Well, The Sky Has Fallen

Well, it’s happened. The financial sky has fallen. The good news is that it hasn’t crashed into the earth yet . . . it’s just fallen. And the next big question after the one that asks, “How does this affect me?” is, “What does it mean to say “the sky has fallen?’”

First of all, the little noticed headline that I read on the financial pages today was that Citigroup was purchasing Wachovia Bank. Think about this for a moment: If the sky is falling, why would one bank buy a bank that would have likely collapsed and been taken over in a few days or weeks? Well the answer is a simple one: Citigroup believes that when the dust clears, there is serious money to be made. They are following John Templeton’s advice to buy the market at the height of the Depression.

But what does it mean that the sky has fallen? Well, first and foremost the sky is the credit markets. When General Motors has to pay their payroll at the end of the week, and they look to see if they have enough and don’t, they call up the man at the money market fund and ask, “Can I borrow $338,000,000 until the end of the month when the dealerships send in their payments for the cars they bought on the 90 day net plans?” And up until most recently, the money market guy would say, “That will cost you 2.57%; okay?” And the GM guy would say, “Great. Will that money be in my account tonight or should I count on it for the morning?” This was and is a conversation that took place thousands and thousands of times each and every day the commercial paper market was open (commercial paper is how these people talk about the bonds that make up money market funds).

Over the past couple of weeks and especially after the collapse of AIG, two critical things happened that made the Treasury executives go crazy. The first was that for the first time in my 28 years in the financial world, a money market fund “broke a buck.” This means that a money market fund said it would pay money market fund holders less than the $1 it had put in. This is something worse than mortal sin. Not only do you have to go to hell forever, you also undermine the commercial paper market. Now the possibility exists that you could put money into a money market fund and not get back your full principal. Under these circumstances, getting money for short term purposes now became anything but routine. Now the possibility existed that banks would refuse to loan money to other banks and commercial paper lenders wouldn't lend money either. Without this capacity to have short term money move, you had what is generally been referred to I the press as a “liquidity crisis.”

What makes this so perilous is that without liquidity, the economy stops. Your credit card doesn’t work when you go to buy makeup at Walgreens and car loans dry up and mortgage loans dry up and payrolls get missed and stores don’t restock shelves. You’re beginning to see the chaos beginning to appear when you start multiplying this across the society and then throughout the world!

The Treasury’s response was to cobble together a plan whose design was to restore trust in the marketplace by taking away all the bad loans on the balance sheets of banks and investment companies. That way, if I now make a loan to a troubled bank, I can know with assurance that that bank is not going to go bankrupt very soon, and so, there is a good chance that I wouldn’t have to stand in line to get paid back after the bad loans get covered. It would be safe to loan money again. Why $700 billion? Because it’s a very large number…enough to convince the markets that there is no bank and any number of banks or investment houses that it could not prop up. The world would be safe again to make loans.

Well it didn’t happen again today. The markets crashed . . . that’s a fair rendering. They crashed . . . 770 points on the Dow is a crash in my book. Now the question is, “Can the sky be raised again?”

I have found myself, more than one this week, thinking about my intellectual pal and mentor, the great Creel Froman. Most people I know never heard of Creel, but I’m on a first name basis with him. He has a 3 handicap on the golf course which is pretty darn good for a California professor. Creel started his career looking at all the rules Congress uses to game the system to their needs. He eventually found himself at the University of California Davis and with the support of his department, he took time to write a series of books—eight I think so far—titled Language and Power. The main thesis of this work—all 8 books—is to establish, without any doubt, that all of reality comes into being by the application of power. Whoever gets to say what is, is, is powerful. Following me so far? So the House Republicans, by not delivering the votes they promised at the start of the day got to say, “Today, we will not pass this bill. That’s "what is so" at the end of the day.” They got to say what the is is. Yes tehre were Democrats voting "no" as well. The difference is that the Dems delivered the promised votes.

Froman also has one other message that he argues, elaborates and illustrates way past the point where it becomes an irrefutable truth: Those in power (Creel refers to these individuals simply as “Power”) use their power to insure that the “distribution of that which is most desired” always favors them. In other words, in Creel’s shorthand way of saying it, “power will always take care of power.”

In a paper I delivered to the psychotherapy community last Friday, I spoke to them about how to bring sanity to their clients’ lives. I mention it here to help you look to see what you need to do to keep yourself sane. Once again, let me again drive home the primary message I keep telling my clients: stay on purpose with your asset allocation program; balance to keep on track for your percentage in interest earning and equity investments. Also, pay attention to the things you can do something about; the amount you save, the place you live, credit or cash.

The comfort I suggested to my psychotherapy colleagues was to really get the importance of the law that power will take care of power. The sky will get propped up one way or the other. You and I may and likely will see a variety of changes that we will not like. Who do you think is going to pay for this? Power? And how will we pay for it? Nether presidential candidate in their debate wanted to even get in the same universe with the word, but you know that you can either print money and drive inflation to the moon, or you can raise taxes and put that burden on the largest tax payer group: the middle class or, more personally, your back. Guess which one is likely to happen after the election no matter who gets elected? This may have some serious implications in terms of what we might want to do in taking out IRAs and converting them to Roth IRAs as much and as soon as possible. Just a tip.

