The talk about finance during crises tends to be categorical and sensational. Sacred principles refuse question. Humility holds fast to its oxymoronic position (Oh, I couldn’t possibly understand that!?). Experts start to look silly. Confidence drops. Or tanks. Here are a few prompts for revised thinking and increased financial confidence.
#1 Simple and complex. A mortgage is a simple financial device. Pooled mortgage-backed securities are not so simple. The Giant Pool of Money (term from This American Life episode) may not be happy with the sketchy instruments (the old simple path), but at some point it will realize the new simple path: invest in simple mortgages. If you are part of the giant pool of money (e.g. you have cash), consider lending it to someone buying a newly low priced house. Just be careful the first time or two so you don’t neglect to put in place normal protections like sufficiently low LTVs and sufficiently high income. If companies engaging in complex finance are struggling then stop giving money to them and invest in simple things. If you are an institutional investor, this can still be done.
#2 Real business versus financial finesse. Companies are making money, selling products and services, and paying workers (except for the 6% unemployed). Many of them have little involvement with financial finesse or risky debt of any kind. Money should head for these companies and probably will. I suggest putting your energy into finding out what companies you believe in and then putting your money there. Think in simple terms: does the money making story make sense? Mortgage loan officers making huge commissions never did and that story got even more incoherent as time went on. A lot of commission-based compensation schemes make sense, but sometimes we just have to face that the service provided is not that complex and not worth that much. Don’t hire a consultant to mop your floors. Of course, the move to make everything complicated (from finance to teaching) creates blinders that encourage overspending on unnecessary complexity.
Here’s a relevant quotation from an NYT article, “Bubblenomics“: “Nonetheless, a significant portion of the finance boom also seems to have been unrelated to economic performance and thus unsustainable. Benjamin M. Friedman, author of “The Moral Consequences of Economic Growth,” recalled that when he worked at Morgan Stanley in the early 1970s, the firm’s annual reports were filled with photographs of factories and other tangible businesses. More recently, Wall Street’s annual reports tend to highlight not the businesses that firms were advising so much as finance for the sake of finance, showing upward-sloping graphs and photographs of traders. “I have the sense that in many of these firms,” Mr. Friedman said, “the activity has become further and further divorced from actual economic activity.”-end
Of course, this implies there is not actual economic activity, when in fact there is. It’s just that the real activity does not need sophisticated financial input.
#3 Diversification can be done without using mutual funds. The dominant view is to use funds and the like to avoid facing the fact that you don’t know what to do with your money. This protects from a big loss on a single company but does less to protect from systemic crises like this one. But funds have rules requiring only very small percentages allocated to each investment. Choose the companies yourself and you can pick 10 companies you believe in instead of leaving it to a fund to choose 20, 50, or more. It’s tough to avoid funds in retirement accounts of course. In that case, it wasn’t that hard to see a drop in stocks coming up this year. Now the question is when to get back in.
