If you, like me, are scratching your head over the last two months, I think we have a lot of company. Some sort of economic untethering has occurred as our economy groans to deleverage itself. The old school thinking was that interest rates, and federal manipulation of same through targets, discount rates and fed funds rates, could control the money supply. But recent evidence suggests that, at least on a macroeconomic level, default risk (or the perception of such risk by the underwriter) can shut down the money supply like a spigot on a leaky garden hose.
The leak in the garden hose is nothing new, of course. It just seemed like enough water was getting to the lawn to keep it green and lush. But now the underwriters at the lending institutions have discovered that, lo and behold, these loans not only have a risk of default, but the asset values that secured the loans are rapidly plunging. And we're not just talking real estate. Stuff, any stuff - stocks, bonds, oil and gas, commodities - just isn't worth what it was a few short monrth ago. And so all those rosy pro formas that projected incrementally increasing revenues over the forecasted period now don't hold up so well.
It doesn't matter what interest rates are if there is nothing worth investing in or loaning to. And consumers won't spend with unemployment steadily rising.
How did this happen? The command-and-control (economic) camp says it was a lack of regulation combined with political patronage of the 'big corporations' and so forth that supported the administration's policies. The laissez-faire camp says it was poor underwriting standards, a lack of accountability in ratings, derivatives, commercial-backed mortgages and SIVs. A lot more decentralized and a lot more people to blame. It is possible both camps are right: a whole bunch of people were on the take here. And they don't wear red or blue, either, because ignorance and greed know no political affiliation.
The economic bubble that was borrowed against our houses, against our stocks, and against our businesses, has now burst. Asset values don't support the loans. The revenue does not support the loans. America is in default.
Let's turn to microeconomics - what can I do to keep my sanity? If you are employable, and have a college degree, your net worth is not just what you have in your portfolio, but rather what you have between your ears. Unless you are over 60, the discounted present value of your future earnings probably exceeds your current net worth (balance sheet-style) by a large multiple. In other words, what you will earn from here to your retirement is a heck of a lot bigger number than what you already have in the bank.
So what's the strategy? It sounds incredibly frightening, and it probably is: buy when everyone else is selling, sell when everyone else is buying. So hard to do, so hard to choose the bottom, you say? Remember "dollar-cost averaging"? Before 1996 (when the market seemed to go up every single day for years and years in a row), this principle was used to address the issue "timing the bottom." You don't plunk down everything at once. Instead, you put a fixed dollar amount into the equity market every week (or every month). When prices are low, you end up getting more, and when prices are high (relatively), you end up buying less. Its a strategy that works when markets go both up and down, but mostly up over time.
Determine the year you will retire (e.g., 2028). Ask yourself, "will real estate, stocks and other assets be worth more in 2028 or less in 2028?" If your answer to that question is yes, then you should be happy that such assets are offered to you so cheaply today.
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