When the proverbial doctor prescribes the “take two and call me in the morning,” it is usually a full dose. Recently, Ben Bernanke and the Federal Reserve (Fed) lowered interest rates by 75 basis-points followed by another 50 basispoint reduction in less than 10 days, an unprecedented move and a huge decrease in the cost of borrowing money for America’s banks. In addition to the moves of the Fed and in a bipartisan manner, Washington’s finest have determined the need to stimulate our economy via tax rebates.
Our nation’s leaders have thus prescribed a “temporary” cure for our current financial ailments and investors are waiting to see the effects of these stimulus packages. Healing our current financial woes is not an easy task and requires a full dose of systematic and long-term stimulus rather than a half dose of temporary motivation. Think of it this way, one wouldn’t prescribe aspirin to treat pneumonia. Unfortunately, our leaders are curing our financial pneumonia with aspirin.
Our current financial crisis is complicated and extensive. This makes it very difficult to ascertain the extent to which it will affect our global economy, and it is frustratingly difficult for investors to navigate through the carnage. The root of our situation is not complicated, however, and understanding the source can offer investors insight into how to get through this difficult time.
Bottom line: Our nation is over leveraged and until our debt levels normalize, investors should err on the conservative side by sticking with highquality investments. Fancy investments such as structured investment vehicles (SIVs), collateralized debt obligations (CDOs) and high-yielding bonds may offer enticing returns. However, much of the current carnage is a direct result of even the most savvy financial institutions (i.e., banks and brokerages) realizing the risk associated with these investments as they watched their investments lose value. When investing, especially during volatile times such as these, keep in mind the relationship between risk and return and don’t over medicate your investments by reaching for unreasonable returns. Too often, what appears to be safe may actually contain greater risks than one thinks.
One type of popular investment vehicle that is susceptible to the current market conditions is the municipal bond market — and few investors see the plague coming. States, cities, or other local government agencies issue bonds to raise funds for capital projects and classify their bonds as either general obligations or secured obligations (secured by revenues of the issuer).
Many municipal bonds secured by revenues require bond insurers to help secure the bond so they may qualify for higher quality ratings by ratings agencies (i.e., S&P and Moody’s). Recently, these agencies have begun to scrutinize bond insurers as many disclosed exposure to the fancy investments that caught many financial institutions offguard, calling into question their ability to secure the municipal bonds. The trickle-down effect of a change in quality rating of these insurers is tremendous, making the ratings of municipal bonds questionable.
During a time when fiscal and monetary policies are taking corrective steps towards curing our financial crisis, don’t be lured into questionable investments that promise high returns. Wait for a full dosage stimulus package (i.e., permanent tax cuts and longer-term liquidity) before considering any investments other than high-quality stocks and bonds. It’s what this doctor orders.
