Ben Stein How Not to Ruin Your Life

If I were to choose a cartoon to represent the financial events of 2007, it would be the familiar one of Lucy promising Charlie Brown that this time, definitely this time, despite all the lies in the past, she would hold the football firmly in place while he practiced placekicking. Then, of course, she snatches it away and he goes flying onto his backside.

In the case of 2007 and investors, Lucy is, as always, Wall Street. The football is collateralized mortgage obligations, and the placekicking dupe is you and me. But the smart observer is the guy or gal or who knows this crisis won't go on forever, and the time to buy stocks, mutual funds, and ETFs is when everyone is worried -- not when they're chirrupy and happy.

What Went Wrong

Let's start at the beginning.

It's not even six years after the catastrophe of the high-tech fraud and stock collapse, and, after endless professions that Wall Street would stick to the highest levels of probity and honesty, it's back to the same old tricks. The trick is -- as always -- to sell "securities" that are not at all secure and are worth far less than the con men on Wall Street say they are.

This time around, the "securities" were immense pools of mortgages issued often with minimal or no credit checks on the borrowers, often on the collateral of homes that were worth less than the loans. Very often, the borrowers had little or no equity in the house, so that as soon as the real estate market went into a cyclical correction of extra-large size (to correspond with the real estate boom that was also of uniquely large size), the borrowers simply left the keys in the mailbox and went back to renting.

In many cases, the borrowers were themselves deceived about the terms of the loans and the likelihood that they could refinance their way out of any problems that occurred.

Crunching the Numbers

No one, and I mean no one, knows how large the losses have been as the buyers of the mortgage pools have seen their investment dry up and blow away. By my rough calculation, with help from the president's Council of Economic Advisers, about 6 trillion dollars of new mortgages were issued between 2005 and mid-2007. Of this, about 20 percent might have been subprime. That makes $1.2 trillion.

Of that, about a third might default (many more from the last period of the lending binge, when standards simply vanished), which would indicate losses of about $380 billion. Of that, about 60 percent will be recovered when the houses are seized in foreclosure and, after the legal fees are paid, sold to shrewd buyers. That leads to a net loss to pension funds, municipalities, labor unions, hedge funds, and wealthy foreigners of about $150 billion, as a very rough number.

That number may be even greater when upwards of $40 billion in losses on mortgages call Alt-A's -- where the borrowers didn't have poor credit, but the interest rates reset too high for them to afford -- are added. If we also assume that defaults might be even greater on mortgage pools sold since the middle of 2007, the total unrecoverable losses will be about $200 billion to $250 billion. Ouch!

On top of that, there are losses on structured investment vehicles, in which speculators basically borrowed short-term money to buy long-term debt -- always risky -- and possibly some losses on car loans as well, but that's not yet clear. There are also losses to hedge funds, which are loosely regulated pools of investments, but their accounting is generally murky.

Still with me? Because there's light at the end of the tunnel.

The Usual Suspects

But first, here are some amazing facts about this debacle: As far as I know, not one person on Wall Street has been even indicted for, let alone convicted of, fraud. Not one. In fact, the leaders of the major investment banks, banks, and brokerages that sold this worthless stuff -- and kept some of it in-house, leading to immense losses for their firms -- have been retired with immense severance bonuses.

The former head of Merrill Lynch -- who led his firm to near ruin by selling this garbage, and led his clients (whom he had a fiduciary duty to always put first) to disastrous losses -- was given a retirement package of about $160 million. The people at the banks who supervised this meltdown were routinely paid multimillion dollar wages per year.

A Peek Ahead

Here are two even more amazing facts: Despite this massacre -- which went far beyond where I originally thought it would go -- the stock market is still up for the year by a few percentage points, even though financial stocks are by far the largest sector of the S&P. Even more amazing, the economy is so large and so resilient that the losses will not be enough to cause lasting damage to the nation as a whole. (Some individuals, however, will be ruined.)

The losses of $200 billion or so amount to only about 2 percent of bank credit, and far less than the percentage of total credit available domestically and from foreign investors. The Federal Reserve is available at the flip of a switch to replenish the lost liquidity of banks, and new, wealthy foreigners are still lining up to invest in our financial entities.

There will obviously be an economic slowdown, and possibly even a shallow recession. But we're extremely blessed to have good fiscal stewardship from our government and top-flight guidance at the monetary-policy pentagon (the Fed). Unless they make major mistakes, we'll get through this in halfway decent shape.

Get Over It

Still, the lessons for us are keen and cut like a knife. But be brave -- these periods of crisis are inevitably the time to buy, even if you have to wait years for the crisis to sort itself out. It takes guts and counterintuitive thinking, and if you don't have the stomach to do it, no one will blame you.

If you do jump into the pool, be sure to diversify, give yourself guaranteed income from variable annuities and annuities, and stick with proven entities like very largely varied index funds at home and abroad. As you all know, I particularly love the emerging market funds and ETFs for the long haul.

Oh, and the next time Lucy offers to hold that football, kick her instead.