Can the U.S. Government Prevent another Meltdown?


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SAN DIEGO ( - In some quarters, the U.S. government is being lauded for stopping the 2007-08 financial crisis from escalating into full-fledged pandemonium. 

In his just published memoir, former U.S. Treasury Secretary Henry Paulson argues the government had no choice but to bailout major Wall Street banks. He declares the financial system was 'on the brink.' While the government may have succeeded in calming financial markets, at least for now, how ready is it for the next crisis? Can it prevent another financial meltdown from occurring?

Before we answer these questions, let's look at what they've been up to.

Deficits and More Deficits
Instead of preventing meltdowns, it's quite possible the government is unwittingly contributing to them. Many people now believe that out-of-control federal debt (NYSEArca: TLT) could become the next financial crisis. Various observers, such as PIMCO's Bill Gross (Nasdaq: PTTAX) have said the U.S. will eventually lose its coveted triple AAA credit rating. How or why this hasn't already happened is largely a mystery. Our best guess is that Fitch Ratings, Moody's and Standard & Poor's are still too busy licking their wounds from the last round of mis-rated debt. Could trillions in mis-rated government debt become their next debacle? Stay tuned, it won't be pretty.

In the meantime, it seems the U.S. government is intent on trying to spend its way out of debt. Of course, this magnificent trick has never worked in a real life stage setting on either a personal or institutional level. Nevertheless, Washington's lawyers figure it's worth a good old 'Hail-Mary' try.

According to the Wall Street Journal, this year the U.S. government will 'borrow one of every three dollars it spends.' And over the next ten years, budget deficits are projected to be $8.5 trillion. While this number is big, it's not nearly as frightening as the unfunded liabilities of Medicare and Social Security.

So, You Want Safety?!
Money market funds (Nasdaq: FDRXX) have long been trumpeted as the one bastion of marketplace safety and liquidity. And for the most part, that's been true. They generally invest in only the safest kinds of debt like government Treasuries. Prime money market funds attempt to get higher yields, but are still restricted to only investing in top quality short-term corporate bonds. Money market funds offer an alternative to bank savings accounts and certificates of deposits.

But it wasn't long ago that money market investments were crisis stricken. The failure of the $60 billion Primary Reserve Fund during the fall of 2008 nearly sank the entire $3.2 trillion money market funds marketplace. The Reserve Fund's risky gamble on shaky debt caused it to break the $1 net asset value ( NAV ) standard expected by investors. Before this, its managers led by Bruce R. Bent, were hailed as genius innovators. Even though the Treasury Department stepped in to offer temporary guarantees on money market funds, it didn't prevent the Reserve Fund's investors from going up in smoke. 

Here's Your Safety, Take it!
In its never ending bid to protect investors, the Securities and Exchange Commission (SEC) sometimes punches them in the face. (Whether these blows are completely intended or subtly inadvertent is the reader's choice to decide.)

Look no further than the SEC's latest 4-1 vote to restrict investors from redeeming their money inside money market funds. Feel free to re-read the previous sentence to make sure your eyes aren't playing games with you. 

Under the rule, should your money market fund's NAV fall below $1 or should the fund's board decide to suddenly liquidate the fund, the fund company has the right to suspend redemptions. In other words, the liquidity you expect from your money market funds can go instantly go away. How about that for causing a run on money market funds! Should another financial crisis erupt, mayhem is likely to ensue in one of the quietest and most boring corners of the investment universe. This could make 2007-08's financial crisis look like a cakewalk. 

What is the SEC's response to all of this? They state, 'We understand that suspending redemptions may impose hardships on investors who rely on their ability to redeem shares.' 

No doubt, the SEC's latest gaffe will re-invigorate our generation to become like previous ones; money mattress stuffers. Who can blame them?

Taxing Your Stock Trades
Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio characterized a transaction tax as the least painful way to address the government's mounting deficits. They also argue such a tax would curb speculation. No doubt, a transaction tax would create just the rigged monster they seek. Without speculators, their law books tell them, the financial markets will go up indefinitely.

Instead of a good solution, many observers see big problems. According to one estimate, taxing stock trades would cut trading volume on U.S. stock exchanges by 90% and lead to illiquidity. The tax would also cripple asset managers, brokerage firms and people with money invested directly in the market or through mutual funds.

Perhaps, Washington D.C. will finish Wall Street's work by completely dismantling the capital markets until they're dust. Maybe a transaction tax on equity trades will finally destroy the financial system once and for all!

Re-thinking Your Own Safety Net
Those that rely on the government to protect and defend their financial interests are likely to be badly disappointed. Now more than ever, it's important to have the right mix of investments within yourportfolio. Is your portfolio ready for another major meltdown?

Where can you go for help? ETFguide's 6 Ready-to-Go Portfolios each offer a different mix of ETF portfolios to help you during these turbulent times. Which asset classes are best positioned for the storm ahead? The ingredients are freely available, now it's up to you to execute the recipe.    

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs

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