Thursday, October 30, 2008

Why Stock Market Jumps Discourage Investing

On Tuesday, Oct. 28, 2008, the stock market jumped about 11% in a single trading session. Good news, yes?

Well, not necessarily. Let's say you had been watching the market fall for most of the preceding week, and decided after the 300 point drop in the Dow Jones Industrial Average on Monday (Oct. 27) to start buying stocks. Your buy orders would have been executed in a rising market on Tuesday. If you have tried to buy mutual fund shares, you would have paid the closing prices for Tuesday (which could have been around 11% higher than the prices you saw Monday evening). The big jump on Tuesday might have been very costly. Most years don't provide investors with an 11% return. Anyone buying stocks or stock-based mutual funds on Tuesday could have "lost" more than a year's gain.

Everyone understands how downward volatility in the stock markets discourages investors. Upward volatility also contains traps. To some degree, you might be able to lessen this risk by buying ETFs, which can be purchased at intraday prices. But in a highly volatile market, getting an ETF order executed at the price you see one moment may be difficult if the market moves abruptly the next moment (which, these days, can easily happen). Consumers would be discouraged if the price of lettuce could rise between the time you took it down from the display case to the time you brought to the cash register. Stock investors can similarly be discouraged by a divergence between the prices they see and the prices they pay.

Much of the volatility may be attributable to big players trading the entire market, using program trading or comparable derivatives contracts. This kind of trading can run right over individual investors (see our blog at There's actually quite a bit of liquidity sitting on the sidelines right now. But the volatility of the market will encourage it to stay on the sidelines. That isn't good. Without a significant inflow of liquidity, the market cannot truly recover.

No federal intervention or bailout can directly reduce stock market volatility. The volatility is a product of the uncertainties about the financial system and the economy, and these uncertainties abound. Perhaps the various federal measures aimed at helping an ever-increasing array of institutions, companies and individuals will eventually lead to calmer markets. Then, again, perhaps the large amounts of still unrecognized losses from the mortgage crisis and the slowing of the world economy will keep the markets jumpy. Until things calm down, though, don't expect a true market recovery.

Monday, October 27, 2008

Financial Projections for This Year and Next

Here are our predictions for the near and not so near term in the world of finance.

The Federal Reserve Board will lower interest rates this week. A half-point cut to a fed funds rate of 1% seems likely, and will very possibly be coordinated with interest rate cuts by the central banks of other major nations.

It won't make much difference. The financial markets will probably rally briefly on the interest rate cut(s). Then, the now familiar credit crisis malaise will settle back in, because interest rate cuts do little to restore confidence on the part of lenders. Banks are starting to lend to other banks again, only because banks have more or less been nationalized and the government will ensure that their debts are repaid. But banks are reluctant to lend to operating businesses in the real economy, because that involves actual risk. With the large amounts of mortgage-related losses that they probably still have to write off, banks would want to hold onto whatever capital they have to offset those write-offs. Making new loans is probably a lower priority than funding the company Christmas party.

Cash will be your new best friend for the next year or two or three. They that holdeth cash sleepeth well these days. That, by itself, makes saving worthwhile. In addition, cash can be used to buy stocks and real estate when they're cheap. Cash provides a buffer in case of job loss, illness or disability. The value of cash can be eroded by inflation, and the government isn't doing anything to combat inflation. The Fed's current anti-inflation policy is to hope that the economic slowdown will constrain price increases. That might work. But economic slowdowns and inflation aren't mutually exclusive. There was a time within living memory when seemingly normal men wore leisure suits and economic stagnation co-existed with nasty inflation. There have been some signs of leisure suits making a comeback. Let's hope that stagflation doesn't come along, too. Whether or not it does, cash has replaced the home equity loan as the latest measure of prosperity. Indeed, much of the purpose of the recent bailouts of banks, brokerage firms, and money market funds is to ensure that there are safe places to keep cash besides your mattress. The government will protect your cash even if it won't prop up your stock holdings or the value of your house.

Taxes will increase. Barack Obama has been pretty straightforward on this point. John McCain won't have much choice, with all the demands of the various federal bailouts along with the wars overseas. Fortunately for both candidates, the Bush 43 tax cuts expire soon, and whoever is the next President can monkey around with "extending" those cuts in ways that effectively raise taxes from current levels. Alternative minimum tax relief, which is needed every year, provides further opportunities for increasing the flow of dollars into the Treasury under the guise of giving taxpayers a break.

