The Financial Selling Panic of 2008 – Autumn 2008

The cheerleaders for recession were about a year early, but it appears that they finally have their way, partly due to their own efforts. Perception can become the reality, and with confidence at very low levels, spending, business activity, and investing decrease, and this can lead to recession. In my opinion we will see contracting GDP in the fourth quarter. Two consecutive quarters of that will equal a recession.

The rampant pessimism had some basis in a bleak reality however. The selling and holding of bad loans which was enabled by the social engineering pushed by Congress and implemented by the “Quasi Governmental Organizations” Freddie Mac and Fannie Mae, caused an increase in defaults and foreclosures when housing prices began to tumble. The mortgage pools were shown to be worth much less than previously thought, and this caused a general loss of confidence, runs on banks, and bankruptcies. Finally, lenders became reluctant to lend to each other and to businesses, and the credit markets became dysfunctional. The Treasury and Federal Reserve instituted an aggressive rescue package designed to pump liquidity into the credit markets.

This crisis was not caused by the capitalist system, greedy Wall Street execs, or the lack of regulation. It was caused by the Government subsidizing of risks and losses at Freddie and Fannie, and their social engineering which dictated that loans be made to borrowers who could not afford them. Meanwhile, borrowers who cannot afford to own a home continue to be subsidized on the backs of taxpayers. In other words, we haven’t learned a thing.

As investors saw the value of their stocks in financial firms plummet, the carnage spilled over into the other market sectors. Investors began to panic, selling everything they owned. The Dow Jones Industrial Average fell 2,400 points in eight straight sessions with triple digit losses each day. On October 9, the Dow saw an intraday low of 7,773, which is lower than it was ten years ago. It is anyone’s guess as to whether that will prove to be the bottom of this bear market.

What is an investor to do? First, the importance of a massively diversified portfolio remains key. Second, our rebalancing method, whereby we maintain a constant percentage of equity assets versus bond assets, is beneficial in our opinion.

Through rebalancing we sell assets that have not depreciated in order to buy others that have. This “buy low, sell high” strategy is rational and has worked quite well for our clients through previous bear markets. Finally, we think it is advisable for clients to tighten their belts if they can when accounts have dropped in value. For example, a retired client who is withdrawing funds each month should consider lowering that amount if possible. Those who were considering a quick retirement should consider waiting if their ability to retire was marginal to begin with. A working client who is depositing funds each month should consider increasing the savings amount if they can swing it.

A down market tests the discipline and risk tolerance of investors. Unfortunately, it is not until accounts decline in value that some investors realize that they do not have the stomach for risk as they thought. The time to get more conservative is not in the middle of a bear market, however. Far better to wait for the recovery and pair down the equity holdings when they can be sold for a good price.

In the meantime, know that together we will survive this, and we are available for you if you need to talk

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