Saturday, July 26, 2008

Reflecting on One of My Favorite Sayings

"If it sounds too good to be true, then it probably is."

We've had many recent examples of the accuracy of this statement.

  1. In the the nineties, the sentiment was that the stock market had nowhere to go but up. The economy had reached new heights, driven by technology and the Internet, never to fall again. Millions of people flocked to technology mutual funds and technology stocks, which rose steeply until 2000 and then the bubble burst. The NASDAQ is still down almost 54% from its closing high of 5048 in March, 2000.

    Yes, becoming rich on tech stock investments was too good to be true.

  2. Not long afterwards in 2001, a housing bubble began in the United States, which ended in 2005-2006. During this time, people were able to finance 100% of their home, sometimes with No Income, No Asset loans. While the market was rising, borrowers could often sell their property for a higher price after owning it for a short time. However, when the housing bubble burst many buyers with these aggressive mortgages found themselves with property less than the value of the loan.

    Yes, a home being a never ending cash machine was too good to be true.

  3. Then the concept of securitization of debt was pressure tested in 2007 to 2008. The theory was that securitization of debt reduced risk and, therefore, increases the safety rating of higher risk bonds. (Collaterized Debt Obligations ) of mortgages were given higher credit ratings than the underlying instruments, thus increasing the number of people willing to buy them. After all, if the agencies gave a CDO a coveted AAA rating, it was to be believed...until defaults and foreclosures began increasing. The writedowns of the CDO values has resulted the demise of Bear Stearns, and significant losses by major banks and investment banks.

    Yes, making high risk investments "safe" was too good to be true.

  4. Finally, this weekend the Senate passed the Housing Bill, which will take effect October 1, 2008. It is estimated the bill will help 400,000 borrowers with $68 billion in mortgages, and may help up to 1 or 2 million borrowers. As President Reagan once said, "The nine most terrifying words in the English language are: 'I'm from the government and I'm here to help.'" Although, the bill has some good elements, such as participants returning profits from the sale of their home for a designated period, I am skeptical that the benefits will be as good as Congress projects. After all, the bill is expected to cost the government $25 billion and as much as $100 billion to bail out homeowners, Fannie and the government doesn't have to spend.

    Yes, this government intervention solving the crisis will likely be too good to be true.

Unfortunately, I think more bad news is coming.

As Lily Tomlin once said, "Things are going to get a lot worse before they get worse." I used the same quote in January, 2008 and March, 2008. Hopefully, this is the last time I will need to quote Lily Tomlin this year.

For more on Reflections and Musings, check back every Saturday for a new segment.

This is not financial advice. Please consult a professional advisor.

Copyright © 2008 Achievement Catalyst, LLC

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