Maxed Out!
"We are enjoying difficult economic times...."
President George H W Bush, 1991
It looks like we are starting to enjoy them again, this time under the second President Bush. Many of our largest banks and investment bankers have posted record losses this past quarter, and the stock market is tanking fast, spurred by the sub-prime lending fiasco.
Unlike previous recessions which were caused by over-production, the one now underway is due to a "credit crunch", and is therefore more serious. Recessions caused by over-production are self-correcting, because eventually the surplus goods are sold, and then laid-off workers are called-back or replaced.
The US economy today depends heavily upon consumers buying on credit. The average American household owes about $9,000 in credit-card debt, in addition to car-loans, mortgages, and student-loans. One study even claimed that in 2006 the average American family actually spent more than it earned---- instead of saving for retirement or financial emergencies, the average family was going deeper into debt!
Although this type of economy can produce years of prosperity as people keep borrowing and buying, eventually the burden of debt will become too heavy to bear, and the system will collapse.
Although you can keep a credit-card active by paying the absurdly- low "minimum payment" each month (1), interest charges will accumulate until the balance owed bumps into the credit limit; at which time the card is "maxed-out." You cannot buy anything with it until you pay the balance down. As long as you can keep opening new credit cards, you can keep buying. You can stay out of "default" by paying the minimum on each.
The trouble is that, sooner or later, no one will lend you any more money. Banks and other lenders can find out how much you owe through credit-reporting agencies, such as FICO(2). Some homeowners have used home-equity loans to finance their consumer spending, but in today's declining real estate market, many of these people have little or no equity in their homes! Those who cannot keep borrowing will have to seriously cut non-essential spending or face bankruptcy.
For this reason, retailers reported declining income during the last quarter of 2007. This news sent retail stocks plunging at the same that bank stocks tanked thanks to the billions in bad loans. The Federal Reserve is trying to stimulate borrowing for investment by cutting interest-rates. Meanwhile , President Bush and congressional leaders are proposing income-tax rebates, tax-cuts, and/or other "stimulus"packages.
But what can you do to protect yourself from the adverse effects of this economic turndown?
1. If you own stocks, sell them now.
This advice would have been worth more a few moths ago,when the Dow-Jones Industrial Average was near 14,000.(3) But chances are that stock prices will sink further as consumer spending drops, so you should get out now.
2. If you have a job, keep it!
Huge numbers of employed people are unhappy with their boss, their jobs, their pay, and their general situation. Many would love to quit their jobs and open a business or even go back to college or yeshiva. Such a move is risky even in the best of times, and is close to financial-suicide now. Henry David Thoreau once wrote that "most men lead lives of quiet desperation." Keep being one of them for now.
3. Reduce debt.
First, if you don't need something, don't buy it. ( I know that this advice will only make the Recession worse, but put your own interests first.) You don't have to drive a new car or always use the latest electronic gizmos. ( I drive a 1991 model, and I always get where I'm going.)
Once you have reduced your monthly spending to something less than your monthly income, use the money left-over to pay-off debt, highest- interest debt first. If you don't owe any money, save what you can in a bank account.
The American economy will re-stabilize after this recession, but probably on the basis of lower home-prices and lower debt-to-income ratios. We can live with that!
-------------------------------------------------------------------------------
(1)Like $15 per month on a $2,000 balance. If the interest rate is 12% (lower than many credit-card rates), the borrower will never get out of debt!
(2) Fair Isaacs Credit Organization.
(3) Since I realized that this advice would trigger a sell-off on Wall Street, I sold all my stock before writing this Glazerbeam.
President George H W Bush, 1991
It looks like we are starting to enjoy them again, this time under the second President Bush. Many of our largest banks and investment bankers have posted record losses this past quarter, and the stock market is tanking fast, spurred by the sub-prime lending fiasco.
Unlike previous recessions which were caused by over-production, the one now underway is due to a "credit crunch", and is therefore more serious. Recessions caused by over-production are self-correcting, because eventually the surplus goods are sold, and then laid-off workers are called-back or replaced.
The US economy today depends heavily upon consumers buying on credit. The average American household owes about $9,000 in credit-card debt, in addition to car-loans, mortgages, and student-loans. One study even claimed that in 2006 the average American family actually spent more than it earned---- instead of saving for retirement or financial emergencies, the average family was going deeper into debt!
Although this type of economy can produce years of prosperity as people keep borrowing and buying, eventually the burden of debt will become too heavy to bear, and the system will collapse.
