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Week of 9.26.08

Q & A: The Financial Crisis and You

How will the current financial crisis affect average working Americans, and what should they do during these uncertain times? Pace University finance professor Ann Lee, a former bond trader who opposes the bailout proposal, addresses personal concerns about the country's economic mess.

How will the current financial crisis affect my savings and investments?

The answer depends on several factors that include which financial instruments one is invested in, how much, and where. According to the current FDIC program, every individual will be guaranteed up to $100,000 per bank. So if you have more than that amount, spreading your savings among several banks by buying CDs or opening multiple bank accounts will ensure the safety of your savings. Regarding investments, the answer will depend on the type of investment you own because every type of investment will perform differently. Stocks, commodities, bonds, etc. will all fluctuate differently in price and magnitude of price changes. The direction of prices for many of these investments will depend on multiple factors such as fundamental changes in government policy and changes in supply and demand for such investments.

What should I be doing with my money right now?

Since things are so uncertain with government interventions, I think it would be wise to be conservative and not try to jump into any risky securities even if they seem "cheap" according to some "gurus" on television. Even hedge fund professionals have been closing shop because they cannot make money in this financial market.

How about retirement funds, like my 401(k)?

The safety of your retirement funds is dependent on the competence of your pension managers. Some pension managers have made unwise investments and have suffered severe losses so it is very possible that your retirement funds are no longer sufficient to support your retirement any time in the near future.

People should be concerned because most pension managers do not have the flexibility of the best hedge fund managers to preserve capital. Nor do these managers get presented with the best opportunities to invest so the chances that your pension manager is going to provide you with the nest egg you envisioned is not a safe bet. People retiring right away will most likely have to reduce their standard of living substantially if they have not already saved something in their personal accounts separate from social security and their pension. People with more time before they retire should start saving aggressively now and not expect to receive social security twenty years down the road.

A number of reputable firms have gone under in recent weeks. Should I be concerned about the health of any other companies?

Yes, because many financial companies still have not offered any transparency on their accounting of illiquid securities that have been artificially inflated. They still have not come clean with their losses. Treasury Secretary Paulson is proposing to use a minimum of $700 billion in taxpayers' money to buy these inflated, illiquid securities as a last ditch attempt to save these companies. However, I have grave concerns that his plan will not work.

How will the proposed $700 billion rescue package affect me?

This rescue package will add at least an additional $3,000 in taxes to every American man, woman, and child. The rescue package will not give you mortgage relief, credit card relief, or any other relief. It is designed to give Wall Street firms relief so that they do not go bankrupt. The government will be buying securities that have almost no value in exchange for $700 billion or more. These securities have virtually no value because they are about ten degrees removed from the actual assets.

Can I expect my taxes to go up?

Yes, because the government debt burden will explode in size if Paulson's plan passes.

What if I need a college loan, mortgage or any other loan: Is that going to be more difficult?

It will be hard to get loans regardless of whether the bailout happens or not. The bailout will not make it easier to get loans because Wall Street banks are not going to loosen lending standards just because they can sell their existing bad paper to the government. If the banks free up their balance sheet to make new loans, they will remain highly stringent and conservative because they can no longer sell these loans to investors anymore now that investors no longer trust the banks. These banks now have to keep the loans on their books so as a result, they don't want to experience any defaults with anyone that doesn't have the highest credit scores.

If you have a decent credit history, there are still multiple places to obtain a loan. Many small regional banks and credit unions are not burdened by these illiquid securities so they can still make new loans. Additionally, many entrepreneurial websites have also sprung up that have loaned billions of dollars, even if your credit history isn't perfect.

Will we enter into a recession?

The economy will slow regardless of whether Paulson's plan passes or not. The United States has relied on a consumption-based economy in which it just consumes and doesn't produce an equal amount. The consumption growth has relied on credit growth through such products as credit cards, auto loans, student loans, mortgage loans, etc. Investors such as foreign central banks, hedge funds, pension funds bought these loans and securities that are correlated to these loans from banks and investment banks. However, when consumers started defaulting on these loans, the investors no longer wanted to buy these securities since they were losing enormous sums of money. Since banks could no longer sell bad loans to investors, the banks were stuck with them and thus have been unwilling to make new loans. The country will enter recession or even depression unless Americans can come up with a new engine of economic growth that will produce something of tangible value such as technology to clean up pollution or cures for cancer that the world will buy and thus create new jobs for Americans. Having the government support the existing consumption model through the $700 billion bailout to Wall Street will not jump start growth because Americans are running out of ways to pay for their debt.