Thursday, December 20, 2007

Ben Stein on the Credit Crunch

Ben Stein has written an article on the credit crunch with good advice for investors:

Still, the lessons for us are keen and cut like a knife. But be brave -- these periods of crisis are inevitably the time to buy, even if you have to wait years for the crisis to sort itself out. It takes guts and counterintuitive thinking, and if you don't have the stomach to do it, no one will blame you.

If you do jump into the pool, be sure to diversify, give yourself guaranteed income from variable annuities and annuities, and stick with proven entities like very largely varied index funds at home and abroad. As you all know, I particularly love the emerging market funds and ETFs for the long haul.

Other parts of the article explain the credit crunch pretty well and as usual Stein is not happy with Wall Street:

No one, and I mean no one, knows how large the losses have been as the buyers of the mortgage pools have seen their investment dry up and blow away. By my rough calculation, with help from the president's Council of Economic Advisers, about 6 trillion dollars of new mortgages were issued between 2005 and mid-2007. Of this, about 20 percent might have been subprime. That makes $1.2 trillion.

Of that, about a third might default (many more from the last period of the lending binge, when standards simply vanished), which would indicate losses of about $380 billion. Of that, about 60 percent will be recovered when the houses are seized in foreclosure and, after the legal fees are paid, sold to shrewd buyers. That leads to a net loss to pension funds, municipalities, labor unions, hedge funds, and wealthy foreigners of about $150 billion, as a very rough number.

That number may be even greater when upwards of $40 billion in losses on mortgages call Alt-A's -- where the borrowers didn't have poor credit, but the interest rates reset too high for them to afford -- are added. If we also assume that defaults might be even greater on mortgage pools sold since the middle of 2007, the total unrecoverable losses will be about $200 billion to $250 billion. Ouch!

On top of that, there are losses on structured investment vehicles, in which speculators basically borrowed short-term money to buy long-term debt -- always risky -- and possibly some losses on car loans as well, but that's not yet clear. There are also losses to hedge funds, which are loosely regulated pools of investments, but their accounting is generally murky.

Still with me? Because there's light at the end of the tunnel.

The Usual Suspects

But first, here are some amazing facts about this debacle: As far as I know, not one person on Wall Street has been even indicted for, let alone convicted of, fraud. Not one. In fact, the leaders of the major investment banks, banks, and brokerages that sold this worthless stuff -- and kept some of it in-house, leading to immense losses for their firms -- have been retired with immense severance bonuses.

The former head of Merrill Lynch -- who led his firm to near ruin by selling this garbage, and led his clients (whom he had a fiduciary duty to always put first) to disastrous losses -- was given a retirement package of about $160 million. The people at the banks who supervised this meltdown were routinely paid multimillion dollar wages per year.

His estimate of losses is about the same as mine and I agree with him that while it may slow the economy, it will not be disastrous. One thing I think Stein needs to review though is his assertiong that brokers have a fiduciary duty to their clients. That is just simply not true. Nowhere should the adage of buyer beware be adhered to more closely than when dealing with Wall Street.


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