Brown Brothers Harriman

Housing, Mortgage-Backeds, and Banks: Our Strategic Perspective

The following address was delivered on December 1st, 2011 at the annual BBH Banking holiday dinner. It's been said that all of us in the investment business share a common gene mutation.

The financial news these days is replete with pundits bemoaning the difficulty in investing because correlations of financial assets are so high. The argument is a relatively basic one: if everything is moving together, how can an investor outperform?

Municipal bonds have long played the role of anchor tenant in the portfolios of taxable investors: they offer predictable and consistent tax-advantaged income, price stability that tempers the volatility of other securities in a portfolio, and the comfort of an asset class with a stellar record of timely payments of interest and principal.

We have recently written about ongoing adjustments in the U.S. economy in the two sectors that were largely responsible for the 2008-09 downturn and financial crisis - imbalances in the banking sector and in household balance sheets.

This commentary will not, mercifully, detail the list of woes weighing on the U.S. economy. Uncertainty is understandably high, but investors have extrapolated much of today's gloom far into the future.

Vanishing Yields: It used to be the case that a basis point seemed like an infinitesimal amount of yield. Now we are measuring yields in tenths of basis points, yet another signpost of this unusual moment in financial market history.

Navigating the Storm: Yes, we are all investing in an increasingly uncertain, complex, and volatile world. And yes, nothing suggests that certainty will regain the upper hand any time soon. Uncertainty is not new to this era.

Recent Housing Market Dynamics and Financial Sector Impacts: The bubble in U.S. housing is in a capitulation phase, with the median U.S. home price drifting downward again to equilibrate still-inflated inventories with anemic demand. The size of the dislocation is historic, spawning a worldwide financial crisis and deep recession in 2008-2009, and continued fallout today.

Plodding Along: In spite of heroic efforts by policy makers, the U.S. economy is merely plodding along at a moderate (2.0%–3.0%) pace. Unspectacular is the word that comes to mind, but that’s what happens when multi-year adjustments are still unfolding from the last cycle, serving to mute what could otherwise be a more robust cyclical expansion.