Monday, July 14, 2008

MAC and MAE's Malaise

I've been getting a lot of inquiries as to my thoughts on this weekend's latest casualties in the ongoing Mortgage Crisis. If you hadn't heard, IndyMac bank, a large California mortgage lender that specialized in "Alt-A" loans has been seized by Federal Regulators. In addition, Fannie Mae and Freddie Mac, the two Government Sponsored Entities that provide a market for home loans are in trouble due to the massive amount of loans that have failed or will possibly fail in the coming months and years. Other news stories are reporting up to 150 banks may fail over the next 12 months. What is an investor to think and do?

I wrote on June 4th that I didn't believe the mortgage crisis was over, in fact that it had a ways to go, I was right, as we are now learning. The good news is that bad news is finally starting to emerge, we cannot face and solve a crisis until and unless we get the cards on the table and deal with them. I still do not believe all the cards are on the table, but I think we are getting closer.

The other good news is that despite the fact that our government essentially allowed the mortgage and housing boom to get out of hand, they seem to have accepted the fate that they are going to have to fix it. Fannie Mae (FNMA) and Freddie Mac (FHMC) will NOT be allowed to fail - if they were the consequences would be devastating (unlike Bear Stearns - which should have been allowed to fail). A failure of FNMA and FHMC would have such a colossal impact on the markets as to most likely wipe out our banking and insurance systems - a complete systemic failure that would essentially be the equivalent of a massive nuclear attack on our financial system. The government cannot and will not allow this to happen under any circumstance, it is in everyone's best interest to keep the FNMA and FHMC stable entities.

I will not get into the failures of government that allowed this to happen, its just way to much information, we can only hope they have learned their lesson (I don't believe they have). I am positive that a bailout of unimaginable proportions will occur and we will foot the bill.

For those of you who think that America has never faced anything of this magnitude I can only point you to the Savings and Loans crisis which saw about 600 S & L's fail in the 80's - taxpayers ended up bailing them out. History tends to repeat itself, yet we should hold our politicians accountable this time and not let it happen again, this potential bailout will be much larger.

As for the markets - I have no idea how this will affect the market in the short term, but I do believe the long term will be fine, as it always has been. Stocks, specifically financials have been battered, but the good news is that they are not insanely overvalued like they were during the last bear market. Stocks may go lower, I don't know, but I believe they will be higher five years from now. I don't know if the next 1,000 point move will be up or down, but I believe the next 5,000 point move will on the plus side (and of course may take several years).

Stocks pay higher returns over time because of the higher risk they pose, these normal 20% drops in the market serve us patient investors with higher returns long term, it is quite simply the price we pay for these higher returns. Remember, the stock market drops by about 20% every five years and 10% every two years.....we are not experiencing anything new.

The bottom line (as I told a Wall Street Journal reporter this week) is to keep costs lows, diversify, don't hold more stock than you need and relax. The patient investor is the rewarded investor.

The headlines will be large and the fear and panic will be splashed everywhere (how else will the news outlets attract eyeballs), just keep your head down and ignore it, those who don't will end up like most investors - losing money and earning poor returns. Don't be like the herd, stay focused.

On another, more sad note, regardless of your political affiliation, I think we can all agree that Tony Snow, the former Fox News Anchor and Former White House Press Secretary was a good man. It was devastating to news to all of us when it was reported that he lost his battle with cancer this weekend. Tony Snow represented what I think we all should strive for, a discourse that was civil and friendly. Our prayers go out to his family. RIP Tony.

Scott Dauenhauer, CFP, MSFP, AIF