Financial Earthquake in Process

The crisis engulfing the financial markets in recent months is no ordinary bear market. It is not your average business cycle, either. This is a full-blown economic earthquake. After the Bear-Sterns failure came Lehman Brothers and Merryl-Lynch. Now there is talk of Morgan-Stanley merging with Wachovia. At this point, it would not surprise me if by the end of next week, both Morgan-Stanley and Goldman-Sachs get acquired, and thus will end the era of the large independent investment bank (at least for now).

The scary thing about what we are witnessing is that the bad news seems to get progressively worse with each passing day. The trouble is no longer confined to the investment banks. Bond insurers are also falling prey to the crisis. If AIG can go under, pretty much any financial institution can follow suit. Earlier this week even money market funds proved that there is no such thing as a safe haven in the midst of the financial hurricane - some of these traditionally ultra safe investments declined in value, and "broke the buck", and a few others have imposed a 7 day waiting period on withdrawals.

Considering everything that is going on, I am amazed that the stock market has held up so well so far. By all rights we should be facing precipitous declines in asset prices at this point, but what we have seen so far is mild, considering that the financial sector is de-leveraging at alarming speeds.

Although some have been speaking against him, it is my opinion that Treasury Secretary Paulson (as well as Fed Chairman Bernanke) has executed impeccably and has taken all possible steps to restore stability and confidence to the market. Only time will tell if he is ultimately successful at averting the worst effects of the storm, but he is certainly doing a fine job trying. Until recently, I did not completely appreciate the full magnitude and scope of the problems we were facing, and even repeatedly wrote against sub-prime bail-outs on this blog. However, at some point, you have to stop thinking about economic policy and principles, and start making sure that the economy does not spiral out of control. I think this man knows exactly what he's doing. If bail-outs are necessary to prevent a complete melt-down, then so be it.

One final word. This post suggests that things are dire and that I expect further declines in the stock market and beyond. I think that's a likely scenario. However, as far as our investment strategy is concerned, I am maintaining strict discipline. This month, just like every other, on the 15th, I made our monthly investment in the stock market. Though the market was tanking sharply that day, I did not change our plan. Fear and greed are the two enemies of rational investors. Keep your head attached and continue to think long term. I have not sold any of our positions, nor do I intend to. This does not mean that I am comfortable with the economic craziness around us. I am as scared and as nervous as the next guy, but I don't intend to let my feelings govern my long term strategy.

Here's hoping for better economic times.