By Ernest Beck, MSN MoneyOK, let's all take a deep breath. Now exhale.
In the midst of a stomach-churning financial crisis, the average investor -- or just plain working Joe or Jane -- will likely benefit from a brief timeout to reflect and figure out what to do next.
True, the titans of Wall Street are warning that some of the financial institutions we depend on are teetering. But, hey, the cataclysm they fear hasn't happened -- not yet, anyway -- mostly because the government seems ready to step in with an unprecedented bailout, one that could eventually cost us, the taxpayers, more than $700 billion.
How did this crisis happen?
Throwing money at the crisis won't make it vanish overnight. And there's probably more pain to come. Witness the gyrations of the stock market as Congress debates the rescue plan's fine print.
Timeline: Wall Street panics in history
Navigating the crisis
But panic never pays when it comes to money. The key is to remain calm. So let's step back for a moment from headlines screaming "collapse" and "apocalypse" and assess what this crisis means to the millions of Americans with mortgages and bank accounts and 401(k)s to worry about.
On the street: Are you prepared?
For starters, here are seven tips for navigating the crisis:
1. Housing. Credit is going to be tight until banks can relax a bit. Only buyers with gilt-edged credit ratings will have easy access to mortgages. So this is not the greatest time to sell. On the other hand, if you have money stashed away and can come up with a hefty down payment, be on the lookout for a bargain that makes sense as an affordable home for the long term.
2. Home equity. If you've been thinking that equity in your home is your cushion against financial setbacks, think again. Don't count on a home-equity loan for extra cash to cushion you. Banks are nervous.
3. 401(k) accounts. Just the other day, legendary investor Warren Buffett invested $5 billion in a financial company. He knows what he's doing. Don't pay a "panic penalty" on your investments. Markets do recover over time, though it can take years. With stocks cheap, the smart money is looking for bargains.
4. Your job. You should anticipate that the boss will get bad news about her budget. That means your big raise will likely be postponed. Also, you might want to think twice about resources you manage. Start thinking about what expenses you could reduce.
5. Saving for a rainy day. The likelihood of a rainy day has increased. The outlook for the economy is not great.
2009 could bring additional bad news, including further weakness and more layoffs. Try to add to your rainy-day fund. If you don't have one, start one. A third of Americans have no emergency savings, according to the National Foundation for Credit Counseling, and 57% of those who have a fund don't have enough in it. It takes an average 4.5 months to find a job. So a good rule of thumb is that you should have three to six months of living expenses in the bank.
6. Insurance. One of the companies that took it on the chin in recent market action was American International Group, the world's largest insurance company. But AIG is an exception in the industry. Generally, insurance companies are on solid ground. If you have policies that seem fair to you, stick with them.
7. Household expenses. Treasury Secretary Henry Paulson remarked the other day that this is a "humbling time" for Americans. The American way of life is under pressure. Swashbuckling capitalism and gas-guzzling SUVs may not be the wave of the future. Though the price of oil has shown some weakness of late, you don't want to count on that as a long-term trend. You don't have to be humble, but be practical and efficient with your personal and household expenses. This is not a good time to waste money and fuel on a gas guzzler or a house bigger than you need. Things will probably get better, but they could get worse first.
Here's the good news: Your bank's ATM is still dispensing cash. Your 401(k) might be a bit dented, but it probably hasn't been flattened, if you heeded all that advice about diversification. And many indicators of the general health of the economy -- inflation, mortgage rates, jobs and salaries -- are holding fairly steady.
So: Apocalypse, not now.
"There is no doubt we have a very serious financial problem, but we are nowhere near the pain felt by society at large in past crises," says Doug Rediker, a former investment banker and co-director of the Global Strategic Finance Initiative at the New America Foundation, a Washington, D.C., think tank.
The bad news about the Panic of '08 is that we're going to be dealing with the aftermath for quite a while. That's because the crisis has roots that reach wide and deep. You didn't know it, but your home mortgage might be linked to a London hedge fund's arcane transactions and perhaps to a nervous AIG policyholder in Singapore. Untangling the web of connections and sorting out who owes what to whom -- and how much -- is going to be tricky.
Who are the winners and losers?
