The “Dumb Money” Is Broke

09/24/2008 12:00 am EST


Tobin Smith

Founder and Chief Research Analyst, Transformity Research LLC

Tobin Smith of ChangeWave Research says the endgame of the financial crisis isn’t close, and investors must protect themselves.

There's one very important thing all investors must understand right now: we are not even close to the end of securities write-downs and rising loan losses.

There is even more pain ahead, and you should expect to see the stock market fall another 20% or so.

Don't believe me?

Well, Standard & Poor's Ratings Services released a report entitled "Global Financial Institutions Eye Another Wave of Write-Downs as US Housing Woes Spread." It said that the world's financial institutions will face more securities write-downs combined with rising loan losses in the second half of 2008.

Top Wall Street management has already gone to the sovereign wealth funds—aka dumb money in the Mideast and other foreign nations—and convinced them that they could be the next Prince Al-Waleed Bin Talal, the sheik who bailed out Citigroup (NYSE: C) in the early 1990s.

They bought it hook, line and sinker, and invested hundreds of billions of petrodollars. And it's all gone to money heaven, with the exception of the money raised by Bank of America (NYSE: BAC) and JPMorgan Chase (NYSE: JPM).

Now those same Wall Street execs are going back to the dumb money—and are being told to "get lost."

So, who's left?

Well, my friends, the dumbest money in the world—the US government and taxpayers. But even the Federal Reserve and the Treasury Department have their limits.

What we're seeing now is the equivalent of the margin call of the century, and it is the inevitable consequence of numerous short-sighted decisions that banks and brokers have made during the past several years.

It took seven years for this toxic waste of bad investments to pile up, and it simply can't be fixed in a year.

The markets will eventually begin to recover once the final purging is through. I can't tell you exactly when that will be, but here are a few signs to watch for:

1. Stocks will be ridiculously cheap.

2. Housing supplies will be tight.

3. The public will hate stocks.

4. The ratings of financial television shows will be in the tank.

In other words, we'll be at a real, honest-to-goodness bottom.

But we have a long way to go before this great financial unwinding plays out. The financial credibility of the United States is severely damaged, and the financial services industry needs hundreds of billions of dollars in new equity.

Ultimately, that is going to come from a Resolution Trust Company 2.0—there is simply no other solution. We caused this problem, and we're going to have to solve it ourselves. The bridge to dumb money is closed.

Under these conditions, it's critical for investors to preserve capital. By the time the real estate market bottoms and the worst of the financial crisis is over, you will need the buying power to take advantage of the tremendous opportunities in the stock market. 

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