wall Street and will fight this potential move. I believe the medicine that many want (lower rates) will be worse than the disease over the long term.

Many of the problems the markets and the economy are now dealing with have been created by the over reaction by Central Banks to market turmoil’s of the past. The reduction in interest rates and the surge in liquidity that followed the 1987 stock market crash and the 1998 Long Term Capital blow up which was followed by the Asian currency crisis and the Russian loan defaults fueled the surging technology bubble and the over heating of the US and European real estate markets.

The Central Banks have a responsibility to ensure that the financial markets function efficiently, but they do not have a mandate to ensure that markets do not go down. I believe the Federal Reserve along with the other major Central Banks have been following a prudent path in the current market turmoil and that those institutions, investors and hedge funds that made  poor decisions should have to accept the consequences of their actions even if that means some of them go out of business.