When to Buy Stocks?
Assessing the problem, what to do now, and when to wade in.
What Is the Problem?
Almost a year ago, I was on television talking about the credit crisis. Everyone was still calling it a "liquidity crisis" back then, and I absolutely disagreed. I said it was a solvency and information crisis. I reiterated my point that our financial system is effectively insolvent again in March. The statement generated some controversy at the time, but it seemed plainly obvious to me. You can sum up all the mortgages outstanding in the system along with the home equity cushion and mark that down to a point where home prices made sense relative to fundamental values like rents and incomes. Then compare that mark to the total amount of capital supporting the financial system, and there you have it: insolvency. At least our leaders have finally realized the root of the problem is not liquidity, but solvency. The $700 billion Troubled Asset Relief Program will hopefully recapitalize the financial system.
The information crisis is twofold. First, financial institutions know too much in the sense that if Bank of America (BAC) knows what kind of junk is on its balance sheet, it can guess at the kind of junk Citigroup (C) has on its balance sheet. On the other hand, we all had too little information, so there is a complete lack of trust by counterparties. To make a macabre analogy, our financial institutions are like victims of various contagious diseases. You know that the other people in room probably have some disease because they were infected by the same outbreak that infected you, but no one is willing to get tested and instead insists they are in perfect health. What's the rational course of action in this case? Avoid everyone else like the plague. That's our financial system right now--no one is willing to extend credit to anyone else.
Toan Tran does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.