The recession will get worse before it gets better. At this point, only the most Panglossian of optimists (e.g., the members of the Board of Governors of the Federal Reserve System) don't see a stomach churner of a recession coming. The economic crisis has gone global. Nations from Iceland to the Ukraine to Pakistan to Hong Kong (which is part of China) are struggling. Even Kuwait, which by numerous measures is a wealthy place, has instituted bank deposit guarantees and bailed out a bank. There won't be any great safe haven overseas for your investment dollars. Even Switzerland, long time bastion of stability, recently infused capital into one of its major banks, UBS. Sovereign wealth funds won't be a source of succor, not with the price of oil falling by more than half in a couple of months. There are storm clouds in every direction and they all seem to be blowing toward us.

Eventually, things will get better. They always have, and that's a reason to think that they will again. Both the stock market and real estate market will find their way out of the abyss. But it's hard to see a quick recovery. Meanwhile, keep in mind the possibility of buying stocks and real estate when they are cheap. It's not clear that you should be buying now. Take your own counsel on that question. But buying low and selling high is probably a strategy you can implement beginning some time in the next year or two.

Friday, October 24, 2008

Reforming the Credit Rating Process

Recent news accounts report that employees at certain credit rating agencies sometimes knew that some of the deals they were evaluating were pigs without lipstick, and questioned the wisdom of rating them. The fact that the credit rating agencies are typically compensated by the issuers of the debt they are rating, instead of by investors, fuels concerns over potential conflicts of interest. Since many mortgage-backed securities that initially received AAA-quality ratings have since been downgraded for reasons that may have been foreseeable, the integrity of the credit rating process has become intensely important. This is particularly so since many institutional investors are required by law to rely on credit ratings with respect to some of the investments they can make.

Probably the greatest concern is the way the credit rating agencies are compensated. When you're paid by the person you're evaluating, how objective can you be? No matter how many rules and procedures are in place, will the credit rating agencies ever be willing to bite the hand that feeds them?

It would be much cleaner to have the rating agency funded by investors. There is a large community of institutional investors--mutual fund management companies, pension funds, university endowments, and so on--that has a powerful interest in disinterested and objective ratings. They also have the money to fund a nonprofit rating organization, and the market power to demand that issuers of debt agree to ratings by nonprofit rating agency.

An investor funded credit rating agency isn't as far fetched as it may sound. The credit rating process began with investors paying the fees, and it can return to that. In the consumer products arena, an independent nonprofit, Consumer Reports, stands as the most credible evaluator. Consumer Reports does not accept advertising from the companies whose products its evaluates, and it buys those products rather take free samples. By maintaining independence from manufacturers, its credibility is enhanced. If you want to find out how much pizazz a car has, you can read an ordinary car magazine. But if you want to find out the hard facts about how reliable a car is, you're better off reading Consumer Reports.

The established credit rating agencies are for profit organizations. Don't look for them to convert into nonprofit do-gooders. The buyside community (i.e., investors) will have to take the initiative to establish a new rating agency. Doing so may seem to involve a lot of work and expense. But, perhaps institutional investors could tally up their losses in the past couple of years from rated securities, and then they might see what's been truly expensive.

Tuesday, October 21, 2008

Why the Stock Market Hasn't Bottomed Out Yet

Today, the stock market rose about 4% on news of a possible second government stimulus package and indications that the credit freeze is thawing as a result of various central bank interventions. Among other things, the Dow Jones Industrial Average briskly rose 411 points. This is a perfect example of the state of today's stock market. The market rises only when governmental action is promised or taken. All other news seems to make the market droop or drop. The market has become all government, all the time.

That's why stocks haven't hit bottom. Economic and other nongovernmental forces would push them lower, but government intervention props them up, at least momentarily. Ultimately, all the governments in the world can't fight the market. Economic and financial realities will overcome government policies. Look at the histories of the Soviet Union and People's Republic of China for examples.