I’m in the same boat with you. I wasn’t planning on retiring any time soon anyway so that’s not big issue for me. The crisis is really about time, more than money. It is going to take time, no matter what the bailout plan ends up looking like, to get back to a time of prosperity. It will. As Froman so perfectly understands these things, power is housed in institutions and the financial institutions will be shored up, propped up, held up and made to survive and as this aircraft carrier of a global economy gets turned around in that direction again, we simply have to allow that time to unfold, doing what we can to use everything available to cover our little worlds while the Titans throw billions and billions around like so many toy cars.

Every good wish,

Michael

Origins of Our Current Crisis

Is this foresight? A regular Cassandra. Check out this blog posting I found while doing research for my next article. It's from November, 2007 by The New York Crank (that is not me). I want to say more about this later, but for now, check out the original article.

The New York Crank: How to keep the whacked-out Bush Administration's free enterprise purists from plunging us into the next Great Depression: "You are absolutely right about the very dangerous consequences of the repeal of the Glass Stiegel Act, as well as the repeal or lack of enforcement of other New Deal measures that protected our economy and consumers for the last several decades. The most recent example is the repeal in 2005 of the Public Utility Holding Company Act of 1935. These laws were passed to prevent the recurrence of economically disastrous activities of banks, utility companies and others that led to the Great Depression Over the last several years, they have been derided as antiquated statutes that strangle the economy. In reality, they were providing needed restraints on corporations that left to their own devices and driven by their own greed could destroy our present economy just as they did in 1929. This is precisely what we are witnessing today."

Anxiety on Main Street

September 16th, 2008

It’s no small thing when two of the very pillars of Western capitalism bite the dust in one weekend! It’s really a big deal and if you haven’t been paying attention, I’m here to tell you that you should. And let’s not forget that the giant insurance company, AIG is still tottering and were it to fall, we may be in territory we’ve never been in before.

Lehman Brothers has a long and venerable history. It grew to have billions and billions of dollars in assets—not the money of its clients, mind you. That money is pretty safe. But they are not too very different from banks in taking money in and using it to make more money for itself. Only brokerage companies are not supposed to commingle client funds with company funds. So when Lehman Brothers goes down the tubes, one of the really valuable assets that it has (and certainly this is also true of Merrill Lynch) is that they have retail accounts with billions and billions of dollars safely tucked away in them. This doesn’t mean that if you had a brokerage account, for example, that had only Lehman Brothers’ stock in it, you wouldn’t be in big trouble. It only means that these thousands and thousands of accounts with assets deployed in all sorts of investments are cash cows. The brokers of these accounts call their clients every day and say, in so many words, “Sell this and buy that.” And for so many ill informed clients, these recommendations are followed even while the broker has a huge conflict of interest: if he doesn’t sell and buy investments, he doesn’t get paid. So, as far as Lehman Brothers’ assets are concerned, being able to sell this “book” of client accounts is a big thing. So the first lesson here is that even though brokerage companies go down the tubes, generally speaking, your money is relatively safe.

But the real issue with Lehman Brothers’ collapse is that we now clearly know with certainty that there are still some very bad loans on the books of a variety of very large companies, like Washington Mutual Bank. What his means is that in the event of additional collapses, the average person in the street comes to the obvious, but erroneous conclusion that the entire financial system will fail. We know, historically, there have always been “unforeseen” events that arise that totally jolt the market irregularly appearing, but also regularly appearing, meaning, you don’t know exactly when or what will trigger these financial crises, but they always come along. So, Lehman Brothers’ collapse, Merrill’s sell off to the Bank of America and AIG’s pending collapse sends panic to the person on Main Street and his/her natural reaction is to grab what money is left and head for the mattress to hide in under!

What the best and brightest of my colleagues are telling their clients is to keep your focus on your existing investment strategy. What this means is that the Asset Allocation model of investing is built specifically for situations like this. We set your mix of equities (stock mutual funds) and interest earnings (CDs, corporate and government bonds and bond mutual funds) and then wait and see what the market does. It the equities market goes up (prosperity) we sell some of your equities and move them to safe interest earning accounts. If the stock markets go down, we tap into our interest earnings accounts and buy enough equities to restore our balance. This means that you are buying your stocks at a discount and selling them for a profit—the way it’s supposed to work. And the financial planner is the guy who gets to twist your arm on both sides of this structure. He or she has to convince you to sell when everything you own is going up and buy when everything is going down.

So as I approach the year end with all of my financial planning clients, as well as my own money, as we do our year-end investment strategies and tax planning meetings, is to prudently look to take some of the tax losses where appropriate for the tax benefits. At the same time, I'm planning to buy some replacement and new equity investments to bring these portfolios back into balance. So that’s it: don’t get caught up in the herd mentality here. Be disciplined; keep the long term view in mind. Do your balancing.

Here’s a nice link to a page on the New York Times that gives a healthy perspective on all of this:

http://www.nytimes.com/2008/09/16/business/yourmoney/16consumer.html?ref=business&pagewanted=print

As ever, with all good wishes,

Michael