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Surviving the Meltdown

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By TMFBigFrog
September 30, 2008

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I've been worried about something like this meltdown happening since late last year, but even I'm shocked at just how quickly things have unraveled.

My personal perspective is that the Fed's inflationary and heavy-handed interventionalist policy kept sending the signal that it would support any failure. As a result, no really at risk bank took significant and painful actions to clean up its act and balance sheet while it still could.

By trying to paper over, cover up, and patch up with cash infusions, the Fed let what otherwise would have been a manageable problem spiral out of control. Specific Fed and Treasury actions that I disagreed with include:
* The January surprise rate cut.
* Lending at too low rates during an inflationary environment.
* The Bear Stearns Bailout 1 and 2.
* Paulson's earlier blueprint for "reform."
* The Primary Dealer Credit Facility -- note how I predicted the "extension" of it that actually happened.
* Extending and expanding the scope of the companies who got all that tainted cheap Federal cash.
* Fannie Mae, Freddie Mac, and AIG.
* The bailout.

(Also, I note that Smart Money seems to be taking a similar philosophy, with pieces like: *http://www.smartmoney.com/tradecraft/index.cfm?story=Fed-Meddling-Masks-True-Value-of-Stocks ,
*http://www.smartmoney.com/tradecraft/index.cfm?story=Government-Intervention-Instills-Chaos-Not-Calm ,
*http://www.smartmoney.com/tradecraft/index.cfm?story=Ultimate-Cost-of-Bailout-Could-Be-Capitalism ,
*http://www.smartmoney.com/tradecraft/index.cfm?story=20080915-financial-crisis , and *http://www.smartmoney.com/tradecraft/index.cfm?story=20080908-mortgage-bailout )

Nevertheless, I'm still investing through this chaos. When this mess started to accelerate I asked myself how I was going to get through it. My answer:

1) Make sure my own family's finances were secure. Avoid all debt except our mortgage. Make sure we our emergency fund is fully stocked with at least 3 months of unemployed living expenses (including health insurance premiums). Cut back on "small luxuries", and know what we'd cut first if the dirty stuff really hit the fan. Save & prepay for all the "mandatory" family travel we've had to do... We've always lived within our means, but to lessen the impact of any blow that might still be coming, we've polished the edges a bit more.

2) Stop chasing investments where I couldn't tell with 100% certainty if they were values or value traps. Yes, I still held financial stocks, but I wasn't going to chase Citigroup or any other struggling financial titan or smaller player that I still thought was going to survive. The risks of them being "saved" out of existence were just too great.

3) Buckle down and hang on for the ride. Perhaps this wasn't my most intelligent move, but I decided to hold on to what I owned, even the companies that were clearly troubled. (I will probably revisit this logic in the future, in light of recent events.) My thought process was that I knew intellectually that I couldn't predict short term movements, but if I started selling into the panic, I'd risk forgetting that valuable lesson and start thinking like a trader, rather than an investor -- to the long run detriment of my financial health.

4) Continue to invest in companies with "smart" debt burdens. Even now, I'm willing to invest in companies that have debt, but it needs to be debt that was largely taken on for the right reasons (to fund profitable growth, not to leverage returns), and it needs to be a manageable debt load given the size and type of business.

5) Focus new money on companies with strong value (in the financial sense) focused operations in critical industries. With the massive inflation wrecking everyone's buying power, I figured those types of companies would be the ones best positioned to thrive or at least to survive.

6) Keep the auto-pilot investing. My 401(k), my wife's and my IRAs, our kids' 529 plans. As much as I suspected the short term would be rocky, I knew that the best chance we had to successfully ride it out and be sure to be still investing and invested when the market eventually turns would be to keep making those regular contributions.

On that note, today, the day of the largest ever one day point drop in the history of the Dow Jones Industrial Average, happened to be pay day. As per those auto-pilot investments, I invested new capital via my 401(k). It's 100% allocated to equities (but Fool disclosure rules prohibit me from telling you what specific security or securities I'll be purchasing when the investment clears).

I'm sure there's a very good chance I could lose a bit of cash on that investment -- especially in the short term. Over the long run, however, we will get through this. My hope of long run success was increased, in fact, by the fact that Congress, by whatever miracle, seems to finally be developing a backbone against the Fed's and Treasury's maniacal and utterly destructive power grab.

I still fear that in the desire to "do something", Congress will pass some sort of slightly modified hasty and ill conceived bailout law that helps destroy the very system it may think it's trying to save. I have new hope, though, that there's now a chance that the dangerous elements running the Fed and Treasury will be reined in before they cause any more and potentially permanent damage to our economy.

Had the right (though tougher) choices been made earlier in this crisis, the recovery may well have been underway by now. Instead, thanks to all the failing bandages and patchwork that simply papered over the problems and let them fester, I believe we're in for a longer and more painful crash and slower recovery than we otherwise would have had. At this point, I believe that's true regardless of whether yet another bloated bandage is put upon the problem to let it get worse or whether the market will finally be allowed to cleanse itself of the toxic buildup that has infested it.

Yet through it all, for as long as I can, I plan to keep investing. I simply don't know any other way to be in the position to be invested when the recovery eventually starts -- a recovery that I probably won't recognize until it's well underway.

Best regards,
-Chuck