With a presidential election campaign in full swing, Pennsylvania Avenue has supplanted Wall Street as the center of the world financial system, and will continue to dominate for a while. But you can't legislate away the business cycle (nor can Wall Street's overly confident financial engineers eliminate it). As we've discussed in our two preceding blogs, the government has focused almost obsessively on the financial crisis and isn't doing enough to resuscitate the real economy. That will be costly down line, when we need economic recovery to complete the revival of the financial system. Don't pin too much hope on a second stimulus package. The first one, the tax rebate paid earlier this year, did little except briefly delay the economy's slide into recession. There's little reason to think that a second bite at the apple will be much different. With the real economy still headed downward, the stock market will have little choice but to follow. Expect turbulent waters in the financial markets for a while.

Sunday, October 19, 2008

Dealing with the Economic Crisis: Get Foreigners to Buy American

As a debtor nation entering a potentially severe recession, the United States has to figure out how to repay its debts. Foreigners won't finance America indefinitely, especially as its economy slows down. For now, with the dollar continuing to serve as the world's reserve currency, foreign sources of capital have little choice but to keep the U.S. afloat. However, relying on being the provider of the world's reserve currency isn't a sound long term economic strategy. In the early part of the 20th century, the British pound was the world's reserve currency. But fighting two world wars required an enormous amount of debt, making Britain's balance sheet, circa 1945 look seriously subprime (kinda the way America's balance sheet looks today). America's forgiveness of Britain's Lend Lease debt did much to help keep the U.K. afloat, although by then the dollar had gained ascendancy over the pound. However, the U.S. cannot expect any of its current creditors to be so generous. America will have to work its way out of its problems.

Getting foreigners to finance America requires that there be something here they want to spend their dollars on. In the past few years, that's consisted to a large degree of mortgage-backed securities and derivatives, a market that has now seriously dried up. For the moment, foreigners are buying lots of U.S. Treasury securities, as safe havens from the worldwide financial crisis. But that crisis will eventually be resolved, primarily through governmental action. Then, investor demand for U.S. Treasuries will drop, and interest rates on them (and all other debt in the U.S.) will rise. With the regulatory mess in the U.S. financial markets, it's likely that foreign investors will be cautious for years about buying anything other than plain vanilla American financial products like stocks and bonds.

Thus, in order to get foreigners to want to hold dollars and dollar denominated assets, increasing U.S. exports becomes critically important. The government should promote U.S. products in a way that plays to American strengths. The U.S. can't compete in the market for sheet steel or DVD players. But it can compete in the commercial aircraft market, the market for movies, television shows and other entertainment products, the sale and/or licensing of high tech products and processes, and the sale of agricultural products. America is creative and innovative, possessing enormous amounts of intellectual property, and has vast agricultural resources. Exploiting American economic strengths in foreign markets would increase real demand for dollars (as opposed to unpredictable short term flows in the capital markets), while strengthening the real economy.

The government continues to obsess over Wall Street and the financial crisis. President Bush and other world leaders have announced their intention to hold a summit after the presidential election this November, to discuss ways to improve the world financial system. That's nice, but it's more reactive politicking in response to news headlines. With the recession appearing ever more likely to be nasty, the government should focus more on buttressing the real economy. The financial system won't truly recover if the real economy slides into the doldrums. Getting foreigners to buy American will strengthen the real economy, and in turn, the financial system.

Wednesday, October 15, 2008

Enough for the Financial Crisis. Now Let's Focus on the Economic Crisis.

Easy come, easy go. The stock market dropped about 8% today, two days after leaders of all the major nations of the world pledged coordinated action to deal with financial crisis. The Dow Jones Industrial Average today finished just about 1% above where it closed last Friday, before the announcement of coordinated international action. The S&P 500 and the Nasdaq indexes are lower than where they closed last Friday. So much for the effectiveness of government action in stopping the stock market slide. As has happened so many times before, each announcement of a new government initiative produces a temporary sugar high, to be followed by a sickening drop.

The truth is that no government action will stabilize the stock markets now. The reasons for the credit crunch are too large and complex for a quick solution. The root cause--the largest morass ever in the mortgage markets--will require years for recovery. The derivatives market added layers of complexity to the mortgage problems, and the convoluted liabilities it created will take years to sort out. The Federal Reserve's and U.S. Treasury's tools for addressing the credit crunch don't, for the most part, fix the underlying problems. They are life support measures, meant to maintain some sort of pulse at the heart of the financial system until the underlying problems work themselves out. Fed Chairman Bernanke said today that the government has the tools it needs to address the credit crunch, and that now he needs time.

