But there is a darker side to the net, as reported in a recent edition of Moneytrack. It’s a variant of the boiler room “pump and dump” scam in which dubious salespeople call and try to pressure you into buying certain stocks. When people buy the price rises and the scam operator is able to dump their holdings at an inflated price, leaving the price to tumble back to its true value.

In the online equivalent “hot tips” are either emailed to your inbox or posted on the numerous investor bulletin boards. The Internet put these tips before huge numbers of readers, and it only takes a few to buy to artificially boost the price.

Remember, most professionals underperform the market, so why listen to anonymous posters? And just ask yourself; if someone really had a hot tip are they likely to want to share their god fortune with a bunch of strangers?

Let the buyer beware – before making any investment take the time and effort to do the due diligence.

The old adage says a fool and his money are easily parted, don’t be the fool!

While it’s unlikely this approach can successfully predict lottery numbers, Brown’s trick has introduced a mass audience to the phenomenon explored in James Surowiecki’s The Wisdom of Crowds.

In financial and investment terms the wisdom of crowds is a re-statement of perfect market theory, ie that at any time the market price accurately reflects value based on all publicly known information as indicated by the combined behavior of all participants (ie the crowd). It also implies the adoption of a “trend is your friend” approach to investment, buying into a rising market and selling when prices are falling.

The crowd cannot beat the market, because the crowd is the market. Therefore those who purchase index trackers and ETFs also subscribe to the wisdom of crowds.

But the crowd isn’t always right. Witness the crashes that inevitably follow sustained bull markets, and the volatility seen in the past year or so in the wake of the credit crunch.

An alternative view was presented in Charles Mackay’s 1841 classic Extraordinary Popular Delusions & the Madness of Crowds which outlines such mass errors of judgment as the South Sea Bubble and the Dutch Tulip fiasco. Human psychology hasn’t changed much since as revealed by the dotcom crash and the sub-prime mortgage crisis and subsequent credit crunch… Subscribers to the mad crowd theory tend to a contrarian approach to investing, finding what the crowd is doing and going in the opposite direction.

In reality neither approach guarantees success. Financial decision making isn’t about what the crowd’s doing today; it’s about predicting what the crowd will be doing at some point in the future! That said, knowledge of what the crowd is doing is a significant input to the decision making process, but it should be considered alongside other inputs, and that all important instinct or gut feeling.

Recommended reading

The Wisdom of Crowds New Yorker business columnist James Surowiecki explores a deceptively simple idea: Large groups of people are smarter than an elite few, no matter how brilliant – better at solving problems, fostering innovation, coming to wise decisions, even predicting the future. Surowiecki ranges across fields as diverse as popular culture, psychology, ant biology, behavioral economics, artificial intelligence, military history, and politics to show how this simple idea offers important lessons for how we live our lives, select our leaders, run our companies, and think about our world.

Extraordinary Popular Delusions & the Madness of Crowds Charles Mackay’s classic work about grand-scale madness, major schemes, and bamboozlement – and the universal human susceptibility to all three. This informative, funny collection encompasses a broad range of manias and deceptions, from witch burnings to the Great Crusades to the prophecies of Nostradamus.

However, the current recession is outstanding in two respects. In terms of severity this one is big, as witnessed by the massive scale of government intervention and bailouts. The Congressional Budget Office has forecast it: “is likely to be the longest since World War II, and by some measures could be the worst since the Great Depression” [Source: McClatchy]. The current crisis also stems from a clear cause, ie so-called the credit crunch, itself the result of irresponsible greed.

In short, banks seeking short-term profit over-lent to borrowers with a high likelihood of default. The banks then re-packaged this (now termed “toxic”) debt, selling it on to even “greater fools”. The crisis we now face is the aftermath of the inevitable borrower defaults.
 
