By Doug Fehr, CFA, Director of Investment Research, Securities America
The nine most terrifying words in the English language are, 'I'm from the government and I'm here to help.
Ronald Reagan, 40th U.S. President (1911 - 2004)
It is a unique time in history when the financial markets are now depending on the U.S. government for help. Nevertheless, markets plunged Monday, Sept. 29, as the House rejected, by a vote of 228 to 205, the $700 billion measure to authorize the biggest government intervention ever. The Dow Jones Industrial Average Index fell 7%, which measures in the top 20 daily losses on a percentage basis. This decline in market value was almost twice the stated explicit cost of the government s plan, almost $1.3 trillion. Democrats voted 140 to 95 in favor of the legislation, while just 65 Republicans backed the bill and 133 opposed it. At mid-week, however, markets are again hoping for passage of a revised bill when it returns to the House, at the earliest on Thursday, Oct. 2. In the interim, the Senate is scheduled to vote on a revised bill as early as Wednesday afternoon.
One reason for these extreme times, it has been said, is that banks are worried that they won't be repaid by counterparties " i.e., other banks! This drives up the cost of short-term loans between banks. Some banks base their lending on the overnight London interbank offered rate (LIBOR). LIBOR spiked to 6.88% annualized, from 2.57%, on this historic Monday. If banks won t lend to other banks, how can we expect them to lend to viable businesses and credit worthy consumers? Clearly, the banking system needs more confidence to lend, whether by bailout or other measures. If the government doesn t pass a broad relief act, other measures may mean that we witness the market continuing its attempt to find a natural bottom. At which time, asset prices will be appropriately priced for the risks they carry and expected returns.
But are these times really that extreme? The answer may be different depending on what part of the country you live in or where you work. Over 100,000 employees in the financial services industry will stand to lose their jobs. Banks and brokers have already suffered $586 billion in credit losses and write-downs since the mortgage crisis began a year ago. If the credit crisis hasn t been felt in your hometown yet, it s probably coming. In the Wall Street-to-Main Street effect, less capital means fewer loans for solid businesses and reputable citizens in our hometowns. This is the main reason we need additional liquidity in the entire financial system.
In recent polls, the majority of Americans are against bailing out Wall Street, as the popular press has labeled these events. Those who understand the proposed bill know that the bailout package is mislabeled. It s really a buy-in. Using the massive financial capacity of the U.S. Treasury (the only entity worldwide with this ability), the government has proposed to begin buying the distressed debt, probably through an auction-type procedure. In a process similar to Flip That House, the government will Flip That Mortgage. Some debts will be just fine, and some will require a work-out; either way there is underlying value in those debts that will, we hope, incent private sector buyers to also purchase these distressed debts. After all, profit loves company.
But what if the bailout doesn t come? Some very prominent investors aren t waiting around and view this as one of the greatest buying opportunities of our lifetimes. Among those buying are Warren Buffett, JP Morgan, Bank of America and Citigroup. They did this prior to and without guarantee of any financial industry bailout by the U.S. government. These investors know that the financial services industry will exist in some form and be profitable five, 10 or 20 years from now, even as next year is not so clear.
On another positive note, other aspects of the economy are still moving forward. Excluding housing and autos, which account for only 7% of GDP, through the second quarter, GDP has grown by 3.8%. Housing and autos are down 16% in the second quarter. Simply put, most of the economy has weathered the housing and credit-related storm in decent shape, at least through the middle of the year. Productivity is still booming, as are exports. Tax rates have not been hiked, yet, and oil prices are under $100 per barrel. It is my belief that any economic problems that the U.S. faces in the next year should be temporary and contained. And, recall that financial markets will rebound long before we again start recording positive growth in the economy.
As long term investors, there is little we can do to recover short-term losses. But failing to take risks where appropriate is a long-term loss we can certainly avoid. Working closely with a professional advisor in these uncertain times can help clients better understand what s happening in the economy and help them make informed, prudent decisions.
Please note that the opinions expressed here are those of Doug Fehr, Director of Investment Research, Securities America Advisors, and should not be construed as investment advice and are subject to change with market conditions. All economic and performance information is historical and does not guarantee future results. Data come from the U.S. Bureau of Economic Analysis, The Federal Reserve, Standard and Poors, WSJ.com, and New York Times and are current as of October 01, 2008.
Lawrence D. Sprung, CFP
Mitlin Financial, Inc.
Securities offered through securities America, Inc., Member FINRA/SIPC and Advisory services offered through Securities America Advisors, Inc., Lawrence D. Sprung representative.
Lawrence D. Sprung- Mitlin Financial, Inc. and Securities America are unaffiliated.
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