What can I say or what should I say when the financial markets may be facing what some have said is the worse financial crisis since the ‘Great Depression’? Do not panic! And I say it again, “Do not panic.” Making decisions when fear may have its grip on your very being is not wise.
Last week I wrote that a number of financial institutions or names have gone away or now are a lot smaller than they once were. Let’s look again. Have Merrill Lynch offices shut their doors? No. The firm lost its independence but is still operating and will be acquired by Bank of America. The name Bear Stearns may have disappeared, but those offices are still functioning and are now part of JP Morgan Chase & Co. The automakers are still producing cars as most other manufacturers in our country are still producing their goods. Construction is still taking place, food is still being delivered to the stores, banks are still cashing checks, and the list can go on and on. It is not the time to panic, but to look for opportunities.
Yes, we are facing a financial crisis, although much of it is based upon lack of confidence. In our economy, banks often loan money to each other, thus providing the very life source of our economy; credit and liquidity. Recently however, many banks are afraid to lend to others because they do not have the confidence the loan will be paid back.
Before I go too far, I need to provide an example.
My example may be simple, but I believe it will make my point. Johnson owns a large ranch free and clear, and he had two ranchers paying rent to use the property which provided his sole source of income. Everything is fine as long as he collects his rent; he can pay all of his bills and live a nice life. But now there is a hiccup. One of his tenants gives notice and leaves, and he does not have a replacement. His income is cut in half, and he does not have enough to pay his bills and meet his living expenses. His first solution is to borrow money using the ranch as collateral. In today’s financial market, few banks if any will consider the loan so he has to find another solution. Because the ranch is so large, it is not easy to sell since there are few buyers looking for that size property. To encourage a quick sell, the price of the ranch is lowered, but there are few buyers with cash, and those interested need to borrow funds to make the purchase, but no banks are willing to lend to them either. Very quickly Johnson has gone from a high net worth with no debt, to someone who needs to sell their property well below current market value to create the cash he needs to meet his expenses. While Johnson had a great balance sheet, he lacked liquidity and that resulted in his financial problems.
Many of the institutions purchased mortgage backed securities (loan packages) believing they had what should be a safe investment. These instruments were a place to invest millions and collect interest until the funds were needed elsewhere. However, due to the decline in the asset values, this did not turn out true, and the institutions wanted to sell the investment. Unfortunately, so did all of the other institutions holding similar investments. Thus few buyers existed, which in turn drove the prices down.
Time will heal this crisis. Given time, a majority of these assets will recover most if not all of their value. But in the middle of a crisis, only an institution such as our government has the time to wait. During this waiting time, new regulations will be developed to better match our current markets. Additional safe-guards will be created to prevent the reoccurrence of this crisis. But until then, confidence needs to be restored. One way is the passage of the asset repurchase plan or economic stabilization plan. Is this the best solution? I cannot answer that question. But I do know, if confidence in our system is not restored, both American and worldwide investors will suffer.
The FDIC, SEC, as well as the Federal Reserve are all taking action on their own to provide liquidity and improve confidence for the markets. Many of these actions have been welcomed. But, will they be enough without legislation? I cannot say.
To get through this time, you should create cash only to the extent you need to do so. Selling now only assures you of the loss. Evaluate each of your equity positions and see if making a change to another position will provide less risk, but potentially a greater recovery for when the markets move up. This requires time, research, as well as patience. The help of a professional can also be a worth while solution.
HOW TO REACH THE WRITER
Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville, TN 37801. Be sure to mark your envelope Money Matters.
Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.
Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member FINRA, SIPC.