Friday, October 24, 2008

Voodoo Economics in the Last Days

I realized during a discussion with my sons last night in the car that at some point in the last twenty to thirty years we, as a society, have lost sight of basic Economics 101 investment strategies. We have gone from making investment decisions based on potential return via interest, dividends and profits to a Las Vegas style buy low, ride it up, and sell high rollercoaster with no real understanding of a company’s underlying performance or financials.

When I was young (I’m now 52) if you had say $1000 to invest, you would take a look at several options for the best vehicle to try to grow your nest egg in a solid, safe and somewhat predictable manner. The safest instrument would be to go to the bank and open a savings account and get approximately 4-5% return a year, or if you were really stepping out you could get a bond that might pay a little more.

If your fancy was more along the lines of stocks you would look for a company that was stable and predictable and that had history of paying regular dividends. One of the primary things to look for was a company with a Price/Earnings ratio of less than twenty. In other words if you bought $1000 worth of stock your return over the next year in a company with a PE of 20 should be $50 or 5%. If the value of the stock went up or down that was considered a bonus or something to keep an eye on. Basically, you investment was driven by the expected dividend rather than the change in stock price. If you bought a stock you were generally in it for the long haul.

A third more risky investment for the more entrepreneurial folks was to start a business. You would take your $1000 sum and expect that after all was said and done that your company would be worth at least the initial $1000 investment but would also give you a return of more than you could do at the bank or in the stock market.

All that being said, the financial world we live in today resembles nothing of the basic structure that our country was built on. Hard work, dedication and doing a good job has been replaced by insider tips, speculation, government bailouts, and a true gambler mentality no different than a drunk with a blond on each side rolling dice at a crap table.

Basic supply and demand economics has been replaced by a supply and speculation mentality. Stocks, options and commodities are purchased based on where the investor thinks the price is headed as opposed to the intrinsic value of the item being gambled on. Oil, recently trading in the $140’s a barrel within a few weeks was trading for half that amount. Neither the before of after price was based on anything other than speculation and what item was in favor with investors (or gamblers as they truly are).

The hocus pocus figure of the Dow (take a look sometime how this monstrosity is actually figured) has 52 week range of close to 14,000 to a recent low of $7800. There is no possible way that that the true bricks and mortar value of the US economy can drop 45% in lest than a years time. The economy was never actually worth the higher figure other than being driven to that point by good feelings and speculation that the price would go higher. The minute that there appeared to be a problem on the horizon investors retreated to the basic principle of supply and demand where there were more sellers than buyers with everyone jumping off the feel good bandwagon and grabbing whatever cash they could on the way down.

Folks that talk about a recession or depression and the great global fears that are swirling are the ones that are driving the market down at a pace far quicker than it should based on true underlying facts of the economy. In the collapse of 1929 banks went under and people with savings in the bank had none left and true poverty was created overnight. I am convinced that now no more folks than would be expected during any economic cycle will experience “poverty” from the recent downturn. Those who are involved in wild market speculation have lost money based on their own greed and need a good reality check as to the “game” they are playing with the world economy. Granted unemployment is rising and the housing industry has slowed to a crawl due to credit concerns but you don’t see thousands in soup lines and millions living in the streets as you did during the 1930’s.

Alan Greenspan testified yesterday that he “made a mistake” never envisioning that banks would not take care of their business and protect their assets. Unfortunately, the same greed that was driving speculation in the market was driving banks and loan companies to make decisions that no logic based business would do. The easy credit for new homeowners driven by new federal government policies in the mid nineties that opened the market to millions who should have never qualified for a gas credit card much less a home loan.

I was thirty years old in 1985 when after years of saving, planning and intense agony of worrying about signing a note for a mortgage I was able to purchase a modest condominium worth $50,000. Even though I had kept my nose clean, was employed, and had a perfect credit record, I had to put $10,000 (or 20%) down in order to qualify for the loan. That was what the American dream was about. I had played the game and did what was right in order to become a home owner.

After the Federal government changes in the mid nineties, none of that blood, sweat and tears stuff was needed in buying a new house no matter how poor you were or how bad a credit record you had. There was a mortgage banker on every corner willing to give you a loan for up to 110% of the value of a property that no one in their right mind would tell you that you could afford. All this was done in the liberal / socialist / feel-good notion that everyone, no matter what, some how or other “deserved” a nice home.

What used to be the American dream where people actually had to work for something before they could have it, has turned into the American nightmare where we have an economic “crisis” where folks who don’t have good credit can’t go spend money they don’t have or never will have. Things are finally returning to reality as to where they actually need to be.

Unfortunately, no matter who wins the presidential election next month, the US government will continue to spend it’s way to a solution to try to return to the situation that got us in this mess to begin with – people spending more than they can afford and others gambling on the fact that they will keep spending more than they have in the future.

Fortunately, each of us has free will, and other than being taxed to death to pay for the errors of our government policies, we can choose as individuals to live within our means, make investment decisions based on hard economic reality, and try not to become a part of the frantic masses who base their life on what the daily whim of an out of control media chooses to have you worry about on a given day.

It’s time for a return to the true American Dream where you work hard for what you have and buy only what you can afford. This will be a true wake up for a couple of generations that have had a “see and buy” mentality and are used to buying everything you want now and pay interest for the rest of their lives, never actually paying on the original principal.

Buddy Oakes for Musings About Life in a Fallen World