What the banking crisis means for you | The Frugalista

What the banking crisis means for you

by frugalista on September 16, 2008

Jeez. I know I’m like most of you and captivated by the banking industry crisis.  Stocks are spiraling and people are wondering, what does this all mean to me?

I found this article online about some things people should watch about the Wall Street crisis.

Here’s the cut and paste of the Q&A:

Q: What does all this Wall Street volatility mean to me?

A:
If you have a 401(k), or shield some of your income from taxation
through an IRA or a lot of your retirement savings are in stocks,
you’ve already seen a sharp drop in value. The Dow Jones industrial
average is on pace for one of its worst years ever, but even if you’ve
parked your cash in a bank, today’s rising inflation is eroding its
value.

Q: Is this like 1929, when the stock market’s crash led to widespread bank failures and the Great Depression?

A:
No. The intervention so far by the Federal Reserve and the Treasury,
the existence of federal deposit insurance for national bank customer
accounts and the willingness of Congress and the president to fight the
downturn with fiscal policy all underscore that there are cushions in
place that didn’t exist 80 years ago. Still, today’s financial turmoil
could spread, and the economy could suffer more before stability
returns.

Q: Will the collapse of Lehman Brothers make things worse?

A:
It could, or it could make things better. The weekend meetings between
top federal regulators and senior executives of Wall Street firms
resulted in the surprise takeover of Merrill Lynch by Bank of America
and a lack of suitors for Lehman. Some analysts feared a Great
Depression-type of financial-market meltdown Monday morning, but
markets were orderly, not panicked, as news of the events sank in.

With
the government-brokered sale of investment bank Bear Stearns in March,
Bank of America’s absorbing of Merrill Lynch and the bankruptcy filing
by Lehman, Wall Street’s weakest players have been pushed off the field.

Goldman
Sachs, Morgan Stanley and JP Morgan remain the biggest traditional
investment banks, and Merrill is expected to keep operating under its
own name. The consolidation in investment banking has taken most
insolvency concerns off the table, and over a longer horizon, this
could point toward a return to stability.

Q: What about the shorter horizon?

A:
The chief executive of Bank of America, Kenneth Lewis, said Monday that
he didn’t see the clouds parting for his industry until 2010. Banks
that still have exposure to the complex mortgage bonds that are at the
heart of the crisis continue to get hammered. That includes Wachovia of
Charlotte, N.C., and Swiss giant UBS.

This
financial crisis is still rooted in bad mortgages that were packaged
into bonds and sold to investors. As long as home prices keep falling,
investment and commercial banks that own vast piles of those bonds will
keep taking write-downs and their bleeding will continue.

Q: How do these banking-sector problems affect me?

A:
Problems in the banking sector spill into the broader economy. As these
complex Wall Street investments sour, banks need to keep more capital
on hand to assure investors that they can weather any future losses
from loan portfolios. That means banks are playing defense.

If
you want a business loan, car loan, home loan, student loan or
virtually any other kind of loan, they’re hesitant to lend, lest they
wind up with more bad loans. With lending drying up, auto dealers are
sitting with inventory they can’t move and real-estate agents are
showing homes they can’t sell. The economy is slowing as credit is
squeezed.

The
crisis feeds on itself. As banks and corporations are perceived to be
short of capital and their stock prices fall, their need to raise
capital grows even as lenders are defensive. That forces them to sell
assets at low prices, and it becomes a vicious circle. That’s what
insurance and finance giant American International Group now faces.

Q: Given all these risks, why isn’t the government bailing out Lehman Brothers?

A:
Bailouts are in the eye of the beholder. The Treasury Department and
Federal Reserve determined that Lehman’s problems had been well
publicized since at least spring, other financial players had made
adjustments to that and Lehman’s failure thus didn’t pose a risk of
contaminating the broader global financial system the way the sudden
failure of Bear Stearns would have if the feds hadn’t intervened. But
make no mistake, a bailout of Wall Street has been under way since last
March, and deepened this weekend.

What
the Federal Reserve began in March and expanded Sunday is the practice
of taking all kinds of collateral in exchange for short-term emergency
loans to investment banks. Previously, investment banks had never
enjoyed this sort of borrowing because they aren’t regulated the same
way commercial banks are. The Fed now accepts as collateral a wide
range of debt, securities and even the controversial mortgage bonds
issued by the private sector and by Fannie Mae and Freddie Mac. The Fed
also is now lending to financial institutions that it doesn’t regulate.

What do you think?

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