It’s generally said that most victims of war are innocent. In this recession it is the innocent faced with losing jobs, homes and businesses; and seeing asset values and returns on deposits slashed. All the while the bankers, whose reckless pursuit of profit created to problem, continue to enjoy huge bonuses. Even those forced out have left with massive golden handshakes and pension arrangements.

Banks have traditionally been run as private, ‘for profit’ institutions, manned by profit-maximizing individuals. While they fulfilled their role of financially oiling the wheels of the economy, governments allowed the banks to operate with minimal interference.

However, the credit crunch has shown that banks attempt to maximize short-term profit with little regard for the risks or consequences to the greater economy. The result is that many have either collapsed, or would have collapsed without massive state bailouts that we will all pay for long into the future.

Given the potentially disastrous outcome that would have followed mass bank failures government, arguably, had no choice but to intervene. However, such a mess should never be allowed to happen again. If/when the banks are ever returned to private ownership they must be subject to rigid regulation & rigorous scrutiny to ensure prudent conduct and risk management. Never again should there be reward for falure. Never again must the lunatics be allowed to run the asylum.

Technically a recession is defined as two consecutive quarters of negative growth. Under normal circumstances economic output increases, so that the economy as a whole produces more than it did in the past. But sometimes that increase is halted and for a time we produce less – that is recession, and is where we seem to be heading at the moment.

Economies typically move in cycles, good times (booms) are followed by the less good and so an and so forth. Despite GB leader Gordon Brown’s claim to have abolished boom an bust, what’s happening right now is just the down part of the cycle.

It could even be argued that recessions serve a useful purpose in trimming the dead wood, ie culling inefficient businesses and practices, and forcing improvement and innovation in the fight to survive. At the very least the recession might give the Earth some breathing space as less fossil fuels are burned.

What follows are some tips on how to survive a recession.

Recession Tips
The only thing that’s certain during a recession is that nothing is certain. You’ll hear daily opinions from countless experts on what they think is going to happen next, but take it with a pinch of salt, it’s just guesswork.

In times of uncertainty, caution is the watchword. As absolutely none of us can be certain of our economic future now is the time to be salting away savings or paying off debt. Limit your spending on the essentials and postpone those luxury purchases until things are more certain.

Savers
Interest rates have fallen and are likely to fall further as central banks use rates to try to stimulate the economy. But for the first time in a long while savers shouldn’t just chase the highest cash account rates.

The current crisis has been sparked by banks suffering huge bad debts, and some well known institutions have gone to the wall. Others may follow. The first concern in choosing a savings account should be security. The safest accounts are those that are government run or government backed. Find out if your country offers any kind of savings guarantee if an institution should fail, eg the UK guarantees the first £50,000 of savings per person per bank.
Outside of these safety nets look closely at the safety of the institution, and only then start looking for the best rates. You might be able to get slightly more by taking out a fixed-term deposit, or accepting a notice period for withdrawals, but make sure such conditions suit your circumstances.

Investors
Stock markets around the world are priced at bargain levels. If you invest now your potential downside is considerably less than the losses already taken by those who were in the market just a few months ago. But no one can be sure they won’t fall further before inevitably rising once more. If you have spare cash the safest policy is to drip it into the market bit by bit, choosing “recession-proof” stocks, ie those that everyone needs regardless of the economy and those most likely to be around when the dust settles.

Employment
Regardless of whether you’re an employee, self-employed or an employer, nothing is guaranteed right now. At this time it’s appropriate to start thinking about what you might do if your current line of work disappears.

Many corporations will be looking to re-strictures, downsize etc with the result that the workforce is likely to shrink. If you do happen to lose your job, don’t take it personally; you’ll be in the company of many others.

In many cases companies prefer voluntary severance to compulsory firings and there may be some generous compensation offers. Should you receive such an offer, consider it carefully, it might open the door to a new and better career.

If you are unfortunate enough to find yourself unemployed, be flexible. Don’t restrict yourself to your old line of work; think out of the box in considering alternatives, even those requiring re-training.

