The same article has appeared in http://www.bizcovering.com/Investing/Investment-Ideas-for-the-Recession.365917. Go on, read it, and make me some money!
There's an old Wall Street adage that says 'Buy on bad news and sell on good news'. For people with secure jobs and ample savings, the current economic downturn may well turn out to be a golden opportunity. This is the perfect time to buy a new house or a car or that stock you have been planning to purchase for a while. You will find that people are actually eager to do business with you and you can snap up a few bargains on the go. The icing on the cake is that if you have a good credit history, this is also a great time to borrow. Interest rates are at the lowest and they might still go lower if the Fed continues to cut rates.
Painful as the recession is, it opens up some wonderful opportunities to the right investor. Here are some great investment ideas to take advantage of the recession-
1. Invest in a house
From 2000 to 2006 the value of the houses were steadily going up and a lot of builders had started building projects, but by the time their projects were finished we were suddenly in a recession. The fear that this is going to be a long recession has led many people to put off their purchases, especially something as important as buying a house. The increasing level of unemployment and layoffs has also forced many homeowners to sell their homes and move to another location where they are offered a job. All of this has resulted in situation where there are a lot of homes for sale, for which there are few buyers. So prices are falling and the sellers are forced to offer more attractive prices.
In addition to the falling prices, you may be pleasantly surprised to find that with demand going down, you suddenly have the power to dictate the terms of the deal. Your real estate agent may be willing to cut her commission or the seller may agree to make some modifications in the house at his own expense.
Due to the sub-prime crisis lenders may have tightened their norms, but for people with good credit history it is still easy to get a loan. With lower mortgage rates and better pricing, this is the perfect time to purchase your dream house.
2. Invest in a car
The U.S. car and light truck sales in 2007 marked the worst sales year in a decade. With oil prices at an all-time high and a bleak outlook on the job market, most Americans are putting off automobile purchases. Worried about the dip in the sales, auto makers are cutting into their profit and have started offering rebates and other deals.
There are also a lot of used vehicles for sale in the market. If you are worried about the depreciation of a new car, it might actually be a good idea to buy a used car. Demand for used cars is also waning due to the overall low demand and you may be able to get some very good deals in this buyers market.
3. Invest in stocks
With bad news after bad news, it might seem that the bad times will continue forever, but every recession has an end and better times will eventually return to the economy. Wise investors can actually use these bear markets to pick up high-quality companies that are selling for cheap. As a matter of fact, the stocks in the S.& P. 500 are now worth about half of what they were at their peak.
If you are worried that the recession is going to last for a while (the great depression lasted 10 years; but normally recessions last for one to two years at the most), then you can start a systematic investment plan, which will allow you to invest small amounts of money every month. A systematic investment plan is great because it allows dollar-cost averaging, or the ability to distribute the cost of purchase over a period of time.
Of course, it goes without saying that in tough times like these you must exercise due diligence. If you are fearful of loosing your job or does not have an emergency fund, then this is not the time to go buying that fancy car or a summer house. At the same time if you are financially sound or have been putting off that purchase just because you could not get the right price, then this is the perfect time to splurge!
Tuesday, December 16, 2008
Monday, October 27, 2008
But have we learned enough?
Here's an article reproduced from the NY Times by N. GREGORY MANKIW
LIKE most economists, those at the International Monetary Fund are lowering their growth forecasts. The financial turmoil gripping Wall Street will probably spill over onto every other street in America. Most likely, current job losses are only the tip of an ugly iceberg.
But when Olivier Blanchard, the I.M.F.’s chief economist, was asked about the possibility of the world sinking into another Great Depression, he reassuringly replied that the chance was “nearly nil.” He added, “We’ve learned a few things in 80 years.”
Yes, we have. But have we learned what caused the Depression of the 1930s? Most important, have we learned enough to avoid doing the same thing again?
The Depression began, to a large extent, as a garden-variety downturn. The 1920s were a boom decade, and as it came to a close the Federal Reserve tried to rein in what might have been called the irrational exuberance of the era.
In 1928, the Fed maneuvered to drive up interest rates. So interest-sensitive sectors like construction slowed.
But things took a bad turn after the crash of October 1929. Lower stock prices made households poorer and discouraged consumer spending, which then made up three-quarters of the economy. (Today it’s about two-thirds.)
According to the economic historian Christina D. Romer, a professor at the University of California, Berkeley, the great volatility of stock prices at the time also increased consumers’ feelings of uncertainty, inducing them to put off purchases until the uncertainty was resolved. Spending on consumer durable goods like autos dropped precipitously in 1930.
Next came a series of bank panics. From 1930 to 1933, more than 9,000 banks were shuttered, imposing losses on depositors and shareholders of about $2.5 billion. As a share of the economy, that would be the equivalent of $340 billion today.
