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Take Advantage Of The Panic Of 2008

Many will rue what they lost in the Panic of 2008, but if you have patience, foresight and the nerve to buck the crowd, the aftermath presents a wealth of opportunity.

Virtually every asset, apart from U.S. Treasury obligations and the dollar itself, is marked down as steeply as a sweater, a television or a car this dismal holiday season. Or as a barrel of oil, which went from $145 to $41 in a matter of months.

Cars, sweaters and oil are just as useful today as they were a year ago. They just are priced differently. The same is true, for the most part, of stocks, commodities and condominiums.

The past year’s steep market declines did not only create bargains in the investment universe. The combination of depressed asset prices and extremely low interest rates also created an ideal chance for affluent families to avoid steep potential gift and estate taxes by shifting today’s cheapened capital to younger generations.

With the paralysis of the credit markets this fall, cash did not merely become king; it kidnapped the entire royal family. The stampede to cash swept up financial institutions, fund managers and endowments that were forced to liquidate other assets at virtually any price, as well as individual investors who simply panicked as they watched their portfolio values plunge.

At such a time, which would you rather be: A buyer or a seller?

Of course, we now know that we are officially in a recession that started in December 2007. The rest of the world is in the same position. With credit markets still creaking, financial institutions reeling and companies as large as General Motors facing oblivion without government rescue, this clearly will be the worst downturn in at least a generation and possibly several. It may not end quickly.

Yet, amid the corporate collapses and the mounting layoffs, financial life will go on for most households pretty much as before. People who get sick in 2009 will go to doctors and hospitals, just as in 2008. People who want or need to travel will get on airplanes and stay in hotels. We will go to the grocery and to the barber. We will drive our cars, fill our tanks (more cheaply than a year ago) and pay for insurance and repairs. Consumption patterns will change and overall demand will be reduced, but not that dramatically. There also will be long-term benefits as American households reduce debt and, for a change, actually put money away.

This is not the 1930s. Bank failures are not vaporizing families’ life savings. Washington has all but decreed that there will be no more crashes like that of IndyMac last summer, in which real accountholders lost real deposits above the $100,000 federal insurance limit. Besides temporarily boosting deposit insurance to $250,000 per account in most cases, federal officials ensured that the much bigger bank implosions that threatened to follow IndyMac — Washington Mutual, Wachovia and Citigroup — were managed into soft landings in which no depositors were hurt.

In early December 2008, health care companies Humana Inc. and UnitedHealth Group both had stock prices down about two-thirds from a year earlier, though people still are getting sick about as often as before. Southwest Airlines and AMR Corp. (parent of American Airlines) were down by about half, even with oil prices 50 percent below a year earlier. General Electric, with its stock at half of year-earlier levels, paid a dividend yield of about 8 percent. A more typical level in recent decades would be around 2 percent. Unlike the crash at the beginning of this decade, this one did not begin with stocks trading at unusually high prices compared with earnings. Recent stock prices are quite likely to prove to be bargains.

Consider that when the Great Depression reached its nadir in 1933, the Dow Jones Industrial Average began a four-year run during which it doubled. It was still well below the 1929 peak (a time of highly inflated prices, of course), but even the mini-crash of 1937, which occurred as it became evident that the Depression was not yet over, did not wipe out the all of the gains.

As we noted, this is not the 1930s. That was a deflationary period in which money itself, which was tied to national stockpiles of gold, was scarce. Today a government can print just as much money as it wishes. The Federal Reserve and both the outgoing and incoming administrations have made it abundantly clear that they will run the presses as long as necessary, and maybe longer, to get money circulating again.

The real risk today is not a deflationary crash. Today’s worst-case scenario would be an inflationary depression, such as my colleague Jonathan Bergman describes in his article on Page 3. If the government leaves too much of this new money circulating too long, it could drive down the value of the dollar and drive up the price of nearly everything else. In fact, with investors today literally paying the United States government to hold their dollars for them, we may be seeing yet another “bubble,” this time in the value of Treasury debt and the dollar, which rallied as the credit crisis intensified.

Inflation is not good for stocks or nearly any other part of the economy. But companies can at least try to raise prices to keep up, and they can makes sales and profits in other countries with more stable currencies. Diversified stock portfolios have an excellent track record of beating inflation over long periods. Real estate values also tend to keep up with inflation over time. A bout of inflation, possibly accompanied by a sliding dollar, would hurt stocks but would do far more damage to investors who tie up their money in long-term, low-yielding government debt. Holders of such debt will be repaid, because the U.S. Treasury will not run out of fresh, crisp dollars, but those dollars might be heavily devalued.

Certainly, a lot of people have been or will be badly hurt by the financial meltdown of 2008. If you lost your job because of the slowdown, or because your financial services employer hit the rocks, all you can do is start over. If you had a big investment in a company like Bear Stearns or Lehman Brothers or American International Group, you learned a painful lesson about the importance of diversification.

Investors who merely hold portfolios whose values slide along with everything else eventually will recover. But if you join the stampede and liquidate long-term holdings amid a market panic, your injury is permanent and very much self-inflicted. This is the classic behavior of the individual investor, who buys stocks after the markets enjoy a lengthy boom and then sells near the bottom of a bust. Long-term trends do not benefit such an investor because she or he tries to time entrances and exits, usually with disastrous results.

An investor who sells during or just after a crash like this autumn’s can only lock in his losses. Staying the course and waiting for the eventual recovery, assuming your portfolio is properly diversified, is a much better option.

But the best approach of all is to recognize the current period for the opportunity it presents. If you routinely keep cash in your portfolio, rebuild your stock allocation by buying into the market now, while it is depressed. If you have, or plan to have, younger heirs who might someday fork over a big estate tax to Uncle Sam, give or lend capital to them today so they can invest and profit from the future recovery without building your taxable estate.

There are many ways to do this. You can sell beaten-down stocks to capture losses for tax purposes and then give cash to heirs or to a trust. You can lend money to heirs at today’s low interest rates, thus keeping some capital for yourself while shifting future investment growth to them. You can plan creatively with a personal residence or other real estate whose value has sunk in recent years. You can create a trust that pays money to charities for a period of years, then distributes the remainder to heirs at little or no tax cost.

Low interest rates such as we have today usually accompany stock market booms. Not so this time. Rather than bemoan the Panic of 2008, you can take advantage of it for your family’s long-term benefit.