One Trillion Dollar And Counting Financial Crisis...what should average Joe do?

By Ab, ibtalk.blogspot.com

I'm assuming if you have been following the news a little bit then I don't need to explain you why we got in to this mess on Wall Street. Here are some actions that Fed and US Treasury attempted to stabilize markets and to stop the domino effect in the past months:

First, Fed and US Treasury quickly arranged the bailout of Bear Sterns by JP Morgan and guaranteed short-term credit line of $30 billion to cover any liquidity shortage associated with acquisition of Bear Sterns;

Second, Fed and US Treasury opened a credit line of $300 billion for major investment banks on Wall Street to cover their bad debts and to increase the liquidity to avoid bank runs and ease investors’ worries. Apparently that wasn’t enough!

Third, US Government bailed out Fannie Mae and Freddie Mac by taking control over two mortgage giants and taking responsibility to cover their losses from mortgage-backed securities that may reach up to $200 billion.

Fourth, US Treasury rejected Lehman Brothers request for loan at a critical time which resulted in LB’s bankruptcy and DOW plunging 500 points and even worth sell off on the world markets especially in Russian and Chinese ones. That same day it was certain that if US Governments wouldn’t act quickly and lend AIG money the company would go bankrupt and that would result in even worth crisis along the globe since AIG is the world’s largest insurance company that operates globally and has more than $1 Trillion in assets! So the next day AIG was given a whopping $85 billion two-year loan at about 11% annual rate and in exchange government became a major shareholder of the company holding about 80% of the shares. Actually this was a good business deal for government!

Last but not least, problems seamed getting worse. Even after announcement of AIG’s bailout the DOW plunged more that 400 points. It was time for government’s major intervention, the time for big actions on the part of Bush’s administration and Treasury secretary Henry Paulson – a man who had the power during this crisis that no one had before for centuries in US history.

So President’s administration came up with a plan to buy all bad debts associated with sub-prime mortgages from institutions in financial industry and the price tag they set was starting at estimated $700 billion with possibility to pay as much as $1 Trillion, yes a Trillion with a capital “T”!!!

Personally I don’t know if this is the solution for the problem. Yes, it will help banks recover sooner but the root cause of the problem is not mortgages but the people who are not able to earn enough money to pay for their homes and bills. Moreover all the money that government spent so far during this crisis was tax payers’ money and nothing in this world is free – somebody has to pay for all this and that’s going to be us, the tax payers.

Now if you take in account the National Debt that as of September 2008 was $9.7 Trillion and add all the additional costs of these bailouts and huge spending on wars in Iraq and Afghanistan then by middle of the next year we may sit at $11 Trillion easily!

And so I wonder if life of average American will improve since hugely increased government spending will require higher taxes or higher borrowing which eventually needs to be repaid either way through higher taxes or smaller government spending which I doubt will happen any time soon.

If you are average investor who already owns stocks then you are probably thinking whether you should stick to your investments or get rid of them and move to money markets. In your case I would stick with my investments since selling them at current prices is the worst thing you can do. Don’t forget that in most cases after financial crisis has happened the markets usually recover to their previous levels in one to two year period. Switching to money markets with intention to wait until markets start to recover is a bad option. You have to understand that timing the market's ups and downs on a constant basis is literally impossible thus you don’t want to be in a situation when you sell your stocks at distressed prices and buy T-bills at premium prices just to see your stock reverse and head up while your T-bills fall down. So unless you are very lucky there is imminent danger to realize huge losses.

However, if you don’t own any stocks but thinking whether you should be investing at this time or wait a bit then you should consider this option. At this moment there are plenty of high quality stocks that you can buy at prices you usually don’t get. As I said in the previous paragraph it’s impossible to time the ups and downs of the market thus you should invest only part of your savings. If after you took positions in certain stocks and their value went significantly below your purchase price then you should take a hard look at them and see if there are company specific problems or is it just a broad market effect that drove stock prices down. In case there are no company specific problems and you think the stock you own is still a good choice then you should consider additional purchases to your initial investment. This strategy allows you to use the dollar cost averaging effect meaning that average price of all your stocks will be lower thus minimizing your downside risk and maximizing your upside potential.

Remember that it’s your responsibility to determine which stocks are of a good quality and which ones are risky. Because each person has his or her own definition of good stocks I withhold my suggestions and opinion on such matter not to influence your decisions.