Money Rules Man by Ben Heine

If you’re not from the financial industry like me, you’d probably be quite clueless about what’s happening with the economy right now.

Aren’t you curious to know what is actually going on?

One moment, we had a booming economy, the next, things come crashing down.  Bills go up, salaries remain the same (hopefully?), investments are lost.  The million dollar question (pardon the pun) – where has all the $$ gone?

There is an overwhelming number of information sources out there on the current situation.  Yet all these seems to be plainly more of obfuscation than elucidation on the current global predicament.

So let me attempt to provide a simplistic explanation to the best of my knowledge.

The Subprime Mortgages

It started out in the U.S., where people were able to obtain loans without proof of income, employment status or guarantors.  With easily available loans and greed for material possessions, coupled with a lack of financial prudence – the consequence was predictable.  More importantly, these loans were made available to subprime borrowers.  Subprime borrowers refers to the group of people who have generally poor credit rating e.g. those who have a history of not paying their debts.

So what this means is, those people who were usually not able to afford homes, cars, televisions, etc. were suddenly able to – by living on future money that is.  Finance companies were offering easily approved loans and credit cards.  The catch? Higher interest rates, higher late payment penalties.  And it certainly doesn’t seem healthy for someone who has a bad credit rating to handle all these.

The Big Money by daviddmuir

But as with the nature of man, people started taking these easily available loans to buy homes, automobiles, home appliances, etc.  In late 2006, there was in increase in the number of defaulters in the US subprime mortgage industry – in other words, a lot of people couldn’t pay their debts.  Consequently, more than 100 subprime mortgage lenders went bankrupt.

To make matters worse, these subprime debts were packaged with other attractive investment offers and sold to other Asian and European financial institutions.  Thus, when the subprime mortgage crisis occurred, the other financial institutions suddenly found their investments practically worthless.  These losses made the financial institutions decide to be more conservative in issuing loans to other banks and businesses.  As a result, many healthy small businesses had to fold up due to cash flow issues, even though they were not involved with the subprime mortgage crisis.

The Involvement of AIG

Then what about AIG’s role? How did an insurance company play a part in fanning these flames to such great intensity today?  Let me just put it as simply as I can – you see, banks have to comply with a set of rules known as Basel II regulations.  They have to maintain a specific amount of capital reserves, with respect to the risk levels of the loans that they’ve issued.  To work around this regulation, banks turned to AIG to purchase insurance contracts, known as credit default swaps, to guarantee the subprime mortgages.  With this in place, they could account to their regulators that their outstanding loans had a lower risk than it really had.  Problem? AIG did not have the financial capability to guarantee all these credit default swaps.  Thus, when people started to default, the whole storm unleashed itself.

The Result

The Domino Effect by demian

Thus we start to see the domino effect.  Banks in other parts of the world who purchased the subprime debts and/or loaned money to the US banks were all inevitably affected.    Also, with the drop in demand for goods from the US, many companies in Asia whose major customers were from the US, faced dwindling orders.  Poor cashflow coupled with a dismal outlook for business started to cause many smaller companies around the world to file for bankrupty.  The man in the street who had invested his life savings into supposedly safe investments like Lehman mini-bonds suddenly sees all of that vanish into thin air.  Almost everyone was and will be affected by this financial crisis.  And it will probably take a few years for the economy to be healthy again.

Some Thoughts

With sales people in the financial institutions trying desperately to meet ever increasing targets, we are now seeing the consequences of them biting off more than they could chew.  More importantly, it is apparent that despite the top management taking their infamous hefty paychecks, they did not examine their own systems and consider the ecology of such systems.  Yet for the common folk, all they can do now is to tighten their purse strings and bite the bullet.

Nevertheless, as an individual, one should never be disheartened.  Continually focus on learning and acquiring marketable skills.  Even in an economic downturn, there are needs to be fulfilled.  People might reassesses what they want and/or need but end of the day, they will still have needs and/or wants.  It is up to your own innovation and creativity to keep producing value.  This might be hackneyed, but it is a timeless truth – we exist to provide value for one another.