Time is what stock market investors don't want to risk. With the way things are going, stocks could drop how much more tomorrow? If it was 8% today, is there any limit for tomorrow? (Okay, the New York Stock Exchange closes if the market drops 3350 points, or 2200 points after 2:00 p.m., and you get a trading halt for an hour or maybe just a half hour if the market drops 1100 points before 2:30 p.m.; but how much comfort is all that?) Much of the selling today is driven by fear, and there is no way to know when that fear will subside. This is the fear of the unknown. The financial markets have become so complex that Wall Street executives and government regulators don't understand them. The average investor, who probably has trouble figuring out how to manage a 401(k), can be forgiven for viewing all this as little more than witchcraft. It's no wonder that so many of them prefer to sell stocks and hold cash than continue to dabble in witchcraft.

Even the smart money is taking a breather. Prominent hedge fund managers are reportedly selling their stockholdings and sitting on their cash. They can't understand what's going on, and choose not to invest when they can't invest intelligently. That point explains, among other things, why Secretary Paulson's decision to let Lehman Brothers go under created so much havoc. Paulson reportedly decided to not to save Lehman because its exposures to the rest of the financial markets were relatively limited, and he wanted to make a point about people--even senior executives on Wall Street--being held responsible for the risks they took. Abstractly speaking, that's a good reason for not bailing out Lehman. But the problem was that no one else in the world has the level of information that Secretary Paulson has. He knows enough about each major bank that he can decide which needs to be saved and which can be allowed to fail. No one else, though, knows what Paulson knows and is thinking. Therefore, it is logical that no one would want to lend to the large banks. Interbank lending today is sensible only if you can get inside Hank Paulson's head and see who will get a thumbs up and who will get a thumbs down. Otherwise, better to sit on your cash. The credit freeze is not based on fear or panic; it's actually quite understandable.

To get around this problem, the Treasury Department revived the Selective Service System and drafted a number of large banks for national service. They were told they would be receiving federal infusions of capital and would give the federal government preferred stock. They were told they would lend out the money they received and couldn't hoard it. They were informed that limitations on executive compensation would be imposed on them. They were told they all would participate; any resistance to induction was swiftly quashed (maybe after one or two were ordered to do some push-ups).

Oddly, perhaps, in this hour of financial socialism, we can see a way to softening the impact of the recession (the one we all know is coming but which the Federal Reserve resolutely avoids acknowledging). Federal capital infusions should be made in regional and local banks, the ones that finance small businesses, farmers and other independently employed persons. The small business sector is a vital part of the economy, employing about a third of all employees and typically creating more jobs than big business. Small businesses are vulnerable to credit crunches, often having fewer resources than large companies. Money pumped into the big, money center banks may not wend its way to Elm Drive in Middletown, U.S.A. Much has been done to protect Wall Street, and the Federal Reserve has all the tools it needs. More must be done now to protect the real economy. Regional and local banks are a good pipeline of funding for small business. They also make a fair number of mortgage loans (with real credit standards, so there's a chance the loans will be repaid). It would be prudent to diversify the bailouts and send some money to Main Street. Who knows: a recovery in the real economy could help revive the real estate market and lift some of the storm clouds over Wall Street.

Monday, October 13, 2008

The Financial Crisis: Risks of Investing in Government Policy

After a weekend of solemn pronouncements of vigorous, coordinated action by numerous governments around the globe, stock markets everywhere rediscovered exuberance. The Dow Jones Industrial Average was among the most joyous, rising 936 points, or 11%, today. That was the Dow's largest point gain in a single day ever. The S&P 500 and the Nasdaq were similarly rapturous. Problems solved?

Hardly. The government pronouncements were long on apparent sincerity, but short on specifics. It helps, at least momentarily, that all these national leaders linked hands and sang Kumbaya. The One World, interconnected nature of the world's financial system today necessitates joint action. No nation can go it alone.

