Great interview in Barrons this weekend with Ray Dalio, one of the few who called this crisis well in advance:
Nationalization is the most likely outcome?
There will be substantial nationalization of banks. It is going on now and it will continue. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?
Let’s say we are going to end up with the good-bank/bad-bank concept. The government is going to put a lot of money in — say $100 billion — and going to get all the garbage at a leverage of, let’s say, 10 to 1. They will have a trillion dollars, but a trillion dollars’ worth of garbage. They still aren’t marking it down. Does this give you comfort?
Then we have the remaining banks, many of which will be broke. The government will have to recapitalize them. The government will try to seek private money to go in with them, but I don’t think they are going to come up with a lot of private money, not nearly the amount needed.
To the extent we are going to have nationalized banks, we will still have the question of how those banks behave. Does Congress say what they should do? Does Congress demand they lend to bad borrowers? There is a reason they aren’t lending. So whose money is it, and who is protecting that money?
The biggest issue is that if you look at the borrowers, you don’t want to lend to them. The basic problem is that the borrowers had too much debt when their incomes were higher and their asset values were higher. Now net worths have gone down.
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Let me give you an example. Roughly speaking, most of commercial real estate and a good deal of private equity was bought on leverage of 3-to-1. Most of it is down by more than one-third, so therefore they have negative net worth. Most of them couldn’t service their debt when the cash flows were up, and now the cash flows are a lot lower. If you shouldn’t have lent to them before, how can you possibly lend to them now?
You mentioned, too, that inflation is not as big a worry for you as it is for some. Could you elaborate?
A wave of currency devaluations and strong gold will serve to negate deflationary pressures, bringing inflation to a low, positive number rather than producing unacceptably high inflation — and that will last for as far as I can see out, roughly about two years.
Given this outlook, what is your view on stocks?
Buying equities and taking on those risks in late 2009, or more likely 2010, will be a great move because equities will be much cheaper than now. It is going to be a buying opportunity of the century.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.