As you’ve all heard by now, John McCain said, “The fundamentals of this economy are strong.”  He said it months ago, he said it again recently, and he’s said it many times between.  Well, he was right, until today when he reversed, and rightly so, his opinion that the economy is now in crisis. When McCain made this statement, he was referring to classic economic indicators.

Unemployment is at 6.5%, which is the text book number for a healthy level of unemployment.   The farther you get away from that number, higher or lower, the worse it is for the economy.  There was a 3% growth in the economy last quarter.  Yes, it’s an indication that the economy has slow, but it’s a heck of a lot better than negative growth. I keep hearing people talk about how we’re in a recession.  By definition, a recession is a decline in economic growth for 2 consecutive quarters.  A 3% growth is not a recession.  The market was well over 14,000.  Just 3 years ago everyone was talking about how it would be impossible for the Dow to hit 12,000.  That’s a 40% increase in 3 years.  Given that lifetime average growth is about 8% per year, I’d say that’s pretty impressive.

Today aside (I’ll get to that later), there are obviously some issues with the economy, specifically oil prices and the credit crisis.  The high oil prices are due to speculators in the market.  In July, the price per barrel was around $140 and the estimated impact of speculators was between 40 – 60% of the price.  President Bush lifted the executive ban on off shore drilling and today oil prices closed at $97.  Even after OPEC recently announced that they are cutting supply, the price per barrel has decreased about 30% in a little over 2 months.  By President Bush lifting the ban, he told the world that we’re serious about decreasing our dependence on foreign oil and drove some speculators out of the market.  If Congress would quit sitting on their hands and actually do what’s good for this country by lifting the congressional ban on off shore drilling, it would drive the majority of the remaining speculators out of the market and the price per barrel would fall to somewhere between $60 and $70 per barrel.  In other words, we’d be back to about $2 per gallon as the gas tank.   Please don’t start pointing fingers and saying that we should have been putting more money into research and development of alternative fuel sources.  I think we can all agree that should have been done all along and it’s EVERYONE’S fault.  The blame doesn’t fall to one party, it falls to everyone in Washington.

As for the credit crisis, the primary blame falls to greedy companies who loaned people money who they knew wouldn’t be able to repay them and to individuals who try to live above their means.  The secondary blame falls on Congress, the SEC, and the Treasury for not regulating sub-prime loans.  Unfortunately, without businesses and individuals being financially responsible and regulators not stepping in to control the situation, the credit crisis would have happened no matter who was in the White House.

The Fed bailed out Bear Sterns because it was the first of the IBanks (investment banks) to fail as a result of the credit crisis.  They had to bail Freddie and Fannie because they are government sponsored enterprises.  The Fed gave a warning to the rest of Wall Street when they bailed out Bear and that’s why they didn’t bail out Lehman Brothers or Merrill Lynch this week.  Lehman, Merrill, Morgan Stanley, Goldman Sachs and others had 7 months to correct themselves and they continued to use paper as hedge funds to cover their loans.   It’s a shame that Lehman went under, but it wasn’t a well run organization and this is a cyclical event that happens about once a decade.  It always feels like a crisis in the short term, but if you look at history and how we survived the fall of other major companies like Salomon Smith Barney and E.F. Hutton, the market will bounce back.   AIG was too large of an insurance company to allow to fail, but at least the Fed didn’t outright bail them out.  They gave AIG an $85 billion loan.

We really saw the impact of the credit crisis in the market today, again due to speculators.  Speculators hammered Lehman with short sells, making their stock price plummet.  Their 52 week high was $67.73; it’s now trading after hours for $0.128.  A lot of people lost money, speculators made a lot of money, and other IBanks are now getting beat up because they were essentially offering themselves as leverage and the market is operating in fear and distrust of all financial institutions.  In addition, The Reserve Money Market Fund closed at $0.97 yesterday because they held so much of Lehman’s paper.  For those of you who don’t know money markets, they’re a short term investment that’s viewed as cash because they’re such a safe investment.  They are expected to have a daily price of $1 and pay a small yield.  This particular Money Market was very popular because it has a higher yield (it’s riskier than most; more risk = more reward).  Other than this one, there was only 1 other money market in 1994 that ‘broke the buck’.  This has caused serious doubt in the market place and we’re going to continue to see the market decline over the next week or so.  Most likely until we see what happens with Morgan Stanley and Goldman Sachs.

Not only was McCain correct for previously saying that the fundamentals of the economy were strong, but he was also correct for changing his stance and saying the economy is in a crisis.  This is the kind of President I want, one who recognizes the strengths and weaknesses of our economy.