Thursday, October 9, 2008

My Thoughts On The Financial Meltdown

First of all, it's 5:25 a.m., Yom Kippur. I should be sleeping, and atoning, or atoning as I sleep, but I just can't right now. I have honestly been kept awake, wondering about the financial meltdown we're all experiencing. In my last post I wondered if I should comment on it here, and Anne Stesney thought she would be interested in hearing my thoughts, as I work at a financial website, and am an editor there. Anne, then, this one's for you, and anyone else who cares to read.

I have to add, though, that I am NOT a licensed financial advisor, and this is not financial advice. It is only one man's thoughts, as he considers the present, the future and things that could affect him, his family, extended or otherwise, his friends and his country.

And Anne is not the only one who's asked me about my views. I've had a few people call me and ask whether they should put their money, more or less, under the mattress. Let's see what I can come up with. So here, in no particular order, and without much linking, are my thoughts.

1. This is crazy. If you would have told me that Bear Stearns, Washington Mutual, AIG and Lehmann Brothers (which survived the Civil War AND the Great Depression) would be gone, all in one year, a year ago, I would not have believed you. Here's how little I know, about three months before Bear folded I thought of it as a stock buying opportunity. I even tried to do a trade online, but my account was too new, and it would take a few days to clear. Yes, I set up an online brokerage account specifically to buy shares in Bear Stearns. As it took a few days for the account to open, and for me to transfer my money, I thought better of it, or, more honestly, just kind of forgot about it. The lesson? I think that's pretty clear: See that grain of salt over there?

2. Having said that, I have had, as mentioned people ask me if their money is safe in their bank account. My answer is I don't know which banks will fail going forward, and I don't know if your money is safe. But, for now, I do not feel there is cause to panic, and I haven't seen a reason to think that the FDIC system would fail. The FDIC, of course, insures accounts up to $100,000, although that is probably going to rise, thanks to the bailout package, to $250,000. And if you have that much dough, you aren't quite on the firing line.

3. In my last post I talked about how the Fed's new rate cut will spur inflation. Most of the financial experts I've spoken to do not agree at all. They are more worried about deflation. Deflation is, more or less, a condition where falling prices lead to consumers waiting even longer to buy goods, thinking they will be cheaper later, and so it spirals. Deflation, to those I have spoken to, is far scarier than inflation, because it means that firms lose money over the long term, leading to massive layoffs. Leading, in the worst case scenario, to The Great Depression. Me? With oil still at $90 a barrel, or so, I could deal with a little deflation. But apparently a little goes a long way.

So the Fed's lowering of interest rates is intended to spur lending between banks, which ultimately leads to more loans for businesses, and so on. (All sorts of loans of course have basically ground to a halt, which is why they call this a credit crisis.) After the cut the business crowd cheered, although the stock market shrugged. Basically, nobody knows anything right now.

4. At a moment like this I am very glad that we, no matter how painful, have really done our best to pay off our credit cards each month. It will be very hard to get a decent loan going forward with bad credit. This is evergreen advice, but it still holds up. Maybe even more now than ever.

5. The bailout/rescue plan may or may not work, and the rate cut may not do what it's intended to do, but the investment pros I have spoken with hope that both do, especially the latter. But my feeling is that while we need to do something, I just can't see an easy way out of this mess. It took decades of neglect to create, and a housing bubble following a tech bubble to seal. There is only one way out: homes have to get cheaper.

I mean, we financial journalists write a lot about all these insane instruments: CDOs, SIVs, whatever, you name it. They all contributed to the problem, boosted a million times by too many loans, to too many people and institutions with the assumption that home prices would never fall. Which is insane. Loaners were more like loan sharks, and ignorant home buyers took loans they couldn't afford, and/or didn't bother to understand that they would in many cases reset later for more money. And everyone made silly, greedy mistakes with the mortgages. The firms sliced and diced them until these bad loans spread everywhere. (Think of it as almost like you took a turd and divided it by a thousand and mixed these divided turds with all these other pieces of turd, and then these packaged turds went around the world.)

And homeowners did dumb stuff like take a second or third mortgage, pocket the cash and go to Cancun. Or they took another mortgage to buy yet another over-priced home, because now they're "investments." They did this because homes prices were only supposed to rise. Which only made sense, because G-d isn't making any more land, right?

But, that's the past. What can clear things up going forward?

