By Shannah Compton

Traditionally September is a great month. The seasons begin to change. The weather begins to shift. Kids are back in school and mom can finally get a reprieve. Stores are all a glow with Halloween decorations.  And you can finally pull out your tall boots, cute sweaters, and great fall jackets. However, this September, September 2008, will forever be known as the month when America’s economy took a turn for the worse and panic began to paralyze us all.

It probably wasn’t until a week or so ago that you really became aware of how perilous our economic conditions are in the country. One day, out of the blue, you saw it everywhere. “We are in a depression. It is Armageddon.”  You heard about the $700 Billion Bailout everywhere. You heard about the 777 point stock decline; the biggest one day Dow point drop in history. Maybe you took a look at your 401K or IRA balance and wanted to cry.  If anything I hope the recent inescapable news, radio, and press coverage of our economy has you curious for some answers.

Being a Gen-Xer myself I am often confused about the news that is generated from Wall Street and Washington. I am an inquisitive person and am always searching for the answers to our headlines. It seems to me that I am not the only one who is curious about our economy as I have received many emails and phone calls from young professionals asking me to explain to them just what is happening. Below is my summation of our current situation and the potential impact that it has on each and every young person.

Give me the bottom line. What is the REAL issue we are dealing with?

The real issue is that it is VERY DIFFICULT, from large institutions to the individuals like you and me, to borrow money (or get credit) from any bank in the pursuit of normal activities (home loans, business loans, personal loans) be it personal or business related.

What is going on?

I have outlined below the normal process for the banking system.  Up until recently this is how the banking system operated and explained how you and I are able to obtain loans for homes, cars, new businesses etc.

1.       Bank makes a mortgage (loan) to individual to buy a house.

2.       The bank sells the loan with other loans that are packaged together to either Freddie Mac, Fannie Mae, or other investment bankers that are going to resell the package. This is done worldwide.

3.       The process of the reselling of loans is that the initial bank retains servicing on loan (they continue to receive your mortgage payments just as if they still had the loan) but then they remit your payment short of a servicing fee to the parties that now own your loan.

4.       By this process of selling the loan the bank received the capital back from your loan which allows them to make a new loan.

5.       These parties buy these packages because they anticipate making a profit either by collection of the interest or by reselling the loan.

6.       Many times these loans are sold to large pension plans or other institutions that are looking for an ongoing stream of income from these loans.

7.       In recent years many of these home loans from the initial bank were made with no income documentation, sub prime conditions, no money down, on adjustable rate loans and even tri-option payment loans (you could pay traditional principal plus interest, just interest, or a teaser rate).

8.       As long as real estate prices continued to rise and employment remained high the dangers in this process were not apparent to many people.

9.       For some, where it was apparent, they wanted to continue the process since some of the people in the middle were making so much $$. Their goal was to sustain it as long as it was sustainable.

How did this process change?

• One thing not always apparent to the person on street is that when these packaged loans were sold for the 2nd, 3rd, or even 4th time, the last buyer might have little knowledge of the basis on which these loans were made. In other words, no income doc, no money down, unreasonable appraisals, and many loans had adjustable rates after some period of time, often after 12 months.
• Once interest rate adjustments go up some people became unable to make payments. (Loans were adjustable in 3, 5, or 7 years, but some loans adjusted after 1 or 2 years and as little as 6 months.)
• As interest rates ticked up on these loans this process began to feed upon itself as more and more people couldn’t make payments, massive foreclosures began to happen, and real estate prices fell. This is further aggravated by a lesser demand for new homes which then placed builders in a position of needing to lay people off their jobs. This then increased unemployment, which then created an even greater body of people that couldn’t pay their loans!
• As this process began to further feed on itself fewer and fewer institutions were willing to buy these loan packages.
• Therefore this back logged these loan packages up to the point where the bank couldn’t sell them anymore.
• The banks couldn’t make new loans because they were fighting to maintain their reserve requirements required by FDIC or State banking authorities. (Banks have to maintain 8% of reserves currently. So if they have 100 million in a loan package that can’t be sold then they can’t make new loans. So this can have an effect on their reserve restrictions because these loans are not liquid and no one wants to buy them. So the banks become very conservative and don’t want to lend money to anyone….not even to other banks which is normally an everyday occurrence in the US banking system.)
• This begins our great liquidity problem where the buyer, with good credit and a good down payment, finds himself in a situation where it is at best very difficult to obtain a loan for a home. If you are a business and you need to borrow money periodically to fund your payroll the business can no longer borrow money. So when it can’t borrow money it has to lay of people and in the worst case file for bankruptcy.
• So, again, this process begins to further feed on itself.

