Crossroads of Depression and Free Enterprise

I'd like to hear, dear readers, your opinion of the current markets and the apparently imminent bailout. I'll admit I'm on the horns of a dilemma.

Philosophically, I'll almost always come out on the side of free markets and reduced control and spending by the government. Besides, I can't escape the feeling that things are not as bad as they are painted. I believe that prices have been driven down to an extreme, such that once the fear recedes, issues would be priced considerably higher and a good, free market bounce could occur. After all, mortgages are going for $.20 on the dollar, and I can’t believe that many mortgages will foreclose, not to mention that the residual value of properties that do foreclose should be at least 70-80 % of the mortgage value.

On the other hand, I'm not really familiar first hand with the conditions in the money market. Those who are and have the economics background to interpret what they see, for the most part, say the markets are grinding to a halt. And, at a certain point, fear begets fear, driving irrational markets to even more irrational pricing and spilling over into seemingly unrelated areas. I'm reminded of my Dad's summary of the Great Depression..."Most people had no money, and those that did were afraid to spend or invest for fear things could get worse. So, everything just ground to a halt." That sounds eerily familiar these days, although obviously that attitude is mostly on Wall Street so far, and the general economy is nowhere near those conditions. But, following the fear begets fear rationale and the tendency to spill over, it is possible to see that shaping up. And, that fear spiral is difficult for any company or individual to reverse. Perhaps that is a role of government.

Meanwhile, I can't escape the conclusion that government regulation has contributed to the situation with the "mark to market" regulations, and government encouragement of questionable borrowing. And if I’m right that the market has been driven far below rational pricing, could it be that government could not only reverse the market psychology but make a substantial profit in the deal? Ok, given usual government performance, that seems too good to be true! Even so, I’m convinced that anything that can reverse the market psychology could return us to a positive future path rather quickly and possibly avert a rather dismal period.

So, this is your chance...What say ye?

Recent Market Chaos was Predictable

The past few weeks got me thinking about some previous posts concerning the implications of debt and leverage. In particular, the following excerpt from a post in Feb 2007 has been screaming in the back of my mind:

"Borrowing to finance an investment that makes money is one way to make debt work for you. For instance, if you borrow to buy a property which has a positive cash flow the result can be very handsome profits. Keep in mind, though, that this enhanced profit is a result of the leverage resulting from the debt and the leverage works both ways. The same leverage that produces handsome profits can result in devastating losses if your assumptions turn out to be wrong."

The column went on to give a real estate example that illustrated the issue and some advice on how to avoid problems. At the time, the advice seemed almost archaic. Today it seems a bit more prescient, although I'll admit I was thinking on a personal scale rather than the macro scale so obviously applicable today. Even so, for those who are struggling to understand the markets today or a related pressure cooker, a review of those Feb 2007 posts might be worthwhile.

If you are considering debt, give the following some consideration:

• What is the worst that can happen?
• Can I afford the debt if the worst case develops?
• Are the benefits worth the risk?

If the risks are seriously evaluated and considered, most debt will not be undertaken.

If you are already in the pressure cooker:

• Accept the reality of your situation. Denial is generally the biggest barrier to recovery.
• Sell off assets to reduce debt.
• Reduce living costs to that required to clear debt in a reasonable time frame.
• For details and support, I'd recommend some time spent listening to Dave Ramsey on TV or radio.

Amazingly, the above advice seems eerily applicable to the CEOs of many financial companies making the news these days. If you are watching the stocks of those companies, be aware the damage has been done. It is too late to unload them. The good news is that, as with individuals, if they can work through the issues, life can be good on the other side.

Blood in the Streets-Time to Buy?

Apparently, I may have been watching too much CNBC. Yesterday, when my "Dollar Cost Averaging on Steroids" (see previous posts) system flashed a buy sign, I considered passing on the opportunity. After all, the talking heads were throwing out scary statements like "collapse of our financial system", "worse than the great depression" and "worldwide economic collapse". Within the past couple of weeks, the feds were forced to bail out Fannie and Freddie, and Lehman and Merrill Lynch ceased to exist as viable, independent companies. AIG seems on the brink of being the next giant to go under, with a string of others in the line behind them. Projected losses are turning from billions of dollars to trillions (with a T).

Yet, times like these are the type that financial gurus are referring to when they talk about buying when the "blood is in the streets". The adage is true precisely because it is so difficult to find buyers in times like these. Even those who use a system designed to enforce discipline may be scared off. These are among the most difficult times to stick to the system, despite the fact that this is where the money is made (Almost as difficult are times like last fall, when my system had me selling while holding a substantial amount of cash in the face of euphoria in the markets!).

So, putting faith in the system, I maintained discipline and bought yesterday. Just like I bought near the lows in July and sold near the highs in August. Of course, it doesn't always work out so nicely. I can't guarantee we are near a bottom. If the market is up next month, I'll smile smugly. If it is down, I'll grit my teeth and buy more. After all, the reason my system all but guarantees beating the market is the discipline it imposes at times like these. If you can't pull the trigger at times like these, you are doomed to underperforming the markets, as the vast majority of investors do.