Economic Crisis 101
By Cireal Americanus
After 8 years of non-stop financial partying, the U.S. is now waking up and asking that all too familiar question, “Where am I?” and “How did I get here?”. This was not a party just for the “Elite” of the Finance Industry but for every American. If you got financing of a car, a house, college tuition, or through a credit card/line, thereby living outside your means you too were enjoying this financial free-for-all.
This party would have continued had the Foreign Bond Markets not forced the U.S. Government to stop the music and turn on the lights. This occurred when the Foreign Bond Markets refused to purchase any U.S. Financial Products, i.e. Bonds, Asset-backed Securities, Securitized Assets, etc., because of what the Market has termed a “Crisis of Confidence”.
This all started when various lenders gave Sub-Prime Loans to buyers because of poor credit histories or for amounts far beyond what they were qualified to receive, i.e. High-Risk Mortgage Loans. These Sub-Prime Loans were then bundled together, through a process called Securitization, “Structured” in a way to make them attractive to investors and sold into the Local and Foreign Bond Markets in spite of the High-Risk Sub-Prime Loans they contained. Since there was no “oversight” for Structured Product content and no accountability to the Originating Financial Institution beyond the sale of the product, Banks played a proverbial financial “hot potato” with loan packages; buying for profit and quickly selling them to eliminate liability before these loans started to default.
These Bonds were backed with a psuedo-insurance policy called a “Credit Default Swaps (CDS)” which guaranteed the value of the bonds and reimburse any loss to the buyer/investor. Since these CDS’ generate a consistent revenue stream they are attractive to buyers in the same Markets as the structured assets they cover thus adding another variable to the ever increasing complexity of this problem.
Given the loss of jobs to foreign competition, corporate downsizing, and a weakened dollar many of these High-Risk Sub-Prime Loans are in/going into default thus causing their value to significantly decrease. This decrease is causing the Financial Institutions and investors to exercise their CDS’ to protect against their losses. Given that CDS Market is a $62 Trillion Dollar unregulated Market, you have many companies unable to fulfill their financial commitments thus being forced to close their doors or succumb to a buy-out from a larger company, e.g. Merrill Lynch, AIG, Lehman’s, Wachovia, etc. This has caused many Foreign Investors and Financial Institutions to refuse to purchase any Financial Products from the U.S. for fear that these products will prove to be a worthless investment when these Structured Assets are properly valued to the Market.
This is why the $840 Billion Dollar bail-out was needed. The bail-out is focused at buying many of these bad loans in the Market to allow financial institutions the opportunity to get this bad debt off their books and focus on developing means to strengthen their existing assets
Given this financial crisis, the average American is left with a few options:
- Don’t panic – resist the urge to make rash moves or react to hear say.
- Educate yourself – become aware of the activity in the financial market place and its trends.
- Develop a global investment mind-set – look for companies that have a solid presence in the Global market place vs. solid U.S. presence.
- Live within your means – avoid taking on any additional credit obligations and work to eliminate the ones you have.
- Seek expert advice – align yourself with a certified financial planner and/or accountant, Tax Attorney, etc.
Given the complexity of this crisis, a bit of prayer and vigilance seem to be the truest answer to this Economic Crisis.