Personal Finance: Part 2

Today’s “Thoughts” post concludes the two-part Personal Finance topic I started, you can find Part 1 here. In Part 2, I’ll be talking about the credit dilemmas, the recent round of Financial Market collapse, and a few other relevant ideas.

Starting with the credit crisis that’s happening now is important because it’s not only effecting Consumers & U.S. Markets, its traversed all areas of financial instruments globally. Regardless of whether you’re a small family in the rural towns of the Mid-West, or a huge conglomerate…the credit crisis has effected you.

In order to do business, you need money. Many times both the individual and the business have enough cash to conduct small to medium scale transactions. What happens when the deal gets too large?

When the time comes that a larger amount of finances are needed than your current cash reserves can provide, it’s here that credit fills the gap. This is where the current crisis comes into play.

The current economic state has lenders of all types cutting back on whom they lend to. Companies and individuals alike depend on credit to accomplish larger tasks, and when that source of funding is suddenly cut off, both the companies and individuals are left in the cold scrambling to fill in the gaps.

Even if you have a large cash reserve, you’ll find that evaporating quickly as you try to balance paying off past credit balances and operating day-to-day. When a business ends up having too much of their operations relying on credit it can become crippling to them (the same principal holds true for the individual).

Businesses had to scale back operations, and some were caught in the middle of huge deals or projects without funding to continue. Many institutions and corporations delved full-on into dangerous and highly risky financial areas like subprime lending. When those loans couldn’t be paid back the lenders themselves were now without cash, having to absorb billions and billions in write-downs of defaulted loans.

This created a double-whammy, businesses and consumers needed money to operate, and institutions and banks didn’t have it. Now without the ability to create new loans, these institutions and banks couldn’t generate enough revenue and capital to cover prior loses and get their balance sheets back into the black. Here is where the first major impact occurred, as giant Bear Sterns was on the brink of collapse and bankruptcy, and Citibank was in dire of need of major restructuring to stem the losses.

JPMorgan Chase was one of the few that positioned themselves well to ride out this crisis, and they did so by playing it safe early on and not diving into risky investments like subprimes. With guidance from the Federal Reserve, JPMorgan Chase bought up Bear Sterns for around $10/Share (Bear Sterns was a company that traded over $100/Share not too long ago). Citibank was under new management, and started the process of fixing their “leaks” by selling off units that weighed on the balance sheet.

The nightmare wasn’t over yet. After one giant had failed, another was now on the brink of collapse, while two more of the Big-5 were heading down that direction. Lehman Brother’s situation pretty much mimicked that of Bear Sterns, except they didn’t have a “white knight” to come riding in and bail them out, and so declared bankruptcy. The scene at their NY headquarters was very much like Enron’s years ago, as somber employees vacated the premises. Morgan Stanley and Meryl Lynch were heading in that same direction if they didn’t get new capital either through merger or buyout. Goldman Sachs was the only one of the Big-5 who were positioned to so far weather the storm.

To add salt to the financial wounds everyone is experiencing, lending giants Fannie Mae and Freddie Mac were also going to collapse. To prevent such an occurrence from happening, the Government stepped in and took them over. Insurance giant AIG was on the brink of collapse, but it was too big to allow failure and looming collapse, so it’s going to receive “help” to right its ship. The planned bill that will infuse enormous amounts of money into these failing businesses and sectors of the Economy, will hopefully help boost the Commercial Business, which in turn will hopefully improve Consumer Confidence & Spending.

We can’t have another round of huge companies collapse, because the ripple effect will cripple Economies not just in the U.S., but Global Markets as well. This is the main reason why Central Banks and Institutions from the around the world are joining forces to help out major sectors that are weighing heavily on their Economies. A good example of why it may not always be a good idea to let a giant collapse, would be AIG. While it’s certainly bad that we the consumers have to fit the bill, the ramifications of a giant like AIG going down would reach far and wide. First, the sectors that AIG does business in would all start dropping in stock price to the ripple effect of a major player falling, which would likely lead to consolidation in their respective industries (The Big-5 mentioned earlier in this article is an example of this).

With such huge failings on the Business side, both the laid-off employees and the consumers who use their products would suffer. Prices would increase due to higher demand, lower supply, and hardened times (for example more unemployment and less spending). This in turn would effect other Industries that would see significant drop-off in purchasing, and decreased revenues. Decreased revenues would then lead to more layoffs and for some eventual closure of business.

Without some interventions and corrections, that’s how one set of events can lead to catastrophic chain events that can have global ramifications. I personally believe that U.S. Markets will start to recover in 2009 (it may be a slow process though), and eventually the rest of the Global Markets will follow suit. Ofcourse any major news can offset this as times are really fragile, but the bailout bill/plans should prove very fruitful inconjunction with the incomming President.

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~ by drcorner on October 11, 2008.

4 Responses to “Personal Finance: Part 2”

  1. […] Personal Finance: Part 2 « DR Corner said this on October 11, 2008 at 7:20 pm […]

  2. Glad to see you back. Thanks for your insight. Here’s a link in the NY Times on Greenspan and the Federal Reserve as part of a series to explain what happened. http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html This led me to read about The Federal Reserve on wikipedia.

    The collapse seems to be a hybrid of government tinkering in some areas (Fannie Mae and Freddie Mae lending practices that loosened and even forced loans to unqualified buyers) to not enough regulation in derivatives to the overall attitude of borrowing to support an unsustainable lifestyle. Unfortunately, some of the same culprits who got us into this mess are advising our current presidential candidates.

  3. Hey Catherine, thanks for the great post, and thank you for the ‘Times article…it was a great read.

    You’re right. This, like most major issues, has been brewing for a long while, and is usually a culmination of many factors all comming together to form one giant reaction.

    Here, things like risky investments on a large scale, too-fast home-building, commodities rising in value to fast, and other factors all made for a bad combination.

    But, the one bright spot is that usually after major downturns, there’s a lot of boom and innovation resulting new ways of the world operating.

    I can’t wait for the next level of advancement. Who knows, maybe paperless money and/or a global economic unity may be on the horizon.

  4. Hey, Dr this is a great explanation of what’s been happening, I certainly agree that it was necessary to intervene, my concern is the rest of the picture, which is what will happen small & medium sized business? If the banks don’t loosen their grip on money, they are all going to be in trouble next. When the banks started calling all the lines of credit due, it is crippling small business. You can’t just stop the flow of working capital and expect any business to survive. I know so many credit worthy business owners who are struggling, thanks to the banks calling their lines of credit due. It’s crazy! I don’t know what the answer is, but thanks for the great article that precisely explained the current financial situation.

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