Wednesday, September 17, 2008


Given that we’re in the midst of a presidential election, even more fingers will be pointed and more mud will be slung trying to blame who’s at fault. But, the bottom line is, it’s not mainly the Democrats nor mainly the Republicans. Rather, the fault for the current mortgage crises/financial meltdown lies at the feet of both parties.

In 1999, Republicans in Congress pushed a law allowing brokerage companies/“investment banks” or other financial institutions, like Lehman Brothers, Bear Stearns, etc., to expand their presence in the investment industry, without the safeguards – i.e. regulations – that are required of commercial banks. And the then Democratic President – Bill Clinton, signed it. These regulations – thrown by the wayside – were put in place during the Great Depression, to prevent situations just like those that are happening today from happening! As a result, the investment bankers/financial institutions, now freed of most needed safeguards/regulations, got, for the most part, greedy (and were either ignorant of or ignored the colossal risks they were taking). The result – the credit crisis/financial meltdown we’re seeing now.

To make an analogy, think of the financial industry as an airline. Arguably, it’s OK to de-regulate the airline industry, from the standpoint of competition (who offers which and how many routes, who charges lower fares, etc., in the hopes of attracting more customers and making more money). If an airline fails due to bad marketing mistakes/excess risks, people get hurt (workers, investors in the company, etc.) but the public, by in large, isn’t – they just choose another airline. But to de-regulate the airline industry from the standpoint of safety, (allowing them to try and make more money by cutting back on well established safety standards and drastically cut back on FAA safety regulations and oversight, would clearly be ludicrous. If an airline was free to set its own safety standards, than many many more planes would crash, the flying public (not to mention those on the ground) would be in very unsafe, and the airline industry would be in danger of screeching to a halt.

Well, that’s what the deregulation of the investment industry in 1999 has almost led to. It removed the safeguards and regulations controlling investment bankers/financial institutions like Lehman Brothers, Merrill Lynch, AIG Et. Al. and let them, in effect, regulate themselves. The result – greed and ignorance took over in far too many cases, and these financial institutions began loosing altitude, fast, and were in grave danger of falling out of the sky, which very likely would have caused a very large portion of the entire economy to screech to a halt. Which is why the U.S. Treasury and the Federal Reserve have stepped in. Just as jumbo jets can’t be allowed to fall out of the sky, so too can’t jumbo financial institutions be allowed to crash.

What’s all this mean going forward? Well, first, the Feds will continue to bail out those companies –“the jumbo jets” – who are simply to large to fail and crash (such as Bear Stearns, AIG, Fannie Mae, Freddie Mac and other companies whose failure could undermine much of the overall economy. Smaller “planes” – Lehman Brothers, for example – will be allowed to fail, if necessary, since their “crash”, while extremely painful to workers and shareholders of those companies, won’t undermine the entire economy. Unfair? Quite possibly. The correct steps to take, especially given the financial realities facing the economy today? Most definitely.

A few more questions, and answers. Can the present administration “fix” the current problem? No. Certainly, they can take steps (like bailing out Bear Stearns, AIG, Fannie Mae and Freddie Mac) to prevent the economy from collapsing and the situation from getting worse. But, due to the de-regulation alluded to back in 1999, ‘the horse has already left the barn’, and we (the American public) are going to have to ride this recession (yes, folks, we’re in a recession) out, and wait for the economy to recover (best guess – at best, but unlikely, maybe one year; 2-3 years, much more likely). Not to mention, pay the bill (in higher taxes) for all of these Federal bailouts. Luckily, despite the “Chicken Little” predictions of far too many pundits and far far too much of the mainstream media, the U.S. economy is, at its core, strong enough to weather this storm, and recover (although, it will be a difficult ride).

