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We have been informed by our leaders and many experts that the US financial system was on the brink of collapse last week. It probably was. And may still be. We’ve also been told that our entire economy is at risk. I think that’s a bit of a stretch and has the unfortunate effect of inciting emotion and panic rather than sound analysis and plain old common sense.
Our “financial system” is not equal to the economy. The economy is the exchange of needed goods and services. The financial system exists to facilitate that exchange. Our financial system has far exceeded that rather modest role. We have come to accept the mainstream message that the financial system creates wealth by creating money. But money isn't wealth at all. Some money is simply air.
If you own a house you have wealth in the form of shelter and security. If you bought the house for $100,000 you have a financial value. If your neighbor’s identical house has just sold for $300,000, you may very well increase your personal statement of net worth by $200,000 based on this one transaction. But the house—the tangible wealth—has not changed. This is fairly innocuous until you decide to go to the bank and cash in on that new value by borrowing $200,000 using your house as collateral. Still fairly innocuous, assuming you can make the loan payments. But, what if you discover that your house isn’t worth $300,000 anymore? Suppose it’s only worth $150,000. Now, you owe $200,000 but don’t have enough collateral to back the loan. The wealth you once had has dissipated—you no longer own the house—and you are left with a great big debt. Now, what if you had taken that $200,000 and used it as a down payment for another house? And what if the new house’s value goes down? All of a sudden you are saddled with lots of debt but fewer assets.
This is what the experts mean when they use the polite term, “leverage.” They really mean debt—too much borrowing against assets. Wall Street took this concept and put it on steroids by using all kinds of tricks, called derivatives, to borrow as much as possible with as low a down payment as possible. It all looked great until the assets at the bottom of the pile of debt started losing value. And then, like a game of Jenga, it all started to fall apart.
As a financial advisor and former Wall Street professional, I find myself caught in alternating waves of nostalgia, sadness, relief and fear. It’s sad to say goodbye to the “good old days,” as flawed as they were. We lived in a speculative bubble that allowed us to make believe for awhile—fun but fictional. It’s a relief to have things finally come to a head. It had to happen sooner or later. There's just too much debt (leverage) backed by now-worthless assets like bad loans and securities structured from these loans. And it’s scary to witness the disaster response mentality of our leaders. It’s as if we can only deal with problems when they become crises—before that, we deny and ignore them. Perhaps, after scaring us into a war in the Middle East, our leaders have come to believe that this is an effective way to govern.
Was the financial system really on the brink of collapsing? In this environment of crisis management and hyperbole, we may never really know. However it is characterized, what I find fascinating is the presumption of control. As if Congress and the Treasury can swoop in and solve the problem. As if they can possibly believe that a country that has more than $9 trillion in debt can keep on printing money in order to save itself. In reality, it may be possible to ease or defer the pain, but, sooner or later, we will have to begin living within our means. It’s actually amusing to listen to the experts talk about “taxpayers” money when, in reality, the funds to rescue our financial system will be borrowed on the world markets. Of course, then it becomes the taxpayers’ obligation. So, it really isn’t our money—it’s our debt.
The one thing I know with certainty is that the people and institutions that got us into this mess are not going to be the ones to get us out of it. Not the Federal Reserve, not Wall Street, not Congress, and not the Administration. Yes, we can engage in discussion and debate about the “right package” and what Paulson had to say today and how the Congressional leadership is doing. But, in the end, my suggestion is that we focus on what we can actually do.
We have been told a horror story, but we don’t have to let it paralyze or immobilize us. And we shouldn’t believe everything we’re told. We need to test every statement, every scare tactic against our own experiences and what we know is true in our lives and communities. And we can choose to see that this “meltdown” is really a cleansing, a time that offers great opportunity to get back to the basics, to focus on what’s realistic and what we can accomplish at a local economic level.
Let’s get to the task of facilitating the efficient exchange of goods and services, which, in the process, employs people in productive capacities so they can then afford to buy what they need. It sounds simple, and it is simple. We have allowed ourselves to be convinced that the Economy is a god when, in fact, it’s our human system for getting things done. Despite the behavior of the Wall Street crowd, the economy is not a casino and does not need gambling to thrive. Much of the financial loss we are seeing is the equivalent of the big winner at the craps table whose luck has all of a sudden turned. If you weren’t at the casino, don’t be fooled into thinking that you’re a loser. Perhaps we’re really the winners.
Every one of us can take a leadership role in some aspect of our local economies. We can buy local food, shop at locally owned stores, enjoy neighborhoods and communities, and engage in financial transactions at the local level.
We can take our deposits to a locally owned bank, preferably a community bank. Talk with them about their financial condition, how many bad loans they have, and how they handle problems with borrowers. Look for the bank that tells you they keep the loans they make and work with borrowers to restructure when necessary. Open a checking/savings account with them. Consider putting your IRA in a bank CD. You are then directly facilitating the transfer of your funds to a borrower in your community who needs to use them.
If you have a financial advisor, ask about community loan funds and other opportunities to engage in your local economy. Or visit www.communityinvest.org for ideas.
Our financial system may be dissolving, but our economy is just getting going!!!
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