Wall Street Crisis

Filed in Rahel , THE BABBIES 8 comments

The top story over the last couple weeks has been the US economic crisis. Much has gone on in the 14 days to shape the future of Wall Street and the US economy overall. Our dear HDIC has asked me to tackle explaining this crisis and hopefully I’ll do a better job than CNBC is doing. If you have questions about any of the terms that I use in today’s post, please feel free to pm me or check out http://www.investopedia.com .

What and when it all went down:

A highlight of major events:

The last 4 years: As a result of lax underwriting standards, Americans began loaded their balance sheets (personal statement of wealth) with debt in the form of credit cards, mortgages, lines of credit, and car notes. Do you all remember that commercial where the guy is riding around his .05 acre home on a riding lawnmower gabbing about what material things he hand and that he was in debt up to his eyeballs? Well yes, that is what many Americans where doing. Many believed that with home prices raising the roof and their increases in salaries would keep up with the cost of the debt they were taking on.

As the average American was getting greedier, so were the investment bankers on Wall Street and the fly by night mortgage underwriting companies.

As mentioned before, underwriting standard became lax and subprime loans were being handed out left and right. A subprime loan is a loan given to a lender with a fico score less than 640 (640 is considered prime). Not only did many of these lenders have subpar credit, but in many cases they did not have to prove their income levels or collateral. Many Americans (and foreigners) were taken advantage of during this time, stories of people with lower fico scores and annual incomes of <$40K with mortgages of an upwards of $600,000 or more were being told more often. Some of you may now be asking how the heck can someone afford a $600,000 home, well, many lenders signed up for type of mortgage called an I/O ARM (interest only adjustable rate mortgage). From investopedia, an I/O ARM loan is a loan where during the interest-only period, only the calculated interest must be paid; no principal must be repaid. The length of the interest-only period varies with each mortgage type. After the interest-only period, the mortgage must amortize so that the mortgage will be paid off by the end of its original term. This means that monthly payments must increase substantially after the initial interest-only period lapse. Many times these mortgages had a initial teaser rates. 1%-2% for the first year or two and then would rise sharply to 10%, 12% or more. No need to go into an explanation here, this was a recipe for disaster.

The investment bankers on Wall Street also got in on the action. Mortgage backed securities (MBS) are a type of asset-backed security where cash flows are backed by the principal and interest payments of a set of mortgage loans. Payments are made monthly over the lifetime of the underlying loans to the investor. Investment bankers were bundling good mortgages and bad mortgages together in hopes that no one would really look to see what was inside of these MBS, and for a very long time, no one did. The investment bankers made money off of the fees attached to these investments; investors had no problems as Americans were generally making all of their mortgage payments so their investments were paying off. Then, foreclosure rates rose as a result of I/O ARMS loans resetting their teaser rates and the interest only period ended. Mortgage payments increased by 50%-100% post reset (take a minute and think to yourself how you would handle if your mortgage payment doubled, not many can swallow that). The MBS lost value as monthly payments stopped, and banks lost money. Foreclosure rates further rose as the economy got worse and people lost their jobs.

Early 2008: House values continued to fall as the housing bubble officially popped. Bear Stearns, a large investment bank, is bought by JPMorgan Chase in a deal orchestrated by and backed up by the government following a sharp decline in shares and a collapse in confidence in the company.

Summer 2008: The credit crisis is in full effect. Bank of America completed the purchase of Countrywide Financial. Countrywide is a financial services firm that was engaged mortgage banking that held many subprime mortgages. Federal regulators seize IndyMac Bank after it succumbs to the pressures of tighter credit, tumbling home prices and rising foreclosures. In early September, again as a result of a failing housing market, the government seizes control of Fannie Mae and Freddie Mac, two publicly traded companies that together hold or guarantee half of the nation’s mortgage loans. Lehman Brothers, another large investment bank, fails to keep its head above water and declares bankruptcy as the government refused to back a deal that would have saved the bank. Last week the U.S. government announced an $85 billion emergency loan to rescue AIG, saying a disorderly failure of the company could further disrupt already delicate financial markets and the economy.