Home Owners
Homeowners are probably feeling a bit poorer as the market value of their homes drop, but unless/until you actually sell this figure is purely academic. If you don’t absolutely have to move now is the time to sit tight and weather the storm.

It can be a good time to upgrade as the gap between homes is reduced, but you need to be double-lucky to sell your existing home at the right price plus finding suitable new accommodation.

Foreclosures are already rampant and likely to increase further. If you’re having problems paying your mortgage, talk to your lender as soon as possible. Lenders hate to foreclose and will be only too willing to come to some mutually beneficial arrangement – so long as you’re up front with them.

Home Buyers
The downturn can be a great time for homebuyers, whether you’re looking for your first home, or to build an investment portfolio. Many of the sellers in the market are likely to be highly motivated so don’t be afraid to go in with some aggressive offers. Researching recent market data for the area and type of property of interest is a must.

Sellers
To say this isn’t the best time to sell is an understatement. Unless you really need to move it’s best to wait awhile until markets return to more normal conditions. The world has limited land but a growing population. Over time real estate has consistently proven to be one of best investments and will surely continue to be so.

If you have no choice in selling, eg due to a need to relocate, bear in mind prices are most likely to keep falling for a while, so the quicker you can sell the better. Set your price realistically, and make sure you show your home to its best.

If you have the financial stability now could be a good time to upgrade, as the price of your next property will also be off its high. Assuming you’re moving to a more expensive property and it has fallen by the same percentage as your home you’d be getting a good deal as in cash terms the new home will have fallen more than the old.

One option is to rent out your old home until its value rises again. This can swing two ways. First there’s the risk of holding two mortgages, which could be untenable unless you can find tenants. And there might be a glut of rental accommodation as others who want to sell decide to rent until prices recover, this would reduce market rents and raise the likelihood of vacancies. On the other hand some buyers might choose to rent while waiting for the market to bottom out. In this scenario the vacancy period will be delayed until prices are at their lowest.

Buyers
Buyers face a double difficulty – fewer properties on the market and the prospect of buying something that is likely to decrease in price in the short term. On the other hand every offer, however aggressive, will receive serious consideration. Don’t be afraid to test the motivation of the seller, you might just find a bargain.

Do your research before writing offers. Get hold of actual sold prices of similar properties in the area, either from your realtor or off the Web. Find out too how much prices in the area have fallen, and reduce the sold prices accordingly to give a starting figure.

Investors
Given the long-term merits of real estate, now is the time to go shopping. There may not be as much inventory as usual, but what’s there will be open to some pretty creative offers. If you don’t try, you don’t get.

In particular look out for foreclosures being re-sold, or those in danger of foreclosure who may be looking for a sale to keep their credit records in tact. Often they’ll be only too happy to stay on and pay rent.

Mortgages
The current financial crisis was caused by banks lending money to those without a hope of repaying. The banks got their fingers burned and the result is it’s now a lot harder for everyone to borrow money. The days of “zero down” are (temporarily?) over.

The range of mortgage choices available has been severely reduced, which means it’s all the more important to choose the right deal. If you’re looking for a mortgage research widely, check out Web comparison sites, and/or visit an INDEPENDENT mortgage broker with access to the whole range of deals. The same applies to those on fixed term deals nearing their end.

Negative Equity
Negative equity is the situation where the amount you owe on a piece of property exceeds the value of that property. In such circumstances the temptation may be to walk away and allow the lender to foreclose. However, this is not a good long-term solution since it will hit your credit record hard and make it harder and/or more expensive to borrow money in the future. Just keep in mind real estate is a long-term commitment and over the years the negative equity will be no more than a blip on the journey upwards.

Avoiding Foreclosure
If you’re having trouble maintaining mortgage payments, the most important thing is to admit you have a problem. Talk to your lender as soon as possible. Lenders HATE to foreclose, they’re not in the business of selling real estate, so they’ll be more than willing to try and work out a deal to keep you in your home.

