This is truly a scary time for America. Our pensions and 401Ks are being depleted faster than we thought possible. Our government is printing money like there’s no such thing as inflation. The US Treasury has injected close to $2 trillion of liquidity in the world economy with little or no effect. Bedrocks of American business like General Motors, Ford, Citigroup, AIG, and Morgan Stanley are struggling for their very survival, while others such as Lehman Brothers have simply vanished. Iceland is on the verge of bankruptcy. Equity markets are plunging. Credit markets are frozen. Our national debt and budgetary deficits are recklessly out of control. Social Security is on track for insolvency. House prices and mortgage values continue to fall.
I believed that a bailout plan was necessary to fix the years of sleeping on the job for our elected official in Washington, but I believe the jury is still out as to whether or not it will be successful. The biggest problem I see now is that the government has taken the approach that injecting liquidity is the key to jump starting the economy. I think they’re wrong: You can make all the cheap cash in the world available to a bank but if that bank is already fully leveraged, they can’t take advantage of it. Banks must maintain certain capital ratios to be considered well capitalized. If a bank had $100 in assets and $8 in capital, they are well capitalized. Now assume that $2 in assets go bad. Now that bank has $98 in assets but only $5 in capital. The bank went from a capital ratio of 8% to 5%. That bank is in dire need of more capital, not cheap money borrowed from the government. The Treasury finally announced yesterday that they are considering buying equity stakes in financial institutions. I think this is a great idea for two reasons: first, the taxpayers take a direct stake in the future upside of the institutions when the markets eventually recover, and second, this help the banks deleverage their balance sheets, thereby allowing them to make more loans.
Now on to the topic of this article: the destruction of the middle class. So far this year, the Dow is down 40%, with the S&P and Nasdaq sustaining similar losses. The middle class that has come to depend upon retirement accounts, mutual funds, and stock ownership to help build wealth has suddenly seen a decade of gains wiped out while the prices of gasoline, food, and other essentials continue remain high. Conventional wisdom has taught us to keep the majority of our assets in the markets as they will bring us about 9% annual returns over the long run. Assuming the average family had 60% of their assets in the stock market, that family has lost a quarter of its net worth. Here’s where it could get worse in the days to come: Now that the United States is printing money like inflation somehow disappeared from the equation like risk in a mortgage underwriting model and the country is stacking up debt as quickly as ever, we are on a collision course with massive dollar destruction. Currently we’re being saved by the fear of collapse of the European Union and consequently the Euro, but that won’t last forever. Asian investors are already pulling their money out of the British Pound and its valuation reflects the exodus. Eventually foreign investors, who finance most of the mortgages in this country along with a considerable portion of our other debts, will demand the United States pay more to borrow their money. Interest rates will rise and inflation will inevitably rear its ugly head. Consumers who were dependent on borrowing money for things such as home purchases and financing college education find their disposable income severely diminished by increased interest payments, preventing them from saving money. Granted, the savings rate in this country has been near zero for some time, but these events could well push it very negative. In contrast, wealthier families who have considerable stockpiles of cash will be able to loan money to the government or other institutions for considerable returns. Remember the early 1970s?
I’ve painted a pretty ominous picture here, so I’d like to leave you all with some words of wisdom, advice, and a little hope. It hurts watching stock prices decline so drastically. I personally take a little comfort in knowing that I own solid companies whose stock prices one day will again reflect the underlying value. The famed investor Barton Biggs one said when asked how to mange a portfolio through a downturn something to the effect of “sell enough so that you feel like you’re doing something.” I believe this is all that anyone can reasonably do. Like any other crisis, you must not let fear and emotions prevail, instead maintain a steady hand to guide you through. Hopefully you’ve raised some cash, and are ready to get back into the markets when the time is right. If not, this is a great time to start saving as much as possible so that you can jump when the time is right. At some point (hopefully soon) we will get an opportunity, which may only present itself once or twice in a lifetime, to purchase stocks at unbelievably low prices. In the meantime, we must all become a little more prudent with our money and try to save a little more than usual if possible. Even if you can only afford to put $50 or $100 a month into a high yield savings account like HSBC Direct, you must discipline yourself and protect your financial future. Take a minute to write to your elected officials who believe that runaway spending is a problem for future generations to deal with. We must hammer home the point that much like its citizens, America must become fiscally responsible and that the time is now, not tomorrow.
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