What should ordinary investors do?

  • Article by: KEVIN G. HALL , McClatchy News Service
  • Updated: July 21, 2011 - 8:27 PM

Most advisers say to stay the course in order to avoid locking in losses and hurting their retirement plans.

As Congress lurches about in search of a deal to raise the nation's debt ceiling before an Aug. 2 deadline, ordinary investors are watching anxiously to see whether there will be a repeat of Sept. 29, 2008.

That's when lawmakers in the House defied the Federal Reserve chief's warnings, as the financial crisis was exploding, and rejected a Bush administration bank-bailout plan, objecting to such an expensive big-government intrusion into the private sector. That sent the Dow Jones stock index plunging 778 points in a single day.

'Largely ignore it'

As they were then, the retirement savings of ordinary Americans are at risk if Congress misses the debt-limit deadline. If it does, the government won't be able to fully cover its debts, which would cause the first default in U.S. history, risk panicking financial markets and sending interest rates soaring.

Most analysts still bet on a compromise, but the question is whether institutional investors will wait patiently for a last-minute deal or move before then by demanding higher rates for U.S. debt. That could force the hand of lawmakers and erode billions, if not trillions, in retirement wealth in the process.

So what's an average Joe or Jane to do? Get out of stocks until the debt-ceiling showdown is resolved? Get into bonds? Put savings under the mattress?

Most advisers say to stay the course, with a caveat. "Reaction to these kinds of market events is typically not a very productive approach," said Brian Reid, the chief economist for the Investment Company Institute, the trade association for large mutual funds and other investment funds. "Whatever happens here is going to be over and done with, and people who would have bought or sold into that period of uncertainty would likely lock in losses and hurt themselves in their 401(k) plan."

As the bullish chief investment strategist for Wells Capital Management in Minneapolis, Jim Paulsen advises investors to look past the debt-ceiling theatrics. He said, "The debt ceiling to me is way down the list. ... I think investors should largely ignore it."

Yet there's still a huge potential risk. If lawmakers fail to reach a deal, things could get ugly fast. It happened on Sept. 29, 2008. The Dow lost more than 7 percent of its value on the day that House Republicans led the defeat of President George W. Bush's initial bank bailout plan. Lawmakers reversed themselves four days later, but deep damage had been done.

'Scare the capital markets'

"That was the catalyst for the Great Recession. We were losing 750,000 jobs a month just a few months later," said Mark Zandi, the chief economist for Moody's Analytics. "There was just nothing to break the free fall."

There's no modern precedent for the world's largest economy defaulting on its debt. The difference between the European debt crises and the United States is that the dollar is the world's reserve currency and Treasury bonds often are used as collateral in all sorts of investment and business deals. Ethan Harris, the chief North America economist for Bank of America Merrill Lynch, warned: "Violating the debt ceiling would scare the capital markets, force at least a temporary credit downgrade to 'default' and it would potentially permanently damage the safe haven and reserve currency status of the dollar."

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