Another alternative is to find a buyer who will let you stay on and rent back your home. This can work well, but be aware the buyer will be looking to pay below market value, and the rental costs may be excessive.

Bloomberg.com reports: “Three of the firms [that received public handouts], Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co., have already set aside $20 billion to pay bonuses this year.”

In the UK The Guardian reports: “Royal Bank of Scotland, which is being bailed out with £20bn of taxpayers’ money, has signalled it is preparing to pay bonuses to thousands of staff despite government pledges to crack down on City pay.”

The levels of compensation received by financial sector workers in relation to value provided have long been a cause of controversy. But in the present climate in which the retirement nest eggs of ordinary investors are being decimated due to the unbridled greed and ultimate, abject, failure of this discredited bunch it is nothing short of disgraceful.

For too long too many people have been spending beyond their means, their ‘spend today pay tomorrow’ mentality financed by spiraling debts. These hapless souls were undoubtedly egged on by dubious ‘sales’ people with thoughts only of commissions and bonuses funded by their employer’s ballooning profits. But inevitably tomorrow has come, and like all balloons this one has burst.

Sure, finance isn’t the only dodgy business. But the sheer scale of its dodginess makes its rivals look like naughty kindergarteners. For years the financial sector has attracted – supposedly – the finest brains, rewarding them with compensation packages that dwarfed other industries.

At the end of the day government intervention is like one man trying to stop a crowd. As former British premier Margaret Thatcher said, “You can’t buck the market.”

That governments (ie you and me, because governments don’t have money of their own) have had to step in to this extent proves that unfettered free markets do not work! After this debacle dawns a new era in which considerably tighter regulation must the order of the day. The taxpayer has the right to nothing less in return for the bail-out.

In the fullness of time the full extent of bank losses will become evident. Until then we must assume there’s more to come.

The message to investors at these stock market levels is to drip money into quality, for there are some likely never repeated bargains to be found. Concentrate on core shares such as utilities, food retailers etc, and avoid financials until the dust settles.

Both presidential candidates want to crucify SEC Chairman Cox for failing to control our creative financial institutions. But rumor has it that Congress specifically excluded the devilish derivatives from SEC purview. Let’s fire the right bunch of “poips” for a change!

Scary markets are brought about by many factors, some normal, and some not so normal. It’s often helpful to look backwards before getting too paranoid about the present. The S & L crisis of the early 80s might be an appropriate starting point.

Later that decade, a multi-year rally had its head lopped off by high interest rates, high inflation, and a computer loop. Ten years later, another soaring market was toppled by economic factors. The turn of the century witnessed the bloody demise of the no-value-at-all dot-com illusion.

A profit taking strategy during the rally days was all that was necessary to cash in on “The Crash of ’87″. In 2000, the route to immunity could be summarized as: “no IPOs, no mutual funds, no dot-coms, no problem”.

The common historical (hysterical) thread is clear. Rally begets correction; correction spawns rally. This time around, ironically, conservative investors had no trouble avoiding the derivatives that eventually sunk the markets. But, the products were so “out there”, and the regulators so out-flanked, that the unwinding has unglued several investment world icons. This correction is different— but not in the ways you might think:

The scope of media coverage, analysis, and sensationalism; masses of inexperienced, non-professional, speculators; and the popularity of investment products are new phenomena. Millions of nameless non-credentialed Internet investment experts and financial bloggers add to the pandemonium.

Similarly, the proliferation of passive investment mediums (index funds); regulatory tolerance of speculations of all forms, shapes, and sizes; and the relaxation of the trading safeguards that have protected investors for decades encourage a reckless, gambling approach toward what was once investing. We’ve seen what conscienceless commodity speculators have accomplished in world markets.

We have experienced a major movement away from plain vanilla stocks and bonds, and have popularized the thrill ride of speculative activities. 401(k) fund selections include short-long funds, currency trading strategies, and commodity futures. IRA investors seek out the most exotic forms of speculation, convinced that, with a Blackberry and a lunch break, they can master the complexities of high finance.