I wrote about it in the last post, but I believe this is the only answer, and, more to the point, I believe it is inevitable. Homes have to become cheaper and cheaper until they start to actually look like bargains again versus renting. Then people will start to buy them and then these toxic mortgage instruments won't look quite so bad.

It's really pretty simple. And a lot of home owners, banks and government officials who keep trying to defy this gravity will have to, sooner or later, give in. Either that or home prices have to stagnate for several years as wages increase. But, the problem is, for most Americans wages haven't been increasing. So it's one, the other, or some combination of both. But homes simply can't remain so expensive versus wages. It's insane to expect people to be perennially broke in order to pay mortgages on assets that are falling in value.

6. For a long time I thought the best way to invest was with a broad palette of stocks, in the form of index funds. They are cheap to own (in terms of annual fees), they outperformed most actively managed funds, which is probably still true, and they offered a form of safety by spreading risk over many firms. I own funds that mirror big indexes like the S&P 500, only the 500 largest firms in the U.S. It's long term average return is something like 10%. So the only way to really lose money there, long term, was if the whole economy goes kabluey.

Well, guess what?

I still think index funds are not a bad investment, at least for me, and I have confidence that sooner or later the markets will rebound. Because they always have, even taking into consideration The Great Depression.

But I've learned a few things. One is that stock index funds are not the only answer. Going forward I would like to own more bond index funds, high quality bonds that is, not junk bonds, because they offer diversification, which offers protection. Which is not surprising. The bigger surprise is that a strong mix of bond and stock index funds mostly beats the pants off just a pure stock index fund in most post-meltdown scenarios. (That link is to an article I wrote proving this. Take a moment and click it on. It might just open your eyes.)

7. Umm, don't panic? Panic is bad, and leads you to do stupid things, like putting money into oil, just before oil has a price meltdown. (I almost invested in oil about two months ago, until I had a realization: When I finally come around, and accept the fact that a trend is happening I am almost always too late. Seriously, it's like The Serchuk Doctrine.)

In other words trying to be hip and time the markets is a sucker's game. The real geniuses have already moved on to the next thing, and the next next thing. You're better off either finding one of those guys, who's had a long record of success in all markets (Warren Buffett comes to mind) or playing it safe. For example, my wife has access to a teacher's pension fund that returns almost 9%. Initially I thought, well, she won't do as well as me with my, on average, 10% returns from the S&P 500. Can I tell you how right I wasn't?

Even crazier? Many teachers she knows don't even use the pension fund, but that's their problem.

8. You will never lose money by making money or having cash. It's good to have up to six months of cash, which is kind of self evident. But the first point, while it sounds stupid, might not be. Is a certificate of deposit, as fuddy duddy as they are, really that bad a place to put your money right now? That's up for you to decide, but they aren't losing money.

9. Being a father has made me look at things a little differently. We budget better than we used to, in that we actually budget at all, and we enjoy making menus of what we want to eat in the week ahead, and sticking to it. Fewer trips to the store leads to fewer impulse purchases, leads to fewer bills. So that's been one positive thing. We also clip coupons, when we can.

But being a dad also has a fear factor with it. I pray I don't lose my job, I am less inclined to take risks with our cash than before and every day I am grateful for employment. And I try to make that evident to my employer.

I don't have much career advice to give--you guys all are in the same boat as I am--other than this. If there is a faster moving part of your company than the part you are in I would consider checking it out. If it's moving faster it probably means it's somebody's pet project, and those things are usually the last to get killed. Knock on wood.

10. I still need to curb dumb expenses. I only stopped buying lunch about three weeks ago. I should've done it a long time before. In the past month I racked up THREE parking tickets! Stupid. At times like these every $100 counts. Hey, that's groceries for a week. I need to get better at eliminating the waste.

So, there are some of my thoughts. I don't offer a lot of stock advice, because there is already so much out there, and I'm not a financial advisor. But it's important to keep things in perspective. Just because banks failed doesn't mean there won't be money. New financial institutions will arise that will be more efficient. The old ones died because their models never made any sense, and there was no way to really oversee something so massive. So if we move away from the financial mega-mart I can only see that as a good thing. Probably.

But today is the day of atonement, and I need to get my own house in order. If anyone out there has any more questions about this stuff let me know. If I don't know I will try to guide you to sources that can be trusted. You can either email me or leave a comment, and I will do my best to answer in an honest, helpful way.

May the the coming year be a happy and rewarding one for you all.


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