Act 1, Scene 3

Neither a borrower nor a lender be. The advice given by Polonius to Laertes in act 1, scene 3 of Hamlet is being taken by banks and consumers today.


In spite of record stimulus, banks are reluctant to lend and consumers and businesses are reluctant to borrow. Why? They there is little need for them to do so. Banks can make enough money via the carry trade. Consumers are still debt-laden. Businesses, without new demand on the horizon, do not need to borrow to expand.

Businesses rarely expand proactively preferring to see demand or at least consumer sentiment to become optimistic and stay that way for a period of time. When it comes to either expanding too soon or too late, later is usually better, or at least cheaper than sooner.

Consumer debt loads have been shrinking. According to the Wall Street Journal U.S. household debt was 122% of disposable income. Although this was down from 131% in early 2008, it is higher than the 100% seen as the highest sustainable level by most economists. With consumer debt loads still high and a lack of new products or service on which to spend (few ground-breaking, must-have big-ticket items or sectors), consumer demand will probably remain below trends to which we have become accustomed.


There has been much discussion of the possibility of a double-dip recession. Not surprisingly, these fears have been stoked by the financial media (the folks who brought you the can't miss "v"-shaped economic recovery). The double-dip is not the scenario most economists believe will play out. The more likely scenarios may be a protracted period of economic stagnation.

Nariman Behravesh, chief economist for IHS Global Insights told the Wall Street Journal:

"The risk here for a lot of countries is not a double dip but a protracted period of stagnation, which is bad news for creating jobs."

I believe Mr. Behravesh's concerns are legitimate. There should be enough economic activity in the U.S. to keep the economy in positive territory, but just. Although consumption is not necessarily a zero sum game, it is not infinite either. Any time sales are increased by stimulus programs or sale incentives we get more than sales which wouldn't have happened at all without incentives. We also get sales which would have happened at a later date moved forward (ask the Detroit automakers about this). Now we have consumers who, under normal circumstances, would have purchased vehicles and homes in 2010, 2011 or 2012 now out of the market because they have taken advantage of sweetheart incentivized deals. Not only has the ability to spend diminished the desire to do so have diminished as well.

Further slowing growth are the headwinds emanating from Washington D.C. Anti-business rhetoric does not instill confidence among business executives. Higher taxes and more restrictive labor practices have executives and business owners frightened.

Forthcoming economic polices are also helping to keep consumers on the sidelines. With debt averaging north of 120% of disposable income, consumers are reluctant to spend with the knowledge that they will have even less disposable income in the near future. One must question economic policies which will inhibit consumers' abilities to reduce debt to where it is at an acceptable ratio with disposable income. Consumers will be like a dog chasing its tail.

It is not like there are no historical precedents to which policy can refer before pulling the legislative trigger. One only need look back to the policy mistakes of the mid-1930s. At that time trade policy became more protectionist, tax rates where increased dramatically and the Fed tightened monetary policy. The rhetoric coming out of the Obama administration, tax increases and soon a more highly regulated business environment promises to slow economic recovery. The one saving grace is that Fed policy is unlikely to tighten any time soon. This will help prevent a double-dip recession.


Fed policy will also keep corporate profits high as borrowing costs will remain low and the carry trade will remain available for banks. With more restrictions on banks' ability to trade, take risk and lend, they will remain more dependent on the carry trade than the have in the past.

Individual investors are puzzled as to why corporate credit yields remain low. They are amazed that anyone will by a ten-year Verizon bond at 4.00% or a ten-year Bank of America bond at 5.00%. What they don't understand is that institutional investors determine value differently than retail investors.

Retail investors tend to view yield in absolute terms. They consider a good return and rate of return on which they can live. Institutional investors view value on a relative basis. five percent for a ten-year Bank of America bond may not thrill the hearts of mom and pop, but to an institution that 200 basis point spread over the ten-year treasury looks comparatively good. Because treasury yields are bound to remain low and because institutions will buy corporate bonds at these spread levels all day long, individual investors should reconcile themselves with this new reality and get out of cash. Laddering across the curve (overweight the 5 to 7 year "belly") of the curve is a good place to start when looking to invest in the fixed income markets. Investors should use caution when reaching for yield by investing in lower-rated bonds or far out on the yield curve. The reward may not justify the risk.

Next time I will discuss Tier-1 capital and what it means to you.