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Be Patient! Rescue Plan Needs Time to Work

October 07, 2008

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The fire is out, but the movie might still stink.

That is our current assessment of the nation’s economy as of Tuesday evening. The rescue plan signed into law on Friday assures the nation and the world that the federal government of the United States will do whatever it takes to provide liquidity to the markets, enabling business to continue (and in some cases, resume) normal operations.

Those operations had been in serious jeopardy because banks and other institutions had found themselves unable to find buyers for the exotic securities they had purchased from Wall Street. With the government’s assurance that it will act as “the buyer of last resort” spending $700 billion (and, let’s face it, more if needed) to purchase these securities, banks can resume normal lending practices, restoring much-needed liquidity into the economy.

So the fire is out, and we can return our focus to the fundamentals: Are businesses making money and creating jobs? What will happen to inflation, interest rates, oil, gold, home prices and the dollar? Although we’ve returned to the theater, we might discover that we don’t like the movie.

We’ll have our answer in the coming weeks and months, but one thing is certain: We will have our answer in the coming weeks and months (and we’re quite confident in what that answer will be — more on that later). We stress this because some consumers unrealistically thought Wall Street’s woes ended Friday — as though President Bush had waved a magic wand instead of merely signing rescue legislation. When consumers read over the weekend that Asian and European markets were faltering, their confidence plummeted — and so did the U.S. stock market on Monday.

So, let’s get realistic. It will take several weeks for the Treasury Department to even begin disbursing the $700 billion into the economy, and it will take more time for that cash infusion, massive though it is, to improve the economy. But improve the economy it will. Thus, as I said in my letter to you on September 19, we must not only be realistic — we must also be patient.

The alternative is to react with extreme emotion, and we’re beginning to see signs of panic. According to the New York Stock Exchange, 80% of the selling on Monday and Tuesday was done by individual investors. After they caused the Dow Jones Industrial Average* to fall 800 points by 2:45 p.m. on Monday, institutional investors began buying furiously, and the Dow rose 430 points in little more than an hour, ending the day down 370 points. In other words, when the Dow was over 14,000, consumers were buying and institutions were selling. When the Dow reached the 9000s on Monday, consumers were selling and institutional investors were buying. Somebody’s acting foolishly here — and it’s not the institutions.

Indeed, we see some very encouraging signs. One comes from Warren Buffett, who two weeks ago invested $5 billion into Goldman Sachs and last week announced a $3 billion investment in General Electric.** Long known as the world’s most successful investor, Warren is showing us how he does it: He makes no big bets, instead investing in a highly diversified manner (his investment in Goldman represents only 2.3% of Berkshire Hathaway’s assets, and GE is 1.4%). And he holds his investments for very long periods (when’s the last time he sold anything?).

Another sign comes from Bank of America. It has announced that it will modify the terms of 400,000 distressed mortgages issued by Countrywide, which BofA acquired in July. Until now, lenders have been unwilling to help homeowners who are facing foreclosure. This move, which we expect will be followed by others, will help reduce further foreclosures and should help stabilize housing prices. (We hope some of the homeowners who get rescued will be required to pay some kind of penalty, but that remains to be seen.)

So, we believe the long-term prospects remain favorable.

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