By Napoleon Brandford, III
Napoleon Brandford, III
The turmoil that is gripping Wall Street today is far worse than anything that I have seen in the thirty years that I've been working in the financial industry. I've seen many kinds of financial crises, people making and losing fortunes, small companies growing to become giants, and financial institutions collapsing before my very eyes.
A Systemic Loss of Confidence
Yet, today's market turmoil is different from previous financial storms. It is an implosion brought on by a sudden collapse of confidence at a systemic level. We, in the credit markets, buy and sell securities worth billion and trillions of dollars based solely on a verbal "handshake." Therefore, we must have trust that the counterparty on the other side of the phone will make good on the trade. There can be no hesitation among market participants that upon settlement on the next day or next week that the proper securities or funds will exchange hands.
Bursting of the Credit Bubble
The easy credit of this past decade has led to unwise spending decisions by consumers and businesses. Just as people unwisely spend beyond their means by over-using their credit cards, many Wall Street firms were also on a credit binge - borrowing ever more to pay off their ballooning debt. Now, we must pay for our excesses. In the coming months and years, deflating the credit bubble will be a painful process for consumers and Wall Street. However, the prudently managed financial institutions will thrive just as prudent individuals on Main Street will make it through the financial and housing crisis.
Small Businesses to Feel the Credit Squeeze
In the near term, deflating the credit bubble will greatly impact small businesses. Community banks often rely on the large global banking institutions for inter-bank loans, which the community banks can then re-lend to small businesses. Tight credit in the foreseeable months means that small businesses will need to put expansion projects on hold. This does not bode well for our national economy because based on Labor Department statistics, small businesses create 75% of all new jobs added to the economy and represent over 50% of the private work force.
What Are Individual Investors to Do?
Each individual investor will have a unique set of parameters that will dictate a different course of action. However, there are common sense and prudent things that we all can try to do in the coming months. The first is not to act in haste. The worst possible reaction is to be pulled into a stampede for the exit door. Selling your stocks and bonds into a weak market is usually not the best thing to do. Markets always bounce back. That's why the individual investor should always be a long-term investor.
Bank CDs, Money Market Funds, Stocks, Mutual Funds, Bonds, et al
In turbulent markets, investors should put a high priority on principal preservation. That is, safety first before seeking higher investment returns. Any investment instrument that promises a return higher than other comparable instrument probably carries additional risks that may not be obvious upon a cursory review. There are neither free lunches nor easy money. Look for the hidden risks. Stocks, mutual funds and bonds are all long-term investments and should be treated as such. Constant trading is a sure way to have the transaction fees eat away at your investment return. Institutional investors can afford active trading because their transaction cost is usually very minimal. A money market fund that carries a higher yield often means the underlying securities may not be all high-grade Treasury securities. In recent weeks, there have been at least two money market funds that "broke the buck," that is, the fund share price went below $1.00. In direct response to this damaging development, the U.S. Treasury announced that it would guarantee up to $50 billion for the next year for both institutional and retail money market investors. This would be on top of existing deposit insurance programs.
FDIC and SIPC Protection for Depositors and Investors
For investors worried about the safety of their deposits at financial institutions, it is important to understand the type of protections that cover your financial accounts. For example, FDIC will cover bank accounts and CDs of up to $100K. SIPC (Securities Investor Protection Corporation) will cover brokerage accounts of up to $500K. However, these insurance programs will not cover market loss in the case of SIPC, or penalties from early withdrawals in the case of FDIC on bank CDs.
Rebuilding Our Credit and Confidence
The painful process of gradually deflating the credit balloon has already begun on Wall Street. As a result, individuals will likely experience tighter borrowing standards for home mortgages, car loans, credit card lines, and other consumer loans. I am very hopeful that our financial system will return back to the basics with focus on traditional products and reduced emphasis on esoteric financial instruments. We need to rebuild our fundamental understanding of what constitutes good credit. From there, our confidence in the markets and financial institutions will return.
Mr. Brandford is Chairman of Siebert Brandford Shank & Co., LLC, the nation's largest African American women-owned bond underwriter. The firm serves primarily institutional clients and provides investment banking services to state and local governments throughout the country. The firm does not provide investment services to individual investors.