Last Friday: The government announces a broad rescue plan for the financial system, including a program to buy hundreds of billions of dollars of bad mortgages and other forms of toxic debt that have been weighing down U.S. financial companies. Our treasury secretary estimates that this plan could cost an upwards of $700 billion (with a B people), but many experts estimate it could be much higher.

What the plan entails:

The bailout program being negotiated by the Bush administration and Congressional leaders calls for the government to spend up to $700 billion to buy distressed mortgages. After the Treasury Department buys up the troubled mortgages, it will try to resell them to investors. The plan is in early draft mode but if you would like to read details, visit http://www.nytimes.com/2008/09/21/business/21draftcnd.html. On the surface this plan appears to be difficult to execute and is receiving much criticism from the general public as it is obvious that money does not grown on tree and we (the taxpayers) will be responsible for flipping the bill.

What happens if this bailout doesn’t happen?

If Wall Street fails, you will fail as well, it’s just a matter of time before it affects you. Many in the banking world got a taste last week when the commercial paper market FROZE. The commercial paper market is the place that businesses go to get very (overnight) short-term loans to fund their daily business operations. If that were to continue, businesses would not be able to operate, for example, pay YOU your wages. Without wages, taxes cease to be collected, and services such as public schools would suffer.

What do I do now?

Retirement:

That depends on how close you are to retirement. If you are retiring in the next 10-30 years, continue to invest in your 401K. Prices are low! I’m going to pause for a moment to say if your employer has a 401k (401B etc), and you are NOT investing, we need to talk. If you are closer to retirement, you shouldn’t be in the stock market anyway. Speak to your financial advisor and more likely than not she will tell you to put your money in safer places (i.e. exchange traded securities) .

Career/Job:

Update your resume (you should always be ready with an updated resume), and if you know you’re in a dying industry, consider going back to school or making a change in careers. Other than that, perform well, as this isn’t the time to get fired. Many BABs can attest that this is not the job market to be in.

Buying a house?

Many experts believe the market hasn’t bottomed out, but if you have the cash, there are deals to be had!

Hopefully I provided you with a little knowledge to guide you through this mess. If there are specific topic you would like for me to cover in this blog, let me know. Also if you would like to go into more detail in private or if you have any questions, feel free to email me at rlassegue@hotmail.com or pm me.

Posted by sweetpy   @   22 September 2008 8 comments
Tags : , ,

Share This Post

RSS Digg Twitter StumbleUpon Delicious Technorati

8 Comments

Comments
Sep 22, 2008
2:35 PM

Nice writing. You are on my RSS reader now so I can read more from you down the road.

Allen Taylor

Sep 22, 2008
7:22 PM
#2 Tangy :

Reading the articles on CNN, NY Times, and other news outlets can really get confusing, all the facts start to run together. Although I had a general overview of what was going on, it was hard to dissect exactly what happened, when it started and how it would directly impact me. I feel like I have a complete understanding of what is going on, especially with the bailout that is currently before congress. Thanks for doing this Rah.

Sep 23, 2008
2:33 PM
#3 Cherise :

Rah,

Very informative, I appreciate how you described this “Crisis” in laymen’s terms..thanks for breaking it down.

Sep 24, 2008
1:58 AM
#4 kendence :

Great Job Rah!!

Sep 24, 2008
3:13 PM

Wow, very interesting, & a well written entry. Thank you so much for this information.

Sep 25, 2008
1:54 PM
#6 Val :

Excellent Rah. I love the way you spelled this out because I was getting a little confused about this whole crisis myself.

Sep 26, 2008
12:30 AM
#7 Dee Dee :

You rock. We needed that.

Oct 2, 2008
12:26 AM
#8 Val :

Rah, you are my she-ro! LOL. Thanks!

Leave a Comment

CommentLuv Enabled
Previous Post
«
Next Post
»
Brown and Bridal Wedding Blogs designed by My Design Diva