How do we know such re-regulation will work (to prevent this happening again)? Because, the evidence is right in front of us. Large commercial banks, who were not (for the most part) completely de-regulated by the 1999 law, have weathered this financial storm (all things considered) fairly well. Why? Because they weren’t allowed to take the extreme risks investment banks and other financial institutions were allowed to take without having enough funds to back major losses and other safeguards in place. (An example – while Bank of America – like other commercial lenders, has (like virtually everyone else), taken their lumps – because they remained, basically, highly regulated over the last 8-10 years, they’re in strong enough financial health to purchase Merrill Lynch without any backing from the Federal government. (It should be noted, the fact that purchasing Merrill Lynch likely puts Bank of America into the ‘too big to fail’ category cannot be totally discounted as one of their reasons for making the purchase.) In any event, did Bank of America like remaining so highly regulated? Almost certainly not – especially as they watched Bear Stearns, Merrill Lynch, Lehman Brothers and all the other investment banks/financial institutions making money hand over fist up until a year or so ago. But, ultimately, remaining so highly regulated served them well.

Is Treasury Secretary Henry Paulson the right man to maneuver us through this very difficult time (at least until the Bush Administration ends in early ’09)? Well, frankly, the jury is still out. But, so far, he has not been afraid to use the powers at his disposal, and take some difficult and unpopular – albeit necessary – moves (for example, again, bailing out Bear Stearns and, more importantly, Fannie Mae, Freddie Mac, and AIG). Given that Paulson is a former CEO of Goldman Sachs, the hope here is that he acts much like Joe Kennedy Sr. did when he was appointed by President Roosevelt to head the then newly established Securities and Exchange Commission in 1934 (the point being, since, like Kennedy, Paulson worked in (and, without making any accusations – at least against Paulson – knows what liberties and risks the investment industry took to get us in this mess, he also may know better than others what needs to be done to ultimately fix it.)

Can the current Presidential candidates fix the current problems? Again, no. What they can do – whoever is elected – is to go back to the regulations of the financial industry prior to 1999 (and tell the lobbyist from the financial industries who will certainly fight this, where to go) so as to prevent this from happening again.

But, are either of the Presidential candidates even talking about what needs to be done to prevent this from happening again? Frankly, no. While both now agree that re-regulation is a must, neither has put forth any comprehensive plans for the deep re-regulation of the investment/financial industry (i.e. pre- 1999 regulations) needed to prevent this from happening again.

BTW – while, as noted, they’re all pointing fingers, only two of the Presidential/Vice Presidential candidates can really claim innocence in all this, and that basically only by default. In 1999, John McCain voted for the original Senate version of the financial industry deregulation law, but then voted against the final House-Senate compromise bill. Joe Biden voted against the original Senate version of the de-regulation bill, but then voted for the final House-Senate compromise bill. Neither Barack Obama nor Sarah Palin, were in Congress at the time, so we can only conjecture how they would have voted. (A guess – like McCain and Biden, ultimately, probably along party lines.)

Finally, and maybe most importantly, how does this affect you, the middle class consumer/investor? While we may sound like a broken record, our best advice is to do, for the most part, nothing. Your bank savings are FDIC insured (to at least $100,000, and in many cases, more) and your investment portfolio is safe (not against losses, of course, but against liquidation), even if invested, for example, through Lehman Brothers. Should you check your portfolio? Yes, definitely, but once or twice a year, just like you should in all markets, up and down, and compare each investment to its peers (a fund that under performs its peers for two straight years, for example, almost always should be replaced – whatever the overall market is doing.)

But, for monies invested for the long run – a minimum of five, but hopefully 10, 15 or more years, the worst thing you can do is market time (i.e. pull your monies out of the market “until it comes back.” Trust us, it will come back, but by the time you figure out it that it has, you’ll have missed much of the recovery, which is the worst way to manage your long term investments. Think of it this way – no matter how far “down” any of your investments are, until you actually sell them, you haven’t lost anything.

Or, perhaps another analogy will put it in better context: If you buy a home, planning on living in that home for the next 20 years, if the value goes down 2 years after you buy it, are you going to sell it, simply because your “equity” in the home has gone down (for the moment)? Of course not! Same with you long term investment portfolio.