Although you can keep a credit-card active by paying the absurdly- low "minimum payment" each month (1), interest charges will accumulate until the balance owed bumps into the credit limit; at which time the card is "maxed-out." You cannot buy anything with it until you pay the balance down. As long as you can keep opening new credit cards, you can keep buying. You can stay out of "default" by paying the minimum on each.
The trouble is that, sooner or later, no one will lend you any more money. Banks and other lenders can find out how much you owe through credit-reporting agencies, such as FICO(2). Some homeowners have used home-equity loans to finance their consumer spending, but in today's declining real estate market, many of these people have little or no equity in their homes! Those who cannot keep borrowing will have to seriously cut non-essential spending or face bankruptcy.
For this reason, retailers reported declining income during the last quarter of 2007. This news sent retail stocks plunging at the same that bank stocks tanked thanks to the billions in bad loans. The Federal Reserve is trying to stimulate borrowing for investment by cutting interest-rates. Meanwhile , President Bush and congressional leaders are proposing income-tax rebates, tax-cuts, and/or other "stimulus"packages.
But what can you do to protect yourself from the adverse effects of this economic turndown?
1. If you own stocks, sell them now.
This advice would have been worth more a few moths ago,when the Dow-Jones Industrial Average was near 14,000.(3) But chances are that stock prices will sink further as consumer spending drops, so you should get out now.
2. If you have a job, keep it!
Huge numbers of employed people are unhappy with their boss, their jobs, their pay, and their general situation. Many would love to quit their jobs and open a business or even go back to college or yeshiva. Such a move is risky even in the best of times, and is close to financial-suicide now. Henry David Thoreau once wrote that "most men lead lives of quiet desperation." Keep being one of them for now.
3. Reduce debt.
First, if you don't need something, don't buy it. ( I know that this advice will only make the Recession worse, but put your own interests first.) You don't have to drive a new car or always use the latest electronic gizmos. ( I drive a 1991 model, and I always get where I'm going.)
Once you have reduced your monthly spending to something less than your monthly income, use the money left-over to pay-off debt, highest- interest debt first. If you don't owe any money, save what you can in a bank account.
The American economy will re-stabilize after this recession, but probably on the basis of lower home-prices and lower debt-to-income ratios. We can live with that!
-------------------------------------------------------------------------------
(1)Like $15 per month on a $2,000 balance. If the interest rate is 12% (lower than many credit-card rates), the borrower will never get out of debt!
(2) Fair Isaacs Credit Organization.
(3) Since I realized that this advice would trigger a sell-off on Wall Street, I sold all my stock before writing this Glazerbeam.
posted by Gerald S Glazer at 10:32 AM
1 Comments:
Interestingly, after the "difficult economic times" of 1991, the stock market in fact did not go down but went up and went up every year until 2000. The NASDAQ went from about 375 in January 1991 to over 4000 by January 2000. If you had sold stocks during this recession you would have made the wrong move.
Similarly after 9/11 many people were predicting a stock market crash. In spite of the biggest attack on US soil ever and at the heart of our financial markets the stock market did not crash. The NASDAQ did fall from about 2000 on 9/11 to about 1300 one year later but steadily recovered every year after until it peaked at about 2500 at the end of 2007. Again, if you had stayed in the market you would have come out well.
On the other hand if you had sold all on 9/11, the amount you would have made would have depended on when you had re-entered the market. It is also possible you would have lost money if you entered at the wrong time.
The problem is how does one know when to re-enter the market? Will Mr Glazer send out an anouncement when it is now time to get back in?
History has shown, even over the past 20 years, that predicting the ups and downs in the stock market is very very tricky business. If one were actually able to predict market movements, thousands of stock analysts would be out of work or we would all be millionaires.
I think it is extremely irresponsible for someone who is not an expert on the markets to advise people on what to do with their money; and it is extremely foolish for anyone to listen to that advice.
While there is no doubt there is much bad news, this bad news is centered on one industry and one selective problem. In many other respects, in fact in most other respects, our economy is doing well. How bad this will affect the stock market and how long this problem will last and when the government will enact policies that will solve this problem are all unknown.
Therefore, if as Mr Glazer says that the "economy will restabilize", and I certainly agree with that, and knowing that it is extremely difficult to predict market moves; maybe the sensible thing to do is not sell all your stocks but to hold tight and wait it out. This policy worked in 1991 and 2001 and actually in the long term this investment policy has always succeeded. Even during the crash of 1929, those who held on or even bought stocks made millions even billions.
Post a Comment
<< Home