Exactly a month ago, I wrote a post about the need for accountability by banks and brokerage houses who were responsible for the current global financial crisis. With the demise of Bear Stearns and Lehman Brothers, the sale of Merill Lynch to Bank of America, the near collapse of AIG and the rumored shopping of Morgan Stanley to anyone who has spare cash, the contagion has spread faster and deeper than anyone could have imagined. At the heart of this mess lies greed and a lack of accountability. Bonuses have long been paid to the creators and promoters of these dodgy financial instruments, and executives and traders will be downgraded from billionaires to only millionaires. But the people left holding the bag will ultimately be taxpayers and shareholders - the average Joe.
The cornerstone of capitalism will surely be tested in the near future, as people ask how the situation could have gotten so bad without the majority of regulators and analysts raising the red flag. Up till the day they declared bankruptcy, most analysts still had a buy or hold recommendation on Lehman. Compensation based on short-term, quarterly results, will be looked at as a key factor with pressure on publicly-listed companies to perform in the short-term, at times to the detriment of building a stronger and longer-term business.
Unravelling the cause of all this pain, is the residential mortgage issue. However, this means trying to value (or sell) sub-prime mortgages and other loans which apparently now has an absence of an active market. How do you determine the value of something that no-one wants to buy? Mark it down so low until someone, anyone, nibbles at it. Barclays PLC bought a portion of Lehman Brothers for $1.75 billion which included physical real estate valued at $1.5 billion, and in the process, snagged the operations side of a leading investment bank for less than 5% of its value just a few months ago. Even though Bank of America paid a premium for Merrill Lynch, they still considered it a once-in-a-lifetime opportunity to buy a leading investment bank at a fraction of their price from a few months ago.
What does this mean for the average person such as myself? If I were extremely brave (and I'm trying to muster up the courage), I would consider selling my home in Toronto which has not (yet) been noticeably affected by price drops, and invest the money in top-quality, dividend-paying stocks in disciplined companies during the peak levels of pessimism (which surely must be close at hand). Why? Because housing prices worldwide are past their peak and will be continuing to head downwards. My friends in the US, UK, Australia and South Africa all report declining property values. Money invested in real estate will be dead money for a number of years and costly (leveraged and likely subject to potentially higher interest rates and stricter lending requirements). On the other hand, stocks will reach historic lows regardless of their performance. Just as the rising tide lifts all ships, the current contagion will hammer all stocks regardless. Look at all major stock exchanges around the globe and they are all down around 20% or more year-to-date. Sifting through the debris and trying to find solid companies will be the key to success. But if you can cobble together a decent portfolio, these will rise to their former levels in a few years, but regardless of how long it takes, you will be paid to wait out the storm. People are still going to drink Coke, clean houses with P&G products, shave with Gillette razors and eat Big Macs. Like I said, this is definitely not for the faint of heart. Any rube can buy a stock when it is going up. But going against the tide - buying when everyone is selling - has been the key to building fortunes. I am pondering ..... and it's a really big ponder.
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