February 20, 2009

A Bad Idea

Were coming into the end of a horrific week in the stock markets and bond markets, and while there is little to point to that reassures us, there is growing discontent that what we’ve done have so far is neither reassuring, or worse, its unfair. There is a very disturbing trend taking place in America right now and until it resolves itself there is very little likelihood that either the broad indexes or the credit markets will recover. It has to do with the decline in housing and the broader implications of its destruction of the wealth effect. In short we’ve spent the last thirty years fine tuning a balancing act I call our “Comfort Index”, that is the feeling of being wealthy without actually having the money to back it up. Between our investments and our homes commanding a disproportionate amount of time I see how we neglected many things that are necessary and incumbent upon their very existence. We ride merrily along and if our investments falter, we inflate the economy which makes our home worth more. And when the economy needs to be reigned in, disinflation stagnates our home values at the expense of our investments. It’s been a never ending cycle and believing that was our mistake. There were many signals that the economy was eventually going to have problems. For example rising housold debt levels were not keeping pace with incomes. Home prices, a function of very easy money became the straw that broke the camels back. That much debt was unsustainable and largely ignored in favor of well worn theories of perpetual economic expansions and subsequent investment profits. Well that’s come to a crashing end as well with home and investment values substantially lower and now most of us suffering the legions of ‘finger pointing politicians’ reminding us that we all screwed up.

Well I don’t think we screwed up, sure we could’ve done some things differently but the way I see it the many were assaulted by the few. What I mean is that there were controls that we trusted, and those controls failed us. But worse those we trusted to watch over our banks didn’t live up to the promise of self regulation and that has provided ammunition to those in government that are talking about nationalizing the banks.

I think the answer is simple, don’t nationalize the banks, do regulate them to what they were intended for. This would be to provide loans to people and businesses with rules designed strictly to protect the banks and the borrowers. Then those of us who save can look to investment banks, what GS and MS used to be, to participate in the practice of investment. There a person could buy bonds, for their safety of principle or stocks for additional return in exchange for additional a risk. And if that’s not enough the most savvy investor looking for even more upside return in exchange for even higher risk can turn to hedge funds who traditionally invest in alternatives including private equity (venture capital, LBO) real estate and arbitrage. It’s worth noting that those I refer to as the savviest investors have actually historically been Pension and State funds and University and traditional endowments. Both entities have the benefit of a horizon that is measured in century’s not in decades and this is an important distinction because it’s why they also historically don’t own any bonds.

We have a saying in our country that there are two ways to look at ones work life which is either to “work to live” or “live to work”. What happened to most people over the course of the 20th century is that the only way to work is to work to live. People who lived to work were looked at like losers. The idea of pride in one’s work became passé’. The fact is most of the jobs we’re told are cool have historically been lowest on the pay scales while the jobs we think are un-cool pay more because they’re harder to fill. So figure out where you belong on the investment curve stay there and get back to the business of making money the way most people have always done it, at work. It’s called making a living.

VENTURE CAPITAL - Early Stage investment and participation.
PRIVATE EQUITY - Leveraged Buy Out, Distressed investment, Restructuring and Real Estate
ARBITRAGE-Long/Short, Futures, Options
STOCKS - US, International Developed and International Emerging
FIXED INCOME- Government, Corporate and Municipal bonds. This would include some structured debt.

Rule: There is no such thing as a “Fixed Income Alternative”. (If you think there is prove it)