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What to Expect Now That the Rescue Plan Passed

We're not out of the woods yet, so get debt under control and don't make crazy investment decisions.

By Bob Frick, Senior Editor, Kiplinger's Personal Finance

October 4, 2008

The Emergency Economic Stabilization Act of 2008 has been passed by the House and signed by the President, and while it was bitter medicine to swallow, many of us are feeling better already. Without this relief for the credit markets, the economy could have been paralyzed -- just in time to make this the scariest Halloween ever.

You might have expected the stock market to soar when the bill became law on October 3. Instead, the Dow was down 157.47 points. Doesn't anything make the markets happy?

Not when the economy lost 159,000 jobs in September, the worst showing since March 2003, according to the Labor Department. We've now lost 760,000 jobs this year, which means the country will almost certainly in a recession in the coming months (see Credit Market Crisis Makes Recession More Likely).

In case you don't remember the last recession -- the one that followed the bursting of the tech bubble in 2000 -- it was a time of frustration and fear: frustration as we watched our shrinking investments portfolios and our disappointing raises and bonuses, and fear that we'd lose our jobs as well.

This recession could be particularly nerve-wracking because more shoes may drop as a result of the credit crisis. Will rising unemployment cause a spike in defaults on the millions of iffy mortgages still in the system? Let's hope not.

A few things we do know for sure. "This is going to be a very bad Christmas for retailers," says Gus Faucher, director of macroeconomics at Moody's Economy.com. Credit will be tight for both businesses and consumers, who will feel the pinch in the form of shrinking lines of home-equity credit and lower credit-card limits. As a result, says Faucher, business and consumer confidence is going to be "very poor."

Complicating things further is the fact that when times get tough we don't always make the smartest financial decisions. At one extreme, we're tempted to ignore our finances entirely. "All human beings are overly optimistic by nature," says Ronald Wilcox, a professor of business administration at the University of Virginia. When we go through prolonged periods of prosperity, we discount the possibility of bad times. When they come, we can go into shock.

Unload losing stocks. As a result, we resist selling losing stocks, telling ourselves on some level that if we don't sell, we haven't actually lost money. But selling some dogs now and taking capital losses could be a nice way to cut your 2008 tax bill, says Wilcox, author of Whatever Happened to Thrift: Why Americans Don't Save and What to Do About It (Yale University, $30).

At the other extreme, we may be tempted to "take all kinds of risks, crazy risks" with our investments just to maintain the status quo, says Don Moore, a professor of organizational behavior at Carnegie Mellon University.

Trim your debt. Your best strategy is to take a look at your overall family balance sheet, including investments and other finances. The government and the banking system aren't the only ones struggling with debt; the average U.S. household has more than $9,500 in credit-card debt alone.

That can't continue. And going on a credit diet means cutting expenses to pay down home-equity loans and credit-card balances. It also means socking away six months' worth of household expenses in an emergency fund -- a safety net that's especially prudent in a weak economy.

Right now those moves are more important than fiddling with your investment portfolio. Besides, "there's no good safe haven now," says financial adviser Brent Kessel. In the bear market of 2000-2002, says Kessel, you could find good returns in real estate and overseas stocks.Today, on the other hand, "there's nothing but T-bills."

Kessel is hopeful that Americans have begun to realize the credit party's over. As evidence, he points out that most people say they used the economic stimulus checks they received earlier this year to pay down debt and increase savings. "The number-one word to describe what's coming is adaptability," says Kessel, author of It's Not About the Money ... unlock your money type to achieve spiritual and financial abundance (Harper One, $25).

"As a species we've always adapted to new environments. It's no different when we're dealing with economic forces."

And while we're living more financially responsible lives as the recession works itself out, we can take comfort in one very encouraging fact. Brian Bruce, editor of the Journal of Behavior Finance, says that in the year following big, bad market setbacks, such as the 1987 market crash and the demise of the dot-coms, the average rise in the Standard & Poor's 500-stock index was 36.6%.

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