What does this mean to you?

While many of you are not homeowners and will not feel the immediate effects of the slump in real estate prices, you will all defiantly feel the effects of our economic situation in one way or another.

First, if you own a home it is very likely that your home value has declined significantly over the last few months. If you are trying to sell your home it will be very, very difficult. While home buyers are out there they are having extreme difficulty getting a loan. Plus they are concerned that home prices may fall even further. As a result your home is likely to stay on the market for many, many months.

Second, there is hardly anyone in the US who has not seen a noticeable decline in their 401K/IRA balances.  Take a deep breath though because you are not alone. The good news is that if you are young you have a long time horizon until you will need your money for retirement. Many of us have a good 30 years if not longer. What this means is that you have a lot of time to recoup your losses. It is a fact that every bear market (meaning less than perfect economic situations with high unemployment, a down stock market, and potential inflation) is followed sharply by a bull market (good economic conditions, low unemployment, exceptional stock market performance etc.)  No one likes to lose money and in fact I may be the poster child for a sore loser when it comes to money. However please do not make any rash decisions, do not pull your money out of your 401K/IRA and please do continue to make contributions.

Third, if you are planning to obtain a student loan anytime soon you might want to put it on hold. Student loans are becoming ever more difficult to obtain due to the credit crunch. In fact a handful of federal lenders have backed out of the student loan business for good which means there are even fewer companies that will lend money for loans. Let this be a reminder that it is vital that you keep your credit score in the superb range (above 700, above 720 is optimal).  Applicants who have fair to good credit scores are being turned away.

Fourth, credit card debt, just like mortgage debt, is bundled and sold in packages as discussed above. Thus the era of easy credit has come to an end. Many credit card companies have less credit they can extend and are raising their interest rates sharply. To avoid these sharp fees remember to pay your credit card bills off when they are due and don’t ever miss a payment.

Fifth, is your job. It is crucial to make yourself invaluable at work given these economic conditions. Take on a new task, learn a new skill, stay one step ahead and turn into your company’s most valuable player. Businesses are suffering just as bad, if not worse, than most individuals. Businesses are not able to easily borrow money from banks and face the consequence of having to downsize.  In this vicious cycle businesses are weary to hire new employees as well.

What now?

It is almost a tradition that during election years the economy is unstable.  This year is proving to be no exception.  The new $700 billion bailout package is sure to keep whichever candidate is elected very busy into the New Year. Whichever candidate is elected most certainly has an uphill battle ahead to stabilize the US Economy and soothe the worries of every American.  As young people we are witnessing one of the biggest financial disasters since the Great Depression in the 1930′s. It is no doubt that we will be paying for our economic mistakes for a large portion of our future. I don’t know about you, but this certainly is not the legacy I wish to leave.

My goal is that this article has encouraged you to be more proactive with your finances. My wish is that when economic news is splashed all over the TV and newspapers that you are encouraged to step back, take a breath, and educate yourself about the real issues at hand. It’s time that we take charge of our futures and arm ourselves with the education to not only build a strong financial future for us and our families but also for the future of America.

Please feel free to email me any questions or thoughts you have about this article or the current economy at shannah@slcinsuranceservices.com.

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