| December 2008
From the Desk of Richard Esposito
December Crisis Update
Even with the Christmas season upon us, we can’t forget that we are in the midst of the financial storm of a lifetime. But since we’re all looking forward to sharing good food and drink with family and friends, we’ll keep this letter brief. (We’re still shopping and decorating as we write.)
Let’s focus specifically on what we believe will help you through the continuing crisis:
- The two most important things you need in this ongoing recession.
- One opportunity that you should look at right now (and it’s not an investment).
- Three critical measures to protect your money in the coming months (one of these may surprise you).
The government informed us a couple of weeks ago that the recession is now a year old. But you knew that already, didn’t you? As business continues to slow down in 2009, companies will take any measures necessary to reduce overhead and expenses. So our first recommendation has to do with dealing with a recession that’s turning rather nasty.
The two most important things people need in a recession
The worst position to be in when a recession begins, especially a severe recession, is to have no job and lots of debt. Seems obvious when we put it this way, doesn’t it? So if you’ve got a job, do whatever you can to keep it. (This isn’t the time to worry about whether you feel fulfilled or inspired about what you’re doing.)
As for debt, do whatever it takes not to increase whatever debt you have. If you’ve lost your job, this may be tough to do. If your emergency reserves are small, you’ve got to cut out every expense that doesn’t address the necessities: food, clothing and shelter.
Look at it this way: everyone else is squeezed during nasty recessions, so you’re not alone. In any case, the message is do your best not to run up debt. Even better, reduce your expensesand your debt – which brings us to:
The single best opportunity out there right now
As we’re writing this, mortgage rates are falling. You can get 30-year fixed rate mortgages for less than 5% if you’ve got decent credit. Good deal. It may be time to re-finance unless you’ve got something near 5% right now. Certainly consider this if you’ve got an adjustable rate mortgage that’s going to re-adjust anytime in the next few years.
While there may be some decent investment opportunities out there, why agonize over what looks best and whether you should “jump in” right now? Why not take advantage of what are the lowest mortgage rates any of us has ever seen? So pick up the phone and start shopping for a mortgage. Don’t be surprised if your current bank comes back and reduces your mortgage rate when you tell them you’ve got a good offer.
As an aside, even though markets may seem a bit calmer lately, don’t let that distract you. We may be living with the repercussions of this financial melt-down for years, maybe decades. So, start making changes now that will better position you for the new world that’s coming. We’ll have more to say about this in coming letters. But for now, let’s move on to our final suggestion:
How to protect yourself from all the government bail-outs and spending programs (that will only increase in the coming months)
Here’s an updated version of advice we’ve given to clients recently: simple but effective steps you can take right away.
1) Be certain that your bank accounts do not aggregate to over $250,000.
Reason: FDIC insurance was designed to pay you up to $100,000 if your bank failed. This was raised temporarily (scheduled to last until December 2009) to $250,000. If your bank experiences a run and the FDIC has to step in and take over, you may lose any money you hold in bank accounts that exceeds $250,000. And even with all the guarantees the government has issued, some banks are not out of the woods yet.
(Understand that as a depositor you are a creditor of a bank. But you do not stand first in line to be re-paid if a bank fails. There is a reasonable chance that, if your bank fails, it will not repay you in full for any amount over $250,000; it may not repay you at all.)
2) Switch any money you have in a regular money market to a government money market fund. Unless you are certain that the money you have sitting in a money market fund is safe, switch the money into a government money market (specifically, what’s sometimes called a “treasury” money market – one that invests only in treasuries and/or other government-guaranteed securities).
Reason: Money funds invest in short-term debt. A few months ago, a large, traditionally conservative money market, The Reserve Fund, held hundreds of millions of Lehman Brothers short-term debt. All of it became worthless when Lehman declared bankruptcy. Yes, worthless. By writing that debt down, the fund did not have enough money to pay out to investors who wished to redeem shares.
Even though the government has announced that they will “back” money market funds, exactly what this means isn’t all that clear. So keep your “safe” money in a money market that only invests in treasuries and/or other securities backed by the full faith and credit of the U.S. government.
(With that said, we must also tell you that the latest talk is that U.S. Treasuries are no longer as safe as once thought. We don’t have time to get into what this may mean going forward, but they’re still safer than debt instruments like commercial paper, repos, etc., which populate some money markets. So short of putting it in the mattress, this is still our best suggestion for your cash.)
Special Alert About Some Money Markets
Be aware of one more potential problem with this strategy: Interest rates are now so low, some treasury money markets may actually be returning negative interest. That means you’ll be paying them to keep your money! Shocking, but true. But the question you need to ask yourself is: do you care more about the return on your money or the return of your money?
Our final suggestion may raise a few eyebrows:
3) Keep enough cash on hand to last at least one week.How much? Enough to buy groceries, gas (just in case credit cards do not work properly at any point), local transportation (if you’re not driving). Consider having even more, if you’ve got a safe enough place to put it.
Reason: We are by no means at the end of the discovery of problems with our banks. If we get to the point where the Federal Reserve and the U.S. Treasury determine that the entire banking system is compromised and might be subject to accelerating or “cascading” defaults, they could shut down the entire banking system until things get sorted out. It’s happened before.
(Remember that the reason the Fed originally loaned AIG $85 billion (it’s more now) was that they felt an AIG failure would trigger such an event.)
The government has the power to shut the banks down and will not hesitate to do so if they feel things are spinning “out of control.” If they do shut down the banks, history tells us it will occur on a weekend without any warning. This will prevent you from getting to your banker or from using your ATM. You will not be able to access your cash.
What about just using a credit card? You may be able to use your credit card, but we can’t say that we know this to be true. We suggest sticking with what we know, rather than just guessing.
(We realize that keeping cash on hand makes many people uncomfortable. We would just remind you that as the year 2000 approached with the potential for “Y2K” technology failures (most of which never, thank goodness, materialized), even the Chairman of the Federal Reserve suggested that it might be a good idea to keep cash around in case the computers of the world failed at the stroke of midnight on January 1, 2000.)
We’re not trying to scare anyone. We may not get to the point where banks are closed temporarily. But if we do, you do not want to be without cash. And don’t put the cash in your safe deposit box, either. If the bank’s doors are closed, you may not able to get to the safe deposit box for a few days.
Don’t worry about any of this. Just take action. It’s a matter of prudence in the face of the unknown. And none of these suggestions will take one bit of holiday cheer out of the season. All we’re saying is that it’s better to be cheerful and safe.
Look for our Christmas Letter soon. We’ll do our best to spread some holiday cheer. Until then, here’s to a saner and safer 2009,
Rick
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