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Bear Sterns deal has me scared


gypsie
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What is this going to mean?

Why are the Feds stepping in with backing and another interest rate cut?

Am I over-reacting? I'm seriously worried about a recession and want to pull out all my money and hide it under the toilet.

I know... slap my hand and tell me no, but I'm more than "bearly" scared.

This was a financial giant....makes me wonder about the other "giants".

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BSC is a large bank. JP Morgan picked them apart. This is what I mean when I say that this is not a subprime problem but a liquidity problem. Everyone is leveraged. And credit markets are scared.

Assume for a minute that BSC has $100 billion in assets, but borrowed $500 billion more to lend and invest. They lent $10 billion to a hedge fund at 8% who only has real assets of $1 billion. Hedge fund then invests all $11 billion of the money in CDOs with a real rate of return of 10%. The spread on the bond yield would be passed onto investors and boost their return. But this "added return" came with a price: risk.

Home prices start to drop and borrowers default, causing CDOs to go from a value of $11billion to $5billion, which means that hedge fund lost $6 billion. Since hedge fund BORROWED $10 billion out of the $11billion, their assets are wipe out and then a $5billion loss rolls onto BSC's books. BSC has instantly lost 5% of its value. Due to the leveraging, what would have been a very minor loss was amplified. This process occurs multiple times, and the banks have a real problem. There are many permutations to this and this is a very simple example. The amount of borrowing on top of borrowing is actually much more and gets complicated, but the end result is that it makes the upside much higher and the downside much lower.

In this case, the lenders to BSC wanted to withdrawal their money because they saw the danger. It was basically a run on the bank. Thanks to to the level of borrowing, there was no way for BSC to pay everyone out. That's when the Fed stepped to calm things down, because these things thrive on fear.

Then JP Morgan stepped up, and offered $2 share to purchase the company. They got a great deal.

These things will pass. These liquidity cycles happen from time to time. Lender and borrowers tend to forget that there is risk in lending, and then the market spooks them into remembering once again. The difference now is that we were letting borrowers buy homes with 0% down instead of requiring a 20% "cushion" of a down payment, so the losses are going to be a bit greater on the downside. These practices are dangerous. Which is why the idea that 3% down FHA loans are the answer to the mess is ridiculous. We have the same high levels of borrowing without an equity cushion, with taxpayers being the insurers instead of shareholders. Sounds fishy, and it is.

My 2 cents: NOW is the time to buy low. I am on full throttle dollar cost averaing into the market. I'm MAXING my 401k for the first time ($15.5k of mine plus $6500 of company match) ever and then putting more into after-tax accounts. I can only do this by living on the cheap so that I don't miss this opportunity. There are GREAT companies being sold at firesale prices. If you are not going to need the money for 5+ years, buy and hold. You'll be rewarded. I'm rooting for Dow 5000, but I don't think we'll be that lucky.

If you sell now and go to cash, you'll lock in losses and lose the advantage of dollar cost averaging into volatile markets. Which in the long run, will pay you in spades.

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My 2 cents: NOW is the time to buy low. I am on full throttle dollar cost averaing into the market. I'm MAXING my 401k for the first time ($15.5k of mine plus $6500 of company match) ever and then putting more into after-tax accounts. I can only do this by living on the cheap so that I don't miss this opportunity. There are GREAT companies being sold at firesale prices. If you are not going to need the money for 5+ years, buy and hold. You'll be rewarded. I'm rooting for Dow 5000, but I don't think we'll be that lucky.

If you sell now and go to cash, you'll lock in losses and lose the advantage of dollar cost averaging into volatile markets. Which in the long run, will pay you in spades.

That's what I keep telling myself as I keep buying stock and buying mutual fund shares. I need to stop looking because everyday they get slaughtered. Well, that might be an exaggeration, but they're going down for no damn reason. The only stock I have that's going up are the bond ETF's and they aren't going up that much. Oh and JPM went up today, as you'd expect with them getting Bear Stearns at a fire sale.

Remember that put I sold on Friday the 7th? Now it's in the money and worth lots more. Citigroup went down to $18, doggone it. Last week it was up and down though. I don't know if I could have lived through last week.

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Jq26,

Thanks for that simplistic explanation. I've been listening to CNBC all day and getting more anxious. You put things in better perspective.

I continue to contribute to my 401k, I guess I should start back contributing to my IRA. What scares me most is -there's no insurance to protect my investments.

Previously, my allocation was more aggressive....I'm letting this scare make me more conservative and I know I'm too young to do that. I think I'm going to buy and only look at it once a month.

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The best thing anyone can do is turn off CNBC and stop checking their online accounts everyday. But it is so hard to do. I am guilty as charged!!!

And keep this in mind- by the time a period of time is labeled a "recession", it is already over. And historically, the market is forward looking and the damage to equity prices occurs BEFORE the bottom. So most likely, the damage is done. Buying now means you are buying at the lows. In October, my small cap mutual fund (50% of my 401k) was worth $37/share. It closed yesterday at $25.50. Which means that for each $xxxx of money I put in, I get 150% more shares than I did just 5 months ago. Lucky for me I am getting good prices. Who cares about the lower balance- I'm not drawing on the funds anytime soon. In 10 years, we won't remember this little blip. But you will thank yourself that you bought all those shares back when they were super cheap.

So think of it as a race to acquire # of shares of your fund and not the current value. Your shares are on sale, so snap 'em up. Good luck!

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jq is right -- buy low and hold but buy smart. Look at the large companies with long standing records. A lot I keep eyeing are the $45 52 week high but are now at $7 -- a lot to gain there in the long run. I stopped looking at my mutual and 401K... it will only scare me.

--- but then again my $7.90 buy is now at $5.15 and barely hanging there with TK :) This one I need to stop peeking at as well.

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These things will pass. These liquidity cycles happen from time to time. Lender and borrowers tend to forget that there is risk in lending, and then the market spooks them into remembering once again. The difference now is that we were letting borrowers buy homes with 0% down instead of requiring a 20% "cushion" of a down payment, so the losses are going to be a bit greater on the downside. These practices are dangerous. Which is why the idea that 3% down FHA loans are the answer to the mess is ridiculous. We have the same high levels of borrowing without an equity cushion, with taxpayers being the insurers instead of shareholders. Sounds fishy, and it is.

It is absolutely true that these things run in cycles although it is very dangerous to solely rely on the press for information. The media loves extremes and they rarely bother to put things into perspective especially in a historical context.

It wasn't very long ago that it was only a pipe dream to buy a house with zero money down or that subprime mortgages would ever be a reality.

However, the worst thing that can be done is to prevent the market to correct itself. A lot of people needed to get burned (which happens when every bubble bursts) especially in this case with exotic lending schemes.

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However, the worst thing that can be done is to prevent the market to correct itself. A lot of people needed to get burned (which happens when every bubble bursts) especially in this case with exotic lending schemes.
I couldn't agree with you more. Despite the percepton of perpetual bailout, the boom-bust cycle will have to happen. If they'd let the foreclosure process occur and mark to market all of the worthless CDOs, we can move forward.
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