The banking panics put downward pressure on economic activity in two ways. First, they put fear into the hearts of depositors. Many people concluded that cash in their mattresses was wiser than accounts at local banks.
As they withdrew their funds, the banking system’s normal lending and money creation went into reverse. The money supply collapsed, resulting in a 24 percent drop in the consumer price index from 1929 to 1933. This deflation pushed up the real burden of households’ debts.
Second, the disappearance of so many banks made credit hard to come by. Small businesses often rely on established relationships with local bankers when they need loans, either to tide them over in tough times or for business expansion. With so many of those relationships interrupted at the same time, the economy’s ability to channel financial resources toward their best use was seriously impaired.
Together, these forces proved cataclysmic. Unemployment, which had been 3 percent in 1929, rose to 25 percent in 1933. Even during the worst recession since then, in 1982, the United States economy did not experience half that level of unemployment.
Policy makers in the 1930s responded vigorously as the situation deteriorated. But like a doctor facing a patient with a new disease and strange symptoms, they often acted in ways that, with the benefit of hindsight, appeared counterproductive.
Probably the most important source of recovery after 1933 was monetary expansion, eased by President Franklin D. Roosevelt’s decision to abandon the gold standard and devalue the dollar. From 1933 to 1937, the money supply rose, stopping the deflation. Production in the economy grew about 10 percent a year, three times its normal rate.
Less successful were various market interventions. According to a study by the economists Harold L. Cole and Lee E. Ohanian, both of the University of California, Los Angeles, and the Federal Reserve Bank of Minneapolis, President Roosevelt made things worse when he encouraged the formation of cartels through the National Industrial Recovery Act of 1933. Similarly, they argue, the National Labor Relations Act of 1935 strengthened organized labor but weakened the recovery by impeding market forces.
LOOKING back at these events, it’s hard to avoid seeing parallels to the current situation. Today, as then, uncertainty has consumers spooked. By some measures, stock market volatility in recent days has reached levels not seen since the 1930s. With volatility spiking, the University of Michigan’s survey reading of consumer sentiment has been plunging.
Deflation across the economy is not a problem (yet), but deflation in the housing market is the source of many of our present difficulties. With so many homeowners owing more on their mortgages than their houses are worth, default is an unfortunate but often rational choice. Widespread foreclosures, however, only perpetuate the downward spiral of housing prices, further defaults and additional losses at financial institutions.
The Fed and the Treasury Department, intent on avoiding the early policy inaction that let the Depression unfold, have been working hard to keep credit flowing. But the financial situation they face is, arguably, more difficult than that of the 1930s. Then, the problem was largely a crisis of confidence and a shortage of liquidity. Today, the problem may be more a shortage of solvency, which is harder to solve.
What’s next? Perhaps the most troubling study of the 1930s economy was written in 1988 by the economists Kathryn Dominguez, Ray Fair and Matthew Shapiro; it was called “Forecasting the Depression: Harvard Versus Yale.” (Mr. Fair is an economics professor at Yale; Ms. Dominguez and Mr. Shapiro are at the University of Michigan.)
The three researchers show that the leading economists at the time, at competing forecasting services run by Harvard and Yale, were caught completely by surprise by the severity and length of the Great Depression. What’s worse, despite many advances in the tools of economic analysis, modern economists armed with the data from the time would not have forecast much better. In other words, even if another Depression were around the corner, you shouldn’t expect much advance warning from the economics profession.
Let me be clear: Like Mr. Blanchard at the I.M.F., I am not predicting another Great Depression. We have indeed learned a lot over the last 80 years. But you should take that economic forecast, like all others, with more than a single grain of salt.
LIKE most economists, those at the International Monetary Fund are lowering their growth forecasts. The financial turmoil gripping Wall Street will probably spill over onto every other street in America. Most likely, current job losses are only the tip of an ugly iceberg.
But when Olivier Blanchard, the I.M.F.’s chief economist, was asked about the possibility of the world sinking into another Great Depression, he reassuringly replied that the chance was “nearly nil.” He added, “We’ve learned a few things in 80 years.”
Yes, we have. But have we learned what caused the Depression of the 1930s? Most important, have we learned enough to avoid doing the same thing again?
The Depression began, to a large extent, as a garden-variety downturn. The 1920s were a boom decade, and as it came to a close the Federal Reserve tried to rein in what might have been called the irrational exuberance of the era.
In 1928, the Fed maneuvered to drive up interest rates. So interest-sensitive sectors like construction slowed.
But things took a bad turn after the crash of October 1929. Lower stock prices made households poorer and discouraged consumer spending, which then made up three-quarters of the economy. (Today it’s about two-thirds.)
According to the economic historian Christina D. Romer, a professor at the University of California, Berkeley, the great volatility of stock prices at the time also increased consumers’ feelings of uncertainty, inducing them to put off purchases until the uncertainty was resolved. Spending on consumer durable goods like autos dropped precipitously in 1930.