However, it is also clear that each nation will choose its own policies and protective measures. The argument here is that each nation's financial system is different from others, and its policies should be tailored to its specific needs. That sounds good. But underneath, it reflects a desire not to subsidize another nation's bailouts. This Balkanization of bailout policies may undercut the recent pledges of international coordination. There are differences of opinion among the world's economic powers as to which policies are best. For example, unlimited deposit guarantees in one country could attract badly needed liquidity from other nations' banks. When there's a credit crunch on (and there still is), that triggers international resentment. The same could be said of proposals to inject government capital into ailing banks. When one nation's banking system is backed by its government, its apparent strength would be improved and it would attract credit away from banks in other nations. Thus, the other nations are forced to inject government capital themselves; they can't wait to see if other measures might lead to private sector recapitalization of their banks. This may well be what's happening to the U.S. government's $700 billion bailout plan. The proposal for the government to buy toxic assets is taking a back seat to a plan for direct U.S. government investments in the largest American banks, which they won't have the option to decline.

The truth is that all of the governments involved in the financial crisis are winging it, scribbling out policy measures on cocktail napkins as they go along. After a year and a half of turmoil, we still don't have anything approaching a clear picture of the losses from the mortgage mess and other problem areas. One suspects that the governments themselves don't know where all the bodies are buried. That, if true, is deeply troubling. You can't make good policy if you don't understand the scope of the problem.

By all appearances, the policies announced in the last few days only amount to a large injection of methadone. They focus on loosening up the flow of credit, which is kind of like a taste of the hair of the dog that bit ya. The stock market's exuberance is likely to be a temporary high, because the underlying problems remain. The world's financial system doesn't merely need to be recapitalized. It needs to be reconstituted, with the bad assets writedown fully. A new, more extensive and effective regulatory scheme must be instituted. Bankers must adopt an ethic of prudence and responsibility, not recklessness tempered with greed. Government regulators must adopt an ethic of vigilance, not somnolence.

Has the market bottomed? Should you start buying stocks again? There's no way to tell based on traditional criteria. We're in a brave new world where stock values are determined by that most unpredictable of factors: politics. The financial markets are being nationalized worldwide, not excluding the United States. How effective this will be remains to be seen. The slowdown in the real economy has been virtually ignored by government policymakers. That slowdown--surely a recession even if it hasn't been officially acknowledged as such--and the eventual recovery from it will dictate the timing and pace of the stock market's true revival. By the time policy makers figure out that they need to stop being mesmerized by the gyrations of the Dow, you'll probably know that today's action was just a dead cat bounce.

Thursday, October 9, 2008

Why the Stock Market is Crashing and How to Recapitalize the Banks

Today, the Dow Jones Industrial Average fell 7%. It's fallen for seven straight trading days now, for a total drop of 21%. This is a market crash. Wall Streeters would euphemistically would call it a "market break." But if it walks like a crash, squawks like a crash, and looks like a crash, we'd better face the fact that it is a crash.

Although there are many cross-currents in the market, there is an overriding reason for the crash. Our leaders in finance and government prepared us very poorly for this moment. For way too long, Wall Streeters demanded palliatives from the government that would make all the boos boos of the mortgage crisis go away. Government leaders, in turn, acted as if that was their intention. The Fed was creative and the Treasury Department was aggressive. Interest rates were lowered. New programs were devised and implemented. Federal loans became available to new classes of borrowers. Rarely, if ever, was anyone heard to suggest that a blissful fix, with no losses or pain to anyone, wouldn't be possible. We seemed to be in a world where six impossible things could be accomplished before breakfast, and the government could protect the values of all assets and investments.

Thus, when bailout after bailout produced only falling stock prices, newer and bigger bailouts, and an internationalization of the credit crunch, investor confidence was not simply shaken, but shattered. As stocks kept falling, some of those who were previously calm have joined in the selling, creating more sell pressure that further depressed stock prices and triggered more selling. There have been waves and waves of selling, because hope, so assiduously cultivated by corporate and government leaders intent on discouraging runs on the banks, is gone. No one knows how bad things will get and everyone simply wants out.

There is no way to predict when the market will bottom out. We're dealing with panic, and irrationality cannot be quantified. Nor can we predict when things will settle down. We can only know the fear and panic will eventually subside. They did before, in 1987 and in the 1970s, both times when the market fell sharply. They did in the 1930s, when the stock market fell 85% before taking the road to gradual recovering.

