Just when you thought it couldn’t get worse

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By Jeremy Gardiner

You will hear much discussion around the terms ‘Wall Street’ and ‘Main Street’. Wall Street is synonymous with the US financial system and Main Street represents the US consumer. It is clear that the average American sees the current crisis as a Wall Street problem and the bailout plan (which taxpayers are expected to pay for) is therefore very unpopular. The perception among those opposed to the Bill is that Wall Street had a party; now it has a hangover, and the people being asked to clean up the mess (i.e. the taxpayers) feel they weren’t even invited to the party.

But, in fact, they were at the party. The average American family has 11 credit cards. They lived in a world where house prices supposedly only went up, and therefore home equity withdrawals (refinancing your house in order to spend more) fuelled the party until borrowers are now drowning in debt. Consumers are blaming the barmen (the banks), who made lots of money selling them the drinks (debt), and they are blaming the Government for not having regulated how much they could drink.

Another prevailing myth is that this bailout is only about Wall Street. The mere use of the world bailout angers taxpayers, as it implies that rich bankers will be bailed out of trouble (which is partly true). It implies that Wall Street, while fiercely backing capitalism when profits were aplenty, is now backing a more socialist model in order to spread the losses across the nation’s taxpayers.

But, despite emotions, and tempting as it is to see those who profited enormously from the subprime debacle punished for this, the global financial system is the plumbing of the global economy, and if the financial system were to melt, the implications for the global economy, the Main Street and consumers in general, are severe. In addition, if the tech bubble was a flat tyre, this crisis is the seizing of the engine. The economy cannot simply roll to the side of the road to change a tyre, and therefore the significance of this situation should not be underestimated.

So what does the future hold?
In the short term, things could get worse. If the bailout package is not passed in some form or another, you may see further banking acquisitions/failures. The risks of contagion as the crisis spreads to industry also increase substantially. However, sanity should prevail, and the message is probably hitting home to Congress and indeed the US public as we speak, so the possibility of a deal certainly does still exist. Politically this is very advantageous to Obama’s campaign.

Value will present itself at some point and the world will move on. Exactly when that is, however, remains unclear. Investors should be careful of making emotional decisions during extraordinary times. It is times like these that illustrate clearly (and sometimes painfully) the benefits of portfolio diversification (or lack thereof). This is exactly why portfolios should be structured according to the individual investor’s specific risk profiles. For those who sacrificed some of the upside when times were good, the fact that they were properly diversified means that the current turmoil – although uncomfortable – shouldn’t be too painful.

Source: Jeremy Gardiner, Investec Asset Management, September 30, 2008.


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