Regulators have allowed funds of hedge funds into small investor portfolios; brokerage firms short shares that don’t exist multiple times; the once sacred up-tick rule has been abandoned when shorting itself should be a banned substance; and CDOs make it difficult to determine just who owes money to whom.

Enough? There’s more, but you get the idea. Today’s problems are much more visible than yesterday’s. Today’s worries involve bigger numbers. Tomorrow’s solutions will undoubtedly bring creative MBAs to discover new financial WMDs.  The investment gods are angry. We need to bring back that old time rock and roll, and an investment world content with individual stocks and bonds.

In less complicated times, the difference was in the fixing. Speculators suffered, but safer investment styles were less vulnerable. Let’s elect a Congress that will regulate the speculations and allow us to get back to the basic, fundamental, adventure of building and protecting our nest eggs. Think back, just a few cycles ago— familiar?

The Market was breezing along during the summer of ’87, enjoying one of the broadest rallies ever experienced on Wall Street. From the very start, equity prices seemed incapable of going down. The mystical DJIA 2000 barrier was shattered early in the year and upward the market soared.

On through 2100 it rumbled, then 2200, and 2300— even the comic strip, dartboard approach proved successful, and many subscribed to it. The securities markets were simple, with fewer labyrinthine products, and only the dark cloud of rapidly rising interest rates in an otherwise clear sky. 2400 on the DJIA by July and on it went. No end in sight.

The institutions introduced hundreds of new mutual funds, pumped up their marketing efforts, and pushed the rally skyward— 2500, 2600, 2700, just incredible. None of the salivating mutual fund unit holders saw it coming; Wall Street didn’t care. The Dow topped out at 2722 that August— about the same number of points involved in a swinging September 2008. Only the names and the products have changed—

The parallels to today’s markets are interesting. Value stocks and bonds were moving lower while IPOs and other speculations were bubbling higher. As prices weakened, analysts began to mumble. The economy certainly didn’t look like a doom and gloom scenario— just those pesky interest rates. And then it hit the fan.

Technology bombed the market when programmed-trading sell signals ran fast and furious down the cables, resetting themselves lower, and lower, and lower— but the stock being sold actually existed! Wall Street panicked! Inflation fears, higher interest rates, tension in Europe, foreign oil, war in The Middle East, and so on. All of the usual suspects were touted by the media as the culprits that caused “The Crash of ’87″.

It just doesn’t take a whole lot of Wall Street manipulation (or arrogance) to turn speculative greed into investment fear. The wizards had done it again, sucking the franklins from unsuspecting individual investor portfolios, just as they would two cycles later when their dot-coms sealed the fate of another generation of speculators.

Yes, the similarities are striking— one meltdown to the next. But this time is slightly different. This time the Masters of the Universe were helped by Congress and the SEC to pick our collective pockets, and a few of them have actually, and appropriately, drowned in their own garbage. I’ll shed no tears for the fallen giants, but let’s all cry out loudly about the problem— a problem that both Barack and John were a part of.

It’s Congress that gets to chastise and create regulations for the bad guys. This year, and in those that follow, let’s fire the DC fat cats that caused the problem, and find some regulators with the guts to label speculations as thoroughly as they do medications.

Steve Selengut
http://www.sancoservices.com/
http://www.kiawahgolfinvestmentseminars.com/
Author of: “The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read”, and “A Millionaire’s Secret Investment Strategy”

Over the past few years banks have been eager to lend money while being less than careful in checking the ability of the borrowers to pay back. In particular numerous mortgages were loaned to sub-prime borrowers (ie those with impaired credit records) by commission hungry salesmen. These risky debts were re-packaged and sold on to other institutions, thus finding their way throughout the financial system.

Once the economy took a turn for the worse sub-prime borrowers began to default in large numbers (according to http://www.realtytrac.com/ nearly 1.3 million U.S. housing properties were subject to foreclosure activity in 2007, 75% up from 2006).

