Personal Investing Advice

Fasten Your Golden Seat Belts

The credit crisis just cost us $2 trillion.

It went poof. Just like that.

For years, now, financial talking-heads have been telling us how the Feds credit expansion of six years ago would come back and bite us in the butts. Last week, it did just that.

The question is, will it keep biting? The unhappy answer is, probably and for longer than wed like to think. Theres a Ludwig von Mises quote floating around the Web that says, “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

Von Mises should know. He had grandstand seats to the economic collapse of pre and post-war Nazi Germany. Of course, what we are wrestling with today couldnt come close to those darkly historic days.

We hope.

MILES OF BAD ROAD?

The road isnt just getting bumpy, its fast approaching an Ice Road Trucker kind of treacherous.

We dont have to look any further than the above-mentioned credit/mortgage woes. How bad will it get? It depends on where the dominos stop falling. Last week they stopped, for the time being, for three Bear Stearns mortgage funds, investments which instantly became their investors worst nightmares. They shut down without so much as a courtesy call. So what happens to these investors hard-earned money? Sadly, its out of their hands.

Bear Stearns wasnt alone. The French bank Paribas also shut the door on three of its funds when the mortgage derivatives they held went into freefall. The bank reported a complete evaporation of liquidity as the value of its three funds plummeted by nearly a quarter in little more than a week.

Then theres the story of American Home Mortgage Investment Corp., the 10th-largest mortgage lender in the US. Shocking the industry, it announced its bankruptcy on August 6th. The scariest thing wasnt that the lender had a spooky portfolio brimming with sub-prime customers, but that it actually dealt with an impressive number of Alt-A clientsborrowers with good, if not painstakingly confirmed, credit.

The mortgage crisis may be deeper than we imagined, and it could lead us to a liquidity crisis. Last week, the European Central Bank lent a whopping $130 billion to head that off. This was so unusual that a Financial Times column wondered whether there is something truly nasty lurking out there in relation to credit losses that only the ECB knows about.

Japan and the Fed quickly followed suit, bringing last weeks total capital infusion to over $200 billion (at least, thats the reported amount). According to Financial Times, published reports put the total number of unsold loans sitting in financial institutions’ warehouses waiting to be resold at around $260 billion in the U.S. and another $200 billion in Europe. So the Feds capital infusion relieved some of that pressure, but thats little more than a stop-gap measure. “There are now some indications that the sub-prime mess is leading to an indiscriminate rationing of credit,” warned Strategas Research’s Jason Trennert.

TOUGH TO JAM INTO REVERSE

The danger of a liquidity crisis is that its a tough road to do a 180 on. According to New York Times columnist Paul Krugman, when liquidity dries up, the normal tools of policy lose much of their effectiveness. Reducing the cost of money doesnt do much for borrowers if nobody is willing to make loans. Ensuring that banks have plenty of cash doesnt do much if the cash stays in the banks vaults.

So that pretty much leaves things up to human nature. Yikes.

ALL ROADS LEAD TO ROME?

Americas outspoken comptroller, David Walker, is worried where this mortgage emergencyand all of todays other economic emergenciesis ultimately taking us.

According to FT.com, Walker said our recent …fiscal imbalance meant the US was on a path toward an explosion of debt.

With the looming retirement of baby boomers, Walker said, spiraling healthcare costs, plummeting savings rates and increasing reliance on foreign lenders, we face unprecedented fiscal risks.

He even warned that there were striking similarities between Americas current situation and the factors that brought down Rome.

This is Americas comptroller speaking. Yikes.

THE SMOOTH, GOLDEN ROAD

With all these scary developments, you can end up feeling a trifle bit overwhelmed. But theres no need to get anywhere near that point.

I keep talking about how gold can act as a sort of reassuring insurance against the economic mischief of the day. Well, I stand by that statement. Since gold tends to move contrary to the ocean of paper investments most of us possess, it will always serve a wonderful purpose for the wise, diversification-minded investor.

And since we obviously face a scary fiscal road aheadmortgage generated and otherwiseit only makes perfect sense to fasten our golden seatbelts.

Far as the credit crisis goes, the sooner the better.

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Top tip for saving: get a low interest loans and high interest saving accounts.