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Bank Crisis – Politicians Fiddle while Rome Burns

I have to say that I am truly disappointed in our government.

They allowed mortgage products to be sold to people who could not pay back the mortgage then they have allowed the banking system to deteriorate to the point where it is having a seriously negative impact on our economy.

Fannie Mae and Freddie Mac are technically bankrupt – the equity investors will likely not see their hard-earned investments returned. The government (i.e., you and I, the tax payers) will be forced to cover the losses from these government sponsored entities’ misdeeds. The most recent estimate that I’ve seen is that the losses here will be four times the cost of Iraq. It is stunning the level of incompetence and stupidity that allowed this situation to occur. This financial crime far eclipses Enron and Worldcom, yet we have not heard any rumblings of criminal investigations.

A perfect example of what transpired in the mortgage industry can be found right here in Champaign. We have always been conservative (yet responsive and innovative) lenders. About 18 months ago, we were criticized by a local attorney for not making a mortgage loan to his illegal alien client. We said that since we could not comply with the terms of the Patriot Act in terms obtaining acceptable identification of his client (the regulations require a government issued ID), we couldn’t make the loan. His reply was that he could take it to any of a few of our larger competitors who would happily make the loan as they had done for a few of his other illegal alien clients. We did not make the loan, they did. Our capital is strong and we are having positve earnings this year with no loan write-offs. Them, not so much.

Senator Schumer accurately called the collapse of Indymac – who’s next? The administration, Treasury, and Fed shouldn’t be blaming him for his statements – maybe they should take it as a wake-up call and put a Financial Marshall Plan into place to recapitalize Fannie & Freddie and the big banks that are in trouble.

From an investment perspective, I do not believe we can end the current bear market in stocks until the banking crisis is properly addressed. Our government has its head in the sand (with the exception of Senator Schumer, maybe). The current situation is at least as cirtical as the 1990 crisis, yet our government has done nothing to be proactive about fixing things – where is the Resolution Trust Corp for the 21st Century?

We need a regulatory organization that tells the banks in trouble that: 1) we will suspend capital requirements for 24 months to give you time to clean up your balance sheets and raise capital; 2) you will raise capital adequate to cover all of your current and projected losses, and to bring your capital levels up to current regulatory standards at the end of 24 months; and 3) if you do not raise adequate capital, we will force a merger upon you as happened in the 1990 crisis.

I am the last person that believes in government overstepping their bounds, but when companies act irresponsibly and threaten our economy, then a situation exists where the government must act. We, unfortunately, are at that point where the government must act.

Stay away from index funds based upon the S&P 500 – financials are still a huge portion of the S&P 500 and you will likely continue to lose money in an index strategy. Do not try to bottom fish the financials – if 1990 is a guide, we are only in the third inning of this banking crisis. Catching the falling knife can be profitable if successful – unfortunately, most people get stabbed. Rumor has it that the traders on Wall Street are looking at 1,150 on the S&P 500 Index as the most likely bottom to this bear market. Given that we are currently at 1,215, that is another 5.5%-ish down before we bottom – this is clearly speculation and rumor on Wall Street, but sometimes the perecption becomes the reality.

The dollar is likely to continue to fall, despite Wall Street’s protests that the dollar bear market is nearly over. The dollar cannot be strong if our banking system is in shambles – buy gold stocks instead – you won’t be sorry. We are overweight gold stocks in client accounts for safety and inflation reasons. You should be, too.

Biotech was the big winner during the last banking crisis. So far, it shows all the signs of repeating that performance.

Be smart in your investing activities in the current market – don’t follow the crowd, use your head, let history provide you with guidance but most importantly, protect your capital.

Mark