Having had their fingers burned banks became far less willing to lend to one another thus resulting in a lack of available funds, or credit crunch.

The credit crunch has seen the collapse of 2 major banks. Bear Stearns in the US was forced to “merge” with JPMorgan Chase while in the U.K. Northern Rock was forced into nationalization after experiencing the first run on a U.K. bank since Victorian times.

The most notable effect has been in the real estate market with US prices dropping 11% in the year to January 2008 (according to Standard & Poor’s/Case-Schiller index) and U.K. prices dropping 2.5% in March alone (The Halifax House Price Index).

The stock market has been extremely volatile of late with large daily swings, and overall losses. The Dow is down 13% on the 12-month high with the FTSE 100 down 12% on its 12-month high.

Central banks on both sides of the Atlantic have taken different approaches to interest rates in light of the crisis. The Fed has slashed rates 6 times by a total of 3% from 5.25% to 2.25% in a bid to stave off recession. However the Bank of England has made just 3 rate cuts from 5.75% to 5% amid fears of rising inflation.

Significantly in the U.K. mortgage rates no longer seem linked to the Bank of England interest rate. Despite the Bank rate falling, rates available on both new and re-mortgages have been rising with many mortgage deals disappearing from the market altogether. Until recently in a climate of prolonged house price increases it was possible to borrow up to 125% of a property’s value. Last week saw the loss of last 100% mortgage deal.

So, what’s to come?

Will the economy dip into recession? And if so how severe and prolonged will it be? How much further will real estate fall before it hits the bottom? Where should investors and savers be looking for the best – and safest – returns?

If you’re a homeowner, don’t panic. Your home still has the same value to you. If your mortgage deal is ending soon, now’s the time to shop around for a new deal as things ma get worse before they get better. If you find you are getting into difficulty with mortgage payments, talk to your lender – the last thing they need right now is another foreclosure so they really ought to bend over backwards to find a way to keep you in your home. Investors with funds might be able to pick up some real bargains, but caution is the order of the day.

Savers may find some good deals by shopping around. After all, banks desperately need incoming funds so they can stay in business. But you may want to take extra care in choosing what institution you place your money with. Bear Stearns and Northern Rock might not be the final casualties, so find out what compensation schemes they are covered by should they run into difficulty.

With stock markets significantly down there are bargains to be had. Don’t try to guess the absolute bottom; rather drip-feed your investments into the market either in low-cost trackers, or in handpicked stocks seeming to offer best value.

Finally, remember economies are cyclical by nature. There are good times, and bad times – but bad times are invariable followed by good!

Despite recent reductions in the Bank of England’s interest rate “Now families face £1,300 a year mortgage increase” reports that mortgages are actually rising by substantial amounts. Those coming to the end of fixed-rate and discounted deals are likely to be hit particularly hard. If you find yourself in this situation, shop around carefully for a new deal, taking account of any exit and “arrangement” fees. And if you are finding it difficult to keep up with payments, speak to your lender as soon as possible. Remember, lenders wish to avoid foreclosure as much as borrowers, and will often try to find a way for you to keep your home.

Hoping to profit from falling prices “Why more families are choosing to sell up and rent instead” reports that as many as one in five homeowners planning to move are thinking of pocketing the cash and renting instead in order to buy again at lower prices. There’s nothing wrong with speculating on financial markets, and many a fortune has been made this way, but to do so with the very roof over your head is indeed a high-risk strategy.

In a free market the current price for a good (ie housing) is pretty much its right price. No one can say whether the next move is likely to be up or down. Taking account of realtor fees, legal costs, mortgage fees, moving costs, inspections… not to mention the high costs of private renting in GB, prices would need to fall quite considerably before any significant gains could be made from this strategy. It also means giving up the satisfaction and dignity of ownership. Without claiming precognition, this is one strategy I’d steer well clear of.