An Interview With Richard Croft
"We have thought for some time that the end game in the credit crunch would ultimately result in the government buying back the debt. What I find interesting about this is that the marketplace in the US is forcing the financial system to look like a system like we have in Canada. The US has always had thousands of independent banks; we have always had 6 major banks which are impenetrable. We are now seeing the emergence of "superbanks" in the US, which from a regulation viewpoint, look a lot more like the Canadian banking system, so maybe we had it right all along."
Commenting about the bailout itself, Richard says this: "The underlying assets in question acquired by the US government currently have no buyers, but may still have a value. The big difference is that the government has time, banks don't, so it can take those assets and sell them off at some price in the marketplace over time. So that's the key benefit of the bailout package; it will filter the assets back into the system eventually. In the end it may not cost the taxpayer much; but we have managed to avoid a long recession, which cuts into government revenues and costs lots of money in term of unemployment insurance or deposit insurance required to be paid in the case of bank failures. So at the end of the day, the bailout will end up as a wash, and together with the tax breaks introduced with it, put more money in the hands of taxpayers."
"Another interesting point, is that many large US banks can't go bankrupt nowóexamplesóJP Morgan, CitiBank, Bank of America, Goldman Sachs, Morgan Stanley, Wells Fargo, óthey are now too big to fail."
"What we are left with is an interesting balancing act between the effect of regulation on financial services and free market activity. One of the reasons why the Great Depression went on as long as it did was tightening regulation in the period. Liquidity, we have learned, is important."
So the bailout was a good thing? "The bailout may bring liquidity back, which will shorten the recession, but I expect that markets won't do anything much more than find stability around the bottom. There won't be a great turn around soon. But the credit issues are also being addressed with the bailout and this is key to recovery. The longer term moral hazard is that the government is seen as the pot of gold at end of rainbow."
Is this a good thing or a bad thing? "You want regulation to prevent the proliferation of the structured products that have emerged to meet investor demandóbut the flip side is less regulation allows more growthóin Canada we have always operated on regulatory regime, but we never got the same level of growth, nor the boom and bust scenario the Americans have scene. If you want a scorecard, look at currency. The fact that the Canadian dollar rolled down to 64 cents, measures and gauges merits of a capitalist economy. We are now seeing a downside of a lower regulation environment but more regulation may not allow needed growth. "
There is so much yin and yangónobody really knows what the immediate future will hold, so what's an investor to do?. "That's true, so the best defence is a diversified portfolio. Decisions made at this moment should be made on whether you can tolerate the risk level of the portfolio you are in."
"If investors are comfortable with risk in the portfolio, some may raise it. There are great buys to be had. Warren Buffet boughtósome investors might also wish to step up to the plate and take a look at great companies undervalued now. "
So the bottom line? "The bottom line is that investors holding portfolios came through this kind of cycle did better than those who did not have one. Many had only a 3-4% downsideówhich is not so painful at all. A well balanced portfolio is what you need to work with to weather these kinds of storms."
Richard Croft is an investment counselor / portfolio manager, and principle of R. N. Croft Financial Group Inc. Richard will also be speaking at the Distinguished Advisor Conference in Monterey, California next month on the subject of portfolio construction with new tax efficient investing tools.