Let us remember, though, that the unwillingness of our corporate and government leaders to level with us about how bad things could get is much of the reason for today's panic. Of course, they were trying to maintain confidence, the key to all financial dealings. But unwarranted optimism will be eventually belied by the truth, and nothing undermines confidence as much as unexpected, unpleasant surprises. This market crash is what results when undue hope is allowed to triumph over knowledge of the truth.

Now, on to the truth. One can reasonably infer that the industrialized world's banking system is effectively insolvent. Maybe some institutions are individually strong, but the system as a whole is broke. Bank regulators haven't admitted this, but it's obvious from their conduct. Government officials worldwide are taking extreme measures to administer financial CPR, and every week comes with a new program or proposal. One of the most recent ideas is for the government to make direct investments in distressed banks. This nationalization of the banking system (let's not pretend that it's anything else) isn't a bad idea. For every dollar of capital invested in a bank, it can reasonably make ten dollars of loans. That ten for one ratio is a pretty good bang for the buck. Purchasing toxic assets (i.e., the heart of the $700 billion bailout program enacted by Congress), would probably free up less lending power for each federal dollar spent.

But federal investments in banks should come with a demand for housecleaning writeoffs of the toxic mortgage-related assets and derivatives that have been bedeviling the banks and tying up their capital. The most important reason for the credit crunch is that banks seeking to borrow from the private sector haven't been transparent enough about their balance sheets to inspire lender confidence. That's why the federal government has thrown a lot of liquidity at the financial system, with little tangible benefit. No one wants to lend, even if they have the money, when they can't discern the borrower's ability to repay the debt.

By way of analogy, consider whether you could get a loan from a bank without telling the bank about your other debts and liabilities. Maybe a few years ago, you'd have gotten a liar loan with a teaser rate. But now, you couldn't hope to get a loan without spelling out your financial condition and circumstances to the nth degree. Many large banks are still trying to borrow in the interbank market without being candid about their potential losses from mortgage-related assets and derivatives. It should hardly be surprising that they get the brushoff.

Time to come clean. Clarity and transparency are crucial to inspiring lender confidence, and writeoffs are essential to cleaning up borrower balance sheets. The price of federal capital should be full disclosure of the toxicity in the recipient bank's balance sheet. Moreover, the values of the nasty assets should be written down to amounts determined through prudent and conservative application of the relevant accounting principles. No smiley-face interpretations of the mark-to-market rules should be allowed. This trip by the banks to the woodshed may reveal that they're actually insolvent. So be it. We know that anyway and no amount of relaxation of the accounting rules will fool investors into believing otherwise (banks and regulators only fool themselves if they think that changing the accounting rules now will mollify investors, who may be stupid but aren't that stupid).

Full disclosure and writedowns would likely increase the amount of federal capital needed. That's okay. We should use the process of taxpayer bailouts to cleanse the banking system and get it started on the road to health. Simply burying the losses while giving the banks some financial methadone won't solve the problem. It will simply delay the day of reckoning. And when that day of reckoning arrives, the panicky selling that will be seen in the stock markets will make these days seem like a walk in the park.

Monday, October 6, 2008

The Financial Crisis Goes Global While Solutions Evaporate

Bank bailouts are all the rage in Europe these days, with Germany, the United Kingdom, Belgium, the Netherlands, Luxembourg, Ireland and even Iceland getting into the act. The U.S. Federal Reserve has gone global, lending dollars to European central banks that are re-loaned to credit crunched European banks. The stock market is having a hissy fit, dropping to levels first attained in 1999. In other words, if you bought stocks in 1999 and held them until now, you'd have gone nowhere. Indeed, you'd have lost money because of inflation.

The Federal Reserve has become the de facto central bank for the rest of the world. It is backed up by a line of credit from the U.S. Treasury, and in the worst case scenario, could literally print money. News reports indicate that the Fed is considering buying commercial paper, short term unsecured debt issued by financial firms, businesses and municipalities. This is the kind of debt used to meet payrolls and pay suppliers. Without it, commerce grinds to a halt. Even some governments may grind to a halt. Two states, California and Massachusetts, have requested loans from the federal government because they are having trouble selling short term debt.

To meet all these needs, especially those of the multi-trillion dollar commercial paper market, the Fed will have to print money. Foreign investors, the only people with serious amounts of excess cash, won't lend enough additional money to the U.S., not after the losses they've already taken. If the U.S. offered really high interest rates to borrow more, it would trigger losses in the existing dollar-denominated portfolios of foreign investors. (Recall Bond Investing 101: a marketwide rise in interest rates causes existing bondholdings to drop in value.) The more the U.S. tries to borrow, it more it damages the portfolios of the people it's trying to borrow from.

