Implications of the bail-out on you and me

With the 1997 hand over to China a distant glimmer in the island’s eye, many ambitious men made their mark developing Hong Kong real estate in the go-go 1980’s. Thus, it wasn’t unusual for a newly-minted commercial banker to find a well-dressed gentlemen sitting across from him, selling dreams of glass and steel punctuating the skyline. All he need was a cool $100 million dollar. With dreams of glory (and a fat bonus) in his mind, the banker gave the green light to the latest high-rise development in Hong Kong.

Several months elapsed and the developer visited the banker hat in hand. Materials are going up. Trades want more money. We are adding 10 more floors. Can you I increase the loan $50 million? Certainly! Replied the banker. This is Hong Kong. This is the 1980’s. Greed is good. Towers are better. And my bonus, the best. With one simply signature, proving the pen is more lucrative than the sword, the loan increased 50%.

Fast forward 18 months. The commercial banker is found in his apartment dead. Suicide. The $100 million loan is now $600 million and there’s no end in sight for the development. The developer? Oh, he skipped town. Can’t find him. The development? Not finished. It appears through some lax supervision, the banker kept loaning the developer more money until his supervisors got wise to why some much money was going to a project not completed and then hard questions started getting asked.

But, wait, what’s the first thing the banker’s supervisor’s do after taking over the file? Why, they lend the project, with a new developer, another $600 million…

…this story (numbers slightly changed) was once told to me by a banker friend of mine with the moral being that sometimes when you are in the hole really deep, the only thing a lender can do is keep digging and hope you hit oil.

This is what the bailout feels like to me. You are in so deep, what’s another $700 billion (however morally abhorrent). From a pure business perspective, the hole is so deep that cutting off funds now is the worse of two options; the option being to stop the bleeding somewhat.

Despite whatever opposition one has to the bail out, it is what it is. The larger question is what are the implications to you and me?

1. Don’t panic. Financial institutions make money by lending money out. Eventually, they will unlock their vaults and pump money into the system again.
2. Interest rates are going up. Large deficits make bankers and holders of government debt worried. The best way to lessen their anxiety is to increase interest rates on new government debt which means the prime rate of lending goes up which means our mortgage rates will go up. If you have a variable interest rate mortgage, you may want to consider locking in your interest rate.
3. Here comes inflation. Inflation is upward movement of the price of goods and service. In other words, a buck doesn’t get you what it use to. Inflation is caused by a wide-variety of factors but one cause is the increased circulation of money into the monetary system. Guess how the American government is going to fund the bail-out? Yep, putting more money into circulation. Canadian Capitalist has some tips (no pun intended) on investing in an inflationary world.
4. Switch from a capital appreciation to capital protection strategy. Instead of trying to pick those high-flying stocks, it may be time to focus on cash flow friendly companies that pay dividends. At the very least, dividend paying stocks mitigate against downside risk in equity investing. A word of caution though, avoid principal protected notes. They only make the issuer richer and not you. As a side-note as well, as many other bloggers have pointed out, equity over long periods of time (10 plus years) are good inflation hedges.
5. Ask yourself where your advisor is in all of this? If you have not heard from them, consider dumping them. A trained monkey can pick stocks in good times. In bad times, you figure out whether you have hired a salesperson or an advisor.