Time To Hold — Anything Else Could Be Hazardous To Your Portfolio's Health

Hot off the presses. The market has gone down. Although this recent decline has shocked the financial system, markets have never gone straight up. The Dow Jones Market Index had broken the 11,000 barrier about a year ago. It passed through 12,000, 13, 000 and 14,000 without taking a breath. With a run like that, it is only natural that it needs to retrace. This is still not a buying opportunity. One can get hurt trying to catch a falling knife.

But it is not time to sell. For those that did not sell earlier, it is too late now. Current holders of stock will have to be patient and wait until things sort themselves out. This is doubly true for holders of sub prime mortgages and collateralized debt obligations. [CDO]. There is no point in selling securities that have no current value. Order will be eventually restored to the mortgage market.

Federal Reserve chairman, Ben Bernanke, has the unpleasant task of sorting out a quagmire that he previously refused to acknowledge. Bernanke testified before Congress on March 28 of this year “the problems in the sub prime market seems likely to be contained.” The sub prime genie had already escaped from the bottle at the time of his testimony. Bernanke still does not know how to coax it back in the bottle.

Neither does Treasury Secretary, Hank Paulson. He has all but disappeared during this crisis. Paulson has proven that he is no Robert Rubin, the treasury maestro during the Clinton years. Rubin would have been vigilant presence during a crisis of this magnitude.

President Bush’s we are “the envy of the world speech” was small comfort for the millions watching their homes and life savings disappear in a matter of months. The SEC’s announcement that they are auditing brokerage firms to verify that there are no hidden sub prime mortgages on the books exacerbated the panic. Instead of playing bridge, Wall Street’s favorite parlor game has become “Who’s Next?”

Bernanke is either playing the role of the strict market or is tone deaf. The market was greatly disappointed that the recent statement from the Fed did not acknowledge the depth of the credit crisis by mentioning the possibly of a rate cut. The omission of the rate cut helped push the market down.

None of the central bankers are getting it right. European Central Bank [ECB] showed their concern for the credit crisis by pumping a whopping $224 billion into the money supply last week. The rest of the world’s central banks had joined the ECB to a lesser degree. Unfortunately, the opening of the money supply spigots rattled investors. It should be noted that this is the first time since 9/11 that the central bankers have acted in concert.

Bernanke may be taking the heat but this is really the Greenspan crash. Some of the fault lies with the easy money policy of the Greenspan years. The system is now choking on all that easy credit.

Alan Greenspan allowed the unsupervised proliferation of obtuse and opaque mortgage products. Greenspan himself would not be able to understand the fine print on some of the mortgage documents that I have seen.

One new product, the 2/28 offered a lower starter rate for two years and then jumps for the following twenty eight. The lenders evaluated the suitability of the mortgage application on the lower starter rate of about 1% and not on the fully indexed rate. When the rates were bumped up, the homeowners could not afford to make the increased mortgage payments and defaulted. Even without my trusty crystal ball, I could have predicted that this disaster would happen. Without a substantial increase in salary, it is next to impossible for the borrowers to afford the higher payments.

Greenspan had a little help from the rating agencies. The majority of bonds that are now worthless were rating AAA by Moody’s and Standard and Poor’s. The buyers thought that they were buying a safe product. The banks were generous in their loan terms because the mortgage bonds were rated AAA.

We need to use different criteria for ratings. The current rating evaluation only deals with the creditworthiness of the issuer. This is mistake. The rating only tells part of the story. It does not take into consideration market forces and illiquidity.

There will be time for recriminations later. Right now my advice is to ignore the media hype. It can only cause unnecessary panic and be perilous to the financial health of your portfolio.