"It's messy out there," notes Mauro Guillen, a professor of international management at the Wharton School in Philadelphia. "This is a crisis with no easy solution.
Who the winners and the losers will be is not clear."
The nub of the world's problem is that financial institutions lent trillions of dollars to homebuyers
who were willing to pay higher and higher prices as the value of housing spiraled upward. It didn't matter that the price of a home was stratospheric -- it would be higher a month later. When the economy gained strength and interest rates began to climb, the upward spiral of home prices paused and then reversed, forcing buyers to sell and setting the reverse process in motion.
Many buyers found they owed more on their mortgages than their homes were worth. They started abandoning both the homes and the mortgages. Defaults began to skyrocket, first among subprime borrowers, and then, as the economy faltered, more broadly.
The mortgages involved weren't simple contracts between you and the bank. They had been sliced and diced and repackaged by nimble Wall Street companies operating with little oversight, then resold as mortgage-backed securities. When the real-estate market collapsed, the value of these sophisticated instruments became hard to gauge.
Uncertainty caused the market for the securities to freeze. When that happened, the value of the securities fell even further, and the large financial institutions that owned them had to take huge write-downs, in some instances facing bankruptcy as a result.
The goal of the big bailout now under consideration is to get the mortgage-backed securities off the books of troubled financial institutions and into the hands of the federal government, which can probably afford to hold the securities until things calm down. With a little luck, the federal government could break even or make money on the deal.
Keeping historical perspective
Want to know whom to blame? Well, it wasn't just the greed-is-good Wall Street moguls and deregulation-happy politicians who led us to the precipice, according to Guillen, the Wharton professor. He thinks we all have lived beyond our means. We have spent more than we've saved. We've wanted to own homes at any cost. Investors haven't been satisfied with fair returns on their money. They've wanted to make killings.
"Wall Street is to blame, but don't forget that everyone was very happy to take part in the big party," Guillen explains. "We are all responsible for what happened."
Let's keep all this in perspective. To be sure, the Great Depression was far worse than today's situation. Then, unemployment ranged as high as 40%, compared with 6% now. Interest rates are still low today. The economy is experiencing weak growth but not the full-blown contraction witnessed during the Depression.
If today's crisis is well-managed, the damage can be
contained. In the 1980s, the savings-and-loan debacle was painful and wound up costing the government an estimated $124 billion, but that outcome could have been a lot worse. Then, shrewd management of the crisis largely contained the damage to banking institutions and protected the broader economy. More than a thousand savings and loans closed.
A tough year ahead
Even with shrewd countermeasures, the average American will likely pay a heavy price for the mistakes our institutions have made. Our government is prepared to invest $700 billion in securities of questionable value. As taxpayers, we're all on the hook for that. The bailout includes a provision to raise the public debt limit to $11.3 trillion, from $10.6 trillion. That works as long as there's a market for bonds issued by the U.S. Treasury. Keep your fingers crossed.
"We have dodged a bullet by virtue of the fact that the U.S. is still in a good position to borrow from central banks and other investors," explains Rediker, of the Global Strategic Finance Initiative. "The great threat would be, what if nobody wants to lend? You would have to print money, which is inflationary."
Much depends on the adoption and successful execution of a bailout. In the unlikely event the current proposal isn't adopted, expect a hair-raising scenario of bank and business failures, layoffs and tight credit. If the bailout is passed and executed reasonably well, get ready for a garden-variety recession (or an extended version of the one many people say we're already in).
"Even with a well-structured bailout, we'll have a tough year ahead with rising unemployment and a slowdown in wage growth," figures Josh Bivens, an economist at the Economic Policy Institute in Washington.
The bottom line is that we have had a close shave with disaster, but disaster hasn't happened. If we can manage to muddle through the crisis with some common sense and some calm, there might be an upside.
After years of a wild, anything-goes free-market ride, new regulatory and financial models will emerge from the wreckage. Americans may use the crisis as an opportunity to set up a better financial system. Some tough love would be a good thing, Guillen believes.
"It is necessary to supervise and perhaps to regulate," he says. "Markets need some discipline."
Published Sept. 26, 2008
Produced by Elizabeth Daza / Graphics by Joe Farro and Sean Enzwiller
