I am an investment advisor with the mission of providing excellent client service while protecting client capital through bad markets. Please note, I emphasize “bad markets” — because the returns in good markets take care of themselves (think of those alleged monkeys who throw darts at stocks and do well in boom times).

So how shall an advisor protect client capital today? Recently, I was accosted by a family member who pointed out that the total sum of liabilities in the U.S. is 220 Trillion. Which means it’s bankrupt, right?

Please take note of the question mark at the end of that last sentence. It’s a question: Are we bankrupt? The answer is a resounding, “No.” Parts of the system, however, are indeed bankrupt. So, let’s just sit back here and analyze, let’s assume the system is bankrupt, and that for the next seven long years we will be working out our nation’s collective Chapter 11.

Chapter 11 is an orderly restructuring of a company during which some of the equity stakeholders may lose some or all of their investment value. The remaining creditors of the company are typically not affected at all. The purpose of chapter 11 (Chapter 13 if you are an individual) is to maintain the organization and to recapitalize the company in order to continue on a viable financial basis.

Chapter 7, on the other hand, is another name for “going out of business.” Chapter 7 is the point where creditors force a company to sell all of their assets in order to pay off the creditors.

The U.S. economy is not in danger of going Chapter 7.

The U.S. economy, however, can arguably be said to be in the midst of Chapter 11 bankruptcy. Remember, in Chapter 11, equity investors stand to lose their entire amount of invested capital.

The implosion of the housing markets is an example of this. Equity stakeholders (home owners), lost their invested capital in real estate when the properties they purchased declined in value more than the amount of equity that they have invested.

The real estate investor who is caught with zero or negative equity investment has lost the value of his investment. However, as long as he can maintain the standing with the mortgage, he has not gone chapter 11. However, when he know longer can pay the mortgage, then the losses must be realized. The equity investor loses his invested dollars, and probably his credit score is significantly affected.

That investor, however, remains an economic participant in the U.S. economy. He may continue to draw a salary, start a new business, or buy a new property. Bankruptcy implies a cessation of economic activity. Reorganization and the realization of investment losses doesn’t have the same long-term effects as going out of business.

The real estate market has suffered the equivalent of what Warren Buffet refers to as being caught “swimming naked.” Just like investors in failed dot.com companies or California restaurants, real estate investors lose their equity invested and then move on.

On a grander scale, neither the implosion of the real estate market nor the stock market is going to destroy Company USA. What the losses do is rebalance the playing field. Those who have lost have hopefully learned. Those who have lost have hopefully not been bailed out by the U.S. Government. At the moment, the big losers will be the purchasers of U.S. Treasury bonds. Long-term government bonds will only triple your money, including reinvestment of income, over the next 30 years. Eventually yields on treasury bonds will increase to accommodate the fact that only the re-inflation of our economy will facilitate the management of Company USA’s obligations. In fact, annualized 4% inflation will cut the debt in half in 18 years, and by 70% in 30 years. You can bet that the natural depreciation of the currency through inflation is going to exceed the current yield of 2.5% on the 10-year Treasury bond.

At Barnes Capital, we continue to protect client capital with municipal bonds, high-quality dividend-paying stocks, which continually raise their dividend — and gold and silver, which have protected wealth in every epoch spanning five millennia of bankruptcies, war and attrition.

Barnes Capital is a Registered Investment Advisor located at in downtown Lafayette. With RB Capital Management, Barnes Capital develops custom tailored portfolios for its clients. Specialized in retirement income portfolios, financial planning in an integral part of our process. Call 925-284-3503.

This entry was posted on Wednesday, September 1st, 2010 at 2:40 pm and is filed under Monthly Column. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.