The End of the World!

Do I have your attention?  I have enjoyed the observation, whose author I cannot pin down, that "the end of the world occurs only rarely."  I think there is a lot of juice in this fruity apercu.

First, in the most mundane way, the end of the world is coming without any doubt.  Something, the apocalypse for the religiously minded, global warming for the scientifically alarmed, and the inevitable solar nova for the scientifically dispassionate, will bring things to an absolute end.

I can think of nothing more pointless, though, than planning for it.  When society as we know it comes tumbling down, no bunker, no stockpile of twinkies and assault rifles, and no stack of krugerrands will shield you from the barbarians.  Somebody with bigger guns and a meaner disposition will take it all away, and you will probably pass your scanty remaining days as a miserable minion.

In a more sensible way, though, the end of the world has occurred a number of times in a number of places.  Both world wars tore holes in the existing social fabric, destroying lives, homes and livelihoods in the process.  This occurs with chilling regularity in less-developed places around the world as we speak.  America has been blessed, having experienced only two world-ends.  The first was the Civil War, which fell unevenly upon Americans.  It was an economic and social tidal wave for the South, and actually a net plus for the North.  (Please don't get  me wrong; those who fought on both sides experienced enormous suffering.)  The second end of the world for America was the great Depression, from 1929 to the beginning of the Second World War. This event impoverished a majority of the population, and destroyed confidence in a better future for a solid generation.

So, why am I trying my hand at both history and philosophy?  Simply this: the end of the world DOES, blessedly, occur only rarely.  And planning for it is an exercise in futility.  Don't waste your time.  Instead, I think a rational person should assume that things will ultimately work out, and make plans based upon that assumption.  This has direct relevance for recent events (2008-2009) and right now (the Euro crisis).  Perhaps you have forgotten how black things looked when Bear Stears and Lehman Brothers went belly-up and AIG's multi-trillion dollar bets went sour.  I haven't though.

I was scared to my very marrow, but ultimately followed this simple line of thought:  If the US government cannot deal with this crisis, then all bets are off.  I have no way of anticipating what will happen next, and no sensible way to shield myself from the collapse of our financial and social system.  So, the only reasonable thing to do is assume that the US government will find a way to prevent that collapse.  It was frantically signaling its intention to do just that, by handing TARP funds to America's largest banks, and arranging forced mergers left and right.  It took over AIG, GM and Chrysler for that exact same reason.

From this simplification, a number of steps became obvious to me.  Financial instruments of nearly every kind were terrific buys.  Stocks were frantically cheap, but bonds offered once-in-a-lifetime opportunities.  Citicorp and Bank of America bonds were sporting yields of 15% and more, while the best banks in America (JP Morgan, Morgan Stanley and Goldman Sachs) were all around 10%.  Either the end of the world was at hand, or I was staring at the best deals of my life.  As I've explained repeatedly, the purchases I made then worked out splendidly.

So what, you reply, that's old news.  EXCEPT, there is a new "end of the world" lurking: Europe, the Euro, Greece, Spain, Italy, Portugal, etc.  The collapse of Greece will lead to ... well, maybe very bad things indeed.  A string of bank defaults might spread to Italy, Portugal and Spain.  The European Union might collapse, along with the Euro.  Since everybody in Europe has his/her wealth in Euros, what will happen to that wealth?  Honestly, I have no idea at all.  It sounds suspiciously like the end of the world to me.

There are parallels to 2008-09.  Some very large banks with very diversified operations, are now selling at a discount to their assets.  Their bonds have been marked down steeply, as bondholders (a notoriously skittish group) seek the safety of German bunds and American (!) treasuries.  What do do, what to do?  Again, I apply Occam's razor: since the end of the world serves nobody, it will, somehow, be avoided.  There will be a lot of noise, a lot of terror, and ultimately a lot of money to be made by those who can control their fears.

I think the Germans, their northern neighbors, and France will eventually find a way to keep things going.  The largest European banks, too big to fail, will receive a functional guarantee of survival from the folks that matter.  When and how will this occur?  Damned if I know.  It's probably too soon to take aggressive advantage.  Buying big chunks of bank bonds now might lead you to stomach-churning, if temporary, paper losses.

The problem, though, is that the bargains will melt away once people think that it's safe.  To quote myself about the issue of timing: if taking action is painful, then it's probably the right thing to do.  So, I would nibble.  I mentioned a couple of banks in an earlier post, both with yields near 8%.  I'm pretty sure those yields will go higher. But guess what, 8% is not a bad return, assuming the company survives.  If you can buy more later, at better prices, then fine.