Planning for disaster

From Megan McArdle’s blog:

 

“In an interview with IMF advisor Robert Shapiro, the bailout expert has pretty much said what, once again, is on everyone’s mind: “If they can not address [the financial crisis] in a credible way I believe within perhaps 2 to 3 weeks we will have a meltdown in sovereign debt which will produce a meltdown across the European banking system. We are not just talking about a relatively small Belgian bank, we are talking about the largest banks in the world, the largest banks in Germany, the largest banks in France, that will spread to the United Kingdom, it will spread everywhere because the global financial system is so interconnected. All those banks are counterparties to every significant bank in the United States, and in Britain, and in Japan, and around the world. This would be a crisis that would be in my view more serrious than the crisis in 2008…. What we don’t know the state of credit default swaps held by banks against sovereign debt and against European banks, nor do we know the state of CDS held by British banks, nor are we certain of how certain the exposure of British banks is to the Ireland sovereign debt problems.”

 

Sounds pretty dire. The good news is that it is two to three weeks away. If you’re going to have a banking crisis, it’s best to have it in slow motion. I’ve been worried about this for a while and it struck me the other day, this is an ideal investment situation. There’s no reason to go down with the ship. I liquidated the vast majority of my holdings in my 401k and am now mostly in cash. I closed out my stocks with a small profit. Now I’ll wait until things implode and buy when stocks are cheap. Foolproof, right?

Welllllll, there’s one little problem. My cash is actually held in a money market fund. Those are usually considered the safest types of accounts and are treated just like cash. The potential problem is that if the credit default swaps (essentially insurance against going bankrupt), are what the above paragraph was taking about, that’s the counter party risk that can bring down the banking system. If a CDS needs to be redeemed, money sitting in money market funds will be a likely place to get the money necessary to pay out the claims. Oh, and my 401k isn’t FDIC insured, so if the money market goes away, so does all of my retirement.

So what to do? I really don’t feel like losing a lot of money like I did the last time the stock market melted down. I was overseas and out of touch in 2008, this is unfolding slowly enough that I feel like I should be able to avoid it. My plan is to act quickly once things look bad. I hope to buy as soon as things tank.

 

Of course if we’re all lucky, this won’t happen. I won’t be in any worse of a situation. I do want to be prepared if things come to a head though. Hang on to your hats folks, this could get rough. Oh, and stay away from bank stocks:)

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