Tuesday, September 16, 2008

Surviving Bedlam

Okay, before we get to the third-party article affixed below, I would like to add just a few words for perspective...

No company ever needs nearly $100 BILLION loan to remain solvent...If AIG is trying to service that level of debt and shore up its books, by borrowing $20B from its own subsidiaries and another $75B from God knows where, then one surely cannot call this a question about financial solvency; it is, instead, a question about mismanagement and operational stability. This is, in essence, a fight by AIG to cover years of, and billions in, bad bets, and that really cannot get solved overnight. Rather, it's a matter that gets remedied in bankruptcy court and unwound in a series of major liquidations.

No one needs to panic...The fundamentals in most non-financial industry sectors of the global economy are pretty good, and we have seen this particular shakeout coming for over a year now. Does that means we can avoid a recession? Perhaps not, particularly if more financial leaders stumble, particularly in Asia and Europe, where exposure to US mortgage-backed debt is also high. There is tremendous likelihood that credit markets could tighten, and economic growth could slow, as a result of the tightening. But do take solace, insofar as, if nothing else, this race to the bottom might be a good time for rational investors to look for sweet buys in the markets.

Washington should stay on the sidelines...We are all capitalists when things are good and money is flowing. We must remain capitalists when things go sour and markets get scared. It is not in the interests of the American people, already saddled with $9.6 trillion in national debt, or of the markets, themselves, if Washington tries to prolong the inevitable consequences of our bad judgments.

The Sovereign Wealth Funds do well to sit this one out...Of course, it would be nice to have governmental investment vehicles of places like Abu Dhabi, Kuwait, or Singapore, step in to save the day, but these guys know that, if they remain silent and indifferent for a little while, ultimately, they will be able to pick up some great assets (U.S. financial firms with globally-recognizable brand names) on the cheap.

Mark-to-Market is a FRAUDULENT PRACTICE...At the core of this home-loan mess, beyond all of the questionable methods to dole out money to even subprime borrowers who did not repay it, was a financial technique that was problematic from the start. When banks made loans and then resold them as securities, the buyers had to find a way to value these collateral-back obligations on their books. Mark-to-market is a technique that, for the sake of brevity, gave these buyers an easy out, because it allowed them to formulate arbitrary calculi for factoring in the risks associated with these obligations so as to determine asset valuations on their balance sheets. The technique has no standard format, and so, no two buyers of these securities ever had a truly consistent, or even thoroughly transparent, way of valuing these assets on their balance sheets. But no one seemed to mind that fact--that is, at least, until the value of the collateral backing those securities--the residential home values--started into go freefall.

The Federal Reserve DOES NOT need to lower interest rates again...The thought that, in the wake of a Lehman bankruptcy and (potentially) a massive AIG bankruptcy, financial markets might panic and banks might cease lending has the Fed quite concerned. In fact, Ben Bernanke is already contemplating another interest-rate cut, but he should definely refrain. The Fed funds target rate already stands at a miserable 2%, and that's nothing compared to the rate of inflation in this country, which popped by 5.1%, year-to-year, during the month of July. A continuation in the lowering of interest rates, just to spur this worried economy, would actually have adverse effects, i.e., lowering the value of the dollar, and prompting investors to again seek shelter in commodities like oil (finally trading below $100) and gold and so on.

With all of this mind, while it might seem simple enough for us to consider more government bail-outs, or while we might even want to simply concede to our fears and run, we must be reminded that everything simple and easy are usually wrong. In the case of this market turmoil, that is especially true. Better that the markets have a shakeout now, however painful, than continue to fight the inevitable, and better that they calculate the losses now than foolishly hope that to refinance our way out of them, because firing good money after bad will only create larger, bad-money problems later.

Gary C. Harrell

Ten Ways to Protect Your Finances From the Crisis

As the country's financial system teeters on the brink of disaster, you need a game plan to minimize the damage.
September 15, 2008 6:29 p.m.

Here are ten things that this financial panic means for you.

1. Check that your bank accounts are federally insured. The Federal Deposit Insurance Corporation (FDIC) guarantees deposits up to $100,000 per person. If you have to hold more than that, spread it across multiple banks. As a taxpayer you are paying for this insurance. Use it.

2. Make sure your brokerage accounts are federally insured, too. The Securities Investor Protection Corporation (SIPC) guarantees you at places like Lehman Brothers, Merrill Lynch, E-Trade and the like up to $500,000, including $100,000 worth of cash. The same rules apply: If you have more to invest, spread it across multiple firms. Note: The SIPC is only there to make sure you get your shares and bonds back if a brokerage fails. It does not, obviously, guarantee those investments' value.

3. Put money in thy purse. If this market and this economy get any tougher, cash isn't just going to be king any more. It's going to be king, queen, emperor, lord high chamberlain, and the whole court - including the royal cat and crazy prince Ruprecht locked in the attic. The easiest way to make or find a buck is to save it. So take an axe to those family budgets. The restaurant meals. The Super Duper Everything Cable package. The rip-off checking account with the high fees and low interest. It's all costing you.

4. Set up a home equity line of credit while you still can. I usually don't like advising people to take on more debt, but if access to ready cash might be a life saver it's best to line it up. That's especially true if you are worried about your job. Credit is already tight, and it may get a lot tighter still.

5. Refinance your mortgage. The panic on Wall Street just caused a collapse in the interest rate on long-term US Treasury bonds, as lots of investors rushed there for safety. And that usually leads to a fall in long-term mortgage rates.

6. Stop pulling a Monty Python when it comes to your worst investments. If you ever saw John Cleese and Michael Palin perform their famous skit about the dead parrot, you know exactly what I mean. No, your Fannie Mae shares aren't "resting." They're lying at the bottom of the cage with their feet in the air. What more do you need to know? So stop waiting for them to "recover" before sorting out your portfolio.

7. Don't panic. Journalists, like markets, tend to move in herds. And by the nature of their jobs they write about the plane that crashes instead of the thousands that land safely. Remember, too, that pundits want to seem really wise by putting on serious expressions and saying things like "we don't know how this thing is going to play out," and "the situation could get a lot worse". Bah. Guess what? We never know how things are going to play out. And the situation could get a lot better too. That's the future for you.

8. When it comes to your short-term money needs, nothing has changed. Any money you might need within the next year or two should be held in cash or equivalents. That was true two years ago and it is true now. The stock market is no home for money you may need urgently. It could fall 30% or jump 30%. Nobody knows. You can get a one year CD paying 5% right now, and it's federally guaranteed.

9. If you are investing for five years or more, buy some stock. The investment outlook is much, much better today than it has been for several years, because shares are much cheaper. World markets overall have fallen 27% from last year's peak. They're not a steal at current levels but they are not particularly expensive either. Invest globally. Vanguard Total World Stock gives you the whole world and low fees. If you are looking for a value focus, Morningstar analyst Bridget Hughes likes Oakmark Global. Another good one is Tweedy, Browne's new Worldwide High Dividend Yield Value. The list is not comprehensive. Remember: I am not trying to call the bottom of the market. Things could fall quite a bit further ahead. No one knows. So only invest little, often, and broadly.

10. If you want to worry about anything, worry about your taxes. The worse this crisis gets, the more they will end up putting the taxpayer on the hook to prevent a meltdown. Taxes are going up sooner or later anyway, no matter who wins the election, because of our gigantic federal deficits. (If you think Lehman Brothers was bad, you should look at Uncle Sam). And you can forget about any talk of tax breaks. Oh, and if you want a break from worrying about taxes, worry about Treasury bonds. Deficits won't do anything good for them.

Write to Brett Arends at brett.arends@wsj.com

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