The crisis on Wall Street prompted plenty of questions from consumers and investors Monday. Investment experts differ in their advice.
The Observer invited readers to share their questions with Tony Plath, a UNC Charlotte professor who teaches commercial banking and corporate finance.
Comments have been edited for brevity and clarity. Jefferson George
Q: Who is going to pay for the war in Iraq, Fannie Mae, AIG, Lehman Brothers and other financial disasters?
For the war in Iraq and the Fannie/Freddie bailout, the taxpayers are liable, since Fannie/Freddie, as well as Bear Stearns, were effectively nationalized by the government.
(Treasury Secretary) Henry Paulson drew a line in the sand on Saturday, however, in failing to extend a bailout to Lehman.
From this point forward, it looks like failing financial institutions will be allowed to fail, and the costs of failure will be shared between investors who hold the debt and equity securities issued by these firms.
Q: What is the status of investors' 401(k)s? Should people worry about their retirement benefits?
Yes, particularly for people approaching retirement within the next five to seven years. With a longer horizon, however, it's important for investors not to panic and sell into a declining and volatile market.
The current crisis does point out the value of diversification across a broad class of assets, like cash, bonds, stocks, commodities and real estate, and you should insure that you are well diversified in your retirement holdings.
You should also make sure that the specific investment providers you use inside your 401(k) and IRA-based retirement accounts provide good market performance, appropriate risk management tools and sufficient investment choices so you can achieve broad-based diversification within your retirement plan.
Q: What about the FDIC? Will the government need to replenish its reserves?
The FDIC's reserves stand just above $45 billion, or 1 percent of insured deposits. This is still sufficient to insure the continuing solvency of the FDIC in an environment of increasing bank failures.
The government will replenish the FDIC reserves through an assessment charge levied against all insured deposit institutions in the U.S. That means the reserve fund will be capitalized by FDIC-insured commercial banks, not the American taxpayer.
Q: What are some safe investment options for a young professional with a relatively small, traditional IRA?
With a long investment horizon, there's simply never been a better time to buy high quality stocks in a market that's dominated by anxious sellers. After all, you want to buy when prices are low, not at the top of an overly inflated market.
I'd recommend a broadly diversified portfolio of large-cap common stocks. These types of investments are well diversified, populated with America's strongest companies and affordable by small investors.
Q: How do you think the current financial “episodes” will impact attempts to privatize Social Security?
It's really difficult to predict what sort of changes we'll see in Washington after the November election season, but I think there will be very little appetite from either a McCain or Obama administration to privatize Social Security.
It's going to be quite difficult for private-sector institutions to make a political argument that they have sufficient risk management skills to accommodate the privatization of SSI, after our largest financial institutions made such a mess of the mortgage market. While privatization may indeed be a good idea, it's not going to happen for quite some time.
Q: Is there any chance that the CEOs of these big companies will have to return any of their bonuses? Serve jail time? Be fined for mishandling these companies? Face lawsuits?
Sadly, no. Pay-for-performance arrangements are almost always tied to short-run corporate performance, so there's no compensation look-back when financial performance deteriorates in years that follow the bonus award.
In the absence of corporate fraud or some other financial crime, there's no case for jail time or a financial penalty.
On the issue of lawsuits, however, shareholders can always file suit against CEOs and other corporate officers for breach of responsibility. In the current environment, when virtually all mortgage-related securities are declining in value, I don't think a suit for breach would be winnable.
Q: Is this really a crisis? Do you foresee us emerging from this rough patch in early 2009 when the prices of homes are supposed to stabilize, or do you see it taking longer to recover?
Yes, the crisis is real. Real estate prices throughout the country – particularly in Florida, Nevada, California and Arizona – are simply too high given market demand. With the slowing economy, rising unemployment rates and continuing banking crisis, it will likely take well into 2009 for the real estate market to bottom out and buyers to emerge for residential real estate.
Given time, the crisis will turn around. And here in Charlotte and the Carolinas, it will turn around sooner, and the turnaround will be sharper than in other parts of the country where real estate became significantly overvalued.
It's important to remember that in some regions, home prices doubled between 2002 and 2006 on excessive buyer speculation fueled by easy mortgage money. That's completely unreasonable within the housing market, and now we're all paying the price.