Financial Crisis 101 - 10/13/08

November 12, 2008 2:33:55 PM PST
We're going to use this space for awhile to try to keep you up to date on the financial crisis. It's obviously a very complex issue, and peoples' eyes tend to glaze over when the experts start throwing around words like recapitalization, collateralized debt obligations and credit default swaps.

Join the club.

So I'm going to do my best to explain some of the main developments of this crisis on a daily basis in a way that we can all understand.

First things first: Don't get too frustrated by the fact that different economists and business experts have widely differing opinions about what's going on and what should be done. That's just the way it is, so we have to plow through the enormity of information as best we can.

Please don't expect that I'll say anything that's meant to be interpreted as advice. For heaven's sake, go elsewhere for that.

Please don't think that a good day in the stock market means the economy and the financial system's problems have been solved. The crisis was a long time in the making, and unfortunately, it will be a long time in the healing.

Having said that, it does appear that some positive steps were taken over the weekend that translated into a 936 point rally in the Dow Jones Industrial Average today.

The United States was able to join forces with European countries to make a move to improve the financial structures of the banks in the respective countries.

The hope is that banks will feel more comfortable in their own abilities to lend money to other banks and private companies. Over the last several weeks, the bloodbath on Wall Street has been a function, most of all, of the credit market freezing up. Lending and borrowing are the engines of capitalism, and when the credit market freezes up, everything comes to a screeching halt.

Screeching halts don't play well on Wall Street, and eventually Main Street. They cause anxiety and then panic, and that's what's been going on for several weeks.

Even the initial version of the infamous 700 billion dollar bailout plan didn't seem to help restore confidence, but the Bush Administration has changed things on the fly.

The original plan was to use the money to buy up the bad mortgages that were strangling banks. Now, the federal government says it will actually give the banks cash so the banks can increase their equity in relation to their debt.

Translation: to make them healthier, and more likely to start lending money again. Of course, the banks will pay a price for the lifeline from the taxpayers. The government will have a partial ownership stake in the banks it helps. We'll be forgiven if we think that sounds a little like nationalizing the banks, which is stunning, not only in a capitalist society, but especially when the action is taken by a Republican Administration that is ideologically committed to free markets and detests the idea of extreme government intervention.

We've all heard so much about how the American economy is now interwoven with the economies of every other country, and that's why this weekend's concerted action by the U-S, and the countries of the European Union was so vital.

Great Britain, France, Germany, Spain, Italy and others have announced plans to prop up their banks, and the U-S has committed to making money available so these bailouts will happen with U-S dollars.

Almost immediately, the interest rate that American banks use to lend each other money went down a smidgeon; not a lot, but a very small step in the right direction. Small steps in the right direction can cause a tsunami response on Wall Street where psychology is so much a part of the action. And that's what happened today.

Does that guarantee we'll see the same thing tomorrow? No way. When someone first said "there are no guarantees in life", they were probably thinking first about the stock market. But I'll check back with you then.

Jim Gardner


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