But printing money triggers inflation. Even though oil prices have been pulling back, they remain very high by historical standards. And food prices keep rising. Printed money will only make things worse. Profligacy in the real estate and mortgage markets turned out to be a bad idea. Profligacy in the money markets, even if seemingly necessary for the sake of expediency, won't turn out any better. Not in the long run.

None of the various governmental bailouts in the U.S. or Europe have accomplished much, and the U.S. Treasury can't do much more. The failure of last week's $700 billion bailout to stabilize the stock market for even one day (there was a 369 point drop in the Dow on Monday, Oct. 5, 2008, the next trading day after the bailout was enacted; there's gratitude for you) has destroyed the Bush Administration's credibility. Secretary Paulson can't go back to Congress and ask for hundreds of billions or trillions more. Not when he doesn't have a track record of getting the job done.

There is talk of a bailout organized by European nations. And of a coordinated interest rate cut by all the major central banks. These things might happen. But it seems doubtful that they'll make much difference. The problem is that there remain perhaps several trillion dollars and Euros of losses emanating from bad real estate loans, and these losses must be taken by someone somewhere--banks, investors, taxpayers, somebody. They won't magically disappear, regardless of how much governments do. The $700 billion bailout may eventually help absorb some of these losses. But it won't solve the problem by itself. Tread cautiously in the stock markets, and keep some cash in the cookie jar. Many unknowns remain ahead.

Friday, October 3, 2008

Protecting Yourself in a Time of Bailouts

After a week of failure, angst, bad press coverage, arm twisting, and pork barrel rolling, Congress finally passed the Bush Administration's $700 billion bank bailout bill. The President signed it into law in less than a New York minute. The stock market, which had swooned when the House rejected the bailout early in the week, got giddy while the voting was under way but then pouted when all was said and done, closing down 1.5%. It seems that the market doesn't think the bailout bill went far enough. Let's face it: $700 billion just isn't what it used to be.

If you've been trying to make heads or tails of the stock market in recent weeks, chances are you haven't had much luck. The Dow Jones Industrial Average has recently moved three digits a day almost every day. Antacid sales are about the only thing going up.

The problem is that your investments aren't just subject to market forces. They're now subject to political forces. Market forces are tough enough to predict. Political forces are, on good days, arbitrary, capricious, warped, perverted, unfair, rife with favoritism and cynical payoffs, and entirely unpredictable. In the last year, the Federal Reserve and Treasury Department have gone a long way toward socializing the financial services sector, and the downturn in the market perhaps reflects the long term prospects for such socialism. At the end of the trading day today, there were calls for more government bailouts. Not that the government call afford more, but there will probably be plenty of bailout talk from both parties that will further bedevil your personal finances.

Today's market action demonstrates that there are limits to what government bailouts can do for you. If there ever were a time to take responsibility for your finances, now is it. Ask what can you do for yourself. Here are some suggestions.

Cash. Cash is your new best friend. Save more, not only to cover personal expenses in case of a job loss, but also to let you dive into the stock market if prices reach a level you consider attractive. Make sure your cash is in federally insured bank accounts ($100,000 per account and $250,000 for an IRA; these levels may rise as a result of today's bailout bill), or in a money market fund that invests only in U.S. Treasury securities.

Creditworthiness. Be a good borrower and repay your debts on time. Build your credit rating. Good borrowers get advantageous rates these days. Bad borrowers are foreclosed on. Get your free annual credit report (at and read it carefully to make sure your credit history is accurate. See that mistakes are corrected.

Health Insurance. Health insurance is very important, especially when times are tough. Economic stress can increase health risks, and a major health problem can blow up your weakened finances in a big way. If you lose your job, continue your health benefits through your COBRA rights. Whatever you do, don't forego health insurance coverage.

Diversify your investments. With the unpredictability of political forces now bruising your investment portfolio, diversification of assets is probably a sounder strategy than ever. There's almost no way to know what direction the pork barrel will roll or when. If you don't already have a piece of the action, you will miss the handout. And, at least in the near term, government handouts may be more lucrative than market forces.