In the future, 2008 may be looked upon as the starting point of significant changes to our economy and how many of our financial transactions are handled. During this year, such names as Bear Stearns, Countrywide Financial, Fannie Mae, Freddie Mac, Lehman Brothers, and Merrill Lynch have disappeared or are no longer independent and in many cases, are a mere shadow of themselves when compared to last year.
At the time I am writing this article, Chairman Bernanke and Treasury Secretary Paulson are testifying before Congress regarding the proposed solution to Wall Street’s financial woes. At this time, the markets need a quick response in order to regain stability. Whether this will occur will depend upon many factors. Unfortunately, we have two Presidential candidates vying for the spotlight and the hopes that their own recommendations will be followed. We also have both parties beating the bandwagon toward a solution all the while pointing fingers at those to “blame”.
This financial turmoil and potential crisis is not the blame of any one group or industry. One of the initial catalysts may be one of this country’s greatest benefits, the right to own a home. During the last economic slow down, the Federal Reserve lowered the Fed Funds Rate to spur growth. The rates had dropped to a low of 1% during 2003. From 2002 through 2005, the mortgage rates were also low, and the result added millions of additional buyers of real estate to the market. Many could now afford a second home due to the low rates. Others were ‘moving up’ while still more became first time home buyers. The impact is now clear; add millions of additional buyers and the price of real estate climbs, and in this case, rapidly. During this period, many lenders also reduced the requirements to modest documentation and/or little or nothing down.
As interest rates returned to a normal range, this slowed the number of new loans being issued and slowed the rise in real estate prices. Unfortunately, the trend continued, and soon the number of sellers of real estate out numbered buyers causing the start of the decline in prices. With the slow down and decline in real estate values, many lenders now had loans on the books that exceeded the value of the real estate backing the loan. While it may have started in the sub-prime markets, with the broad decline in values, problems migrated to higher quality loans as well.
The domino effect and impact continued to grow. Many institutions purchased packages of existing loans thinking there was sufficient collateral supporting the loans. However, as the real estate values continued to decline, what was thought to be a safe investment now had significant risk. While this alone did not cause our financial turmoil, it was a contributor. Could it have been avoided? That will be talked about for years to come, but regulators will try to add new safe-guards. These may prevent similar occurrences in the future, but I suspect many will be mystified by the far reaching impact some of the upcoming regulations will have.
In past decades, while our economy has grown, others have grown faster. This change in relationship of the U.S. economy to the world’s economy from what it was in the sixties and seventies to today, is also changing how we regulate, manage, and direct our economic growth. Earlier, when the U.S. economy sneezed, everyone else got a cold as well. This was due to the U.S. economy constituting a large portion of the world’s economy. Today, our portion of the world’s economy is significantly lower. As a result, when other economies are incurring economic booms, the demands on raw materials also impact our costs. Most of you should remember when China was growing at a very rapid pace in 2006 and 2007, the price of cement, steel, and other building materials here in the U.S. climbed rapidly. This is also a new paradigm. In the past, the Fed could raise interest rates to slow our economy and thus reduce inflation. With many factors impacting our costs arising from outside this country, the Fed’s tools do not always work as well.
Despite the financial concerns and extreme volatility, investing will be here to stay. But for today, remember not to make quick decisions without thought. Many have said the best time to buy is when others are running for the exits. For this to work though, you must have the staying power to see the recovery occur. These are times when it is best to have a financial professional assisting with the many decisions to be made.
HOW TO REACH THE WRITER
Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville, TN 37801. Be sure to mark your envelope Money Matters.
Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.
Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member FINRA, SIPC.