Next came a series of bank panics. From 1930 to 1933, more than 9,000 banks were shuttered, imposing losses on depositors and shareholders of about $2.5 billion. As a share of the economy, that would be the equivalent of $340 billion today.
The banking panics put downward pressure on economic activity in two ways. First, they put fear into the hearts of depositors. Many people concluded that cash in their mattresses was wiser than accounts at local banks.
As they withdrew their funds, the banking system’s normal lending and money creation went into reverse. The money supply collapsed, resulting in a 24 percent drop in the consumer price index from 1929 to 1933. This deflation pushed up the real burden of households’ debts.
Second, the disappearance of so many banks made credit hard to come by. Small businesses often rely on established relationships with local bankers when they need loans, either to tide them over in tough times or for business expansion. With so many of those relationships interrupted at the same time, the economy’s ability to channel financial resources toward their best use was seriously impaired.
Together, these forces proved cataclysmic. Unemployment, which had been 3 percent in 1929, rose to 25 percent in 1933. Even during the worst recession since then, in 1982, the United States economy did not experience half that level of unemployment.
Policy makers in the 1930s responded vigorously as the situation deteriorated. But like a doctor facing a patient with a new disease and strange symptoms, they often acted in ways that, with the benefit of hindsight, appeared counterproductive.
Probably the most important source of recovery after 1933 was monetary expansion, eased by President Franklin D. Roosevelt’s decision to abandon the gold standard and devalue the dollar. From 1933 to 1937, the money supply rose, stopping the deflation. Production in the economy grew about 10 percent a year, three times its normal rate.
Less successful were various market interventions. According to a study by the economists Harold L. Cole and Lee E. Ohanian, both of the University of California, Los Angeles, and the Federal Reserve Bank of Minneapolis, President Roosevelt made things worse when he encouraged the formation of cartels through the National Industrial Recovery Act of 1933. Similarly, they argue, the National Labor Relations Act of 1935 strengthened organized labor but weakened the recovery by impeding market forces.
LOOKING back at these events, it’s hard to avoid seeing parallels to the current situation. Today, as then, uncertainty has consumers spooked. By some measures, stock market volatility in recent days has reached levels not seen since the 1930s. With volatility spiking, the University of Michigan’s survey reading of consumer sentiment has been plunging.
Deflation across the economy is not a problem (yet), but deflation in the housing market is the source of many of our present difficulties. With so many homeowners owing more on their mortgages than their houses are worth, default is an unfortunate but often rational choice. Widespread foreclosures, however, only perpetuate the downward spiral of housing prices, further defaults and additional losses at financial institutions.
The Fed and the Treasury Department, intent on avoiding the early policy inaction that let the Depression unfold, have been working hard to keep credit flowing. But the financial situation they face is, arguably, more difficult than that of the 1930s. Then, the problem was largely a crisis of confidence and a shortage of liquidity. Today, the problem may be more a shortage of solvency, which is harder to solve.
What’s next? Perhaps the most troubling study of the 1930s economy was written in 1988 by the economists Kathryn Dominguez, Ray Fair and Matthew Shapiro; it was called “Forecasting the Depression: Harvard Versus Yale.” (Mr. Fair is an economics professor at Yale; Ms. Dominguez and Mr. Shapiro are at the University of Michigan.)
The three researchers show that the leading economists at the time, at competing forecasting services run by Harvard and Yale, were caught completely by surprise by the severity and length of the Great Depression. What’s worse, despite many advances in the tools of economic analysis, modern economists armed with the data from the time would not have forecast much better. In other words, even if another Depression were around the corner, you shouldn’t expect much advance warning from the economics profession.
Let me be clear: Like Mr. Blanchard at the I.M.F., I am not predicting another Great Depression. We have indeed learned a lot over the last 80 years. But you should take that economic forecast, like all others, with more than a single grain of salt.
Thursday, October 2, 2008
Why it is a bad idea to stop investing now
The markets are in turmoil. Everywhere you hear accounts of banks going down and banks being taken over by other banks. The stocks which you bought one year before, has halved in it's value. The markets are all heading southwards and the investor confidence is at an all-time low.No one knows for sure when the fogs will clear. So it is better to stop investing for the time being and wait for some semblance of sanity, right?
Wrong. If you are the kind of person who invests for your retirement or your child's college savings fund or any other long-term goal, it is actually a good idea to invest RIGHT NOW. This is the perfect time to get that overvalued stock that you have been tracking for a long time but couldn't buy because you thought the price was too high.
Fear and greed are two important factors governing market fluctuations. In times like these the most important thing is to remain focused on the fundamentals, so as not to get carried away by the daily volatility and swings in emotions. The fear factor is at an all-time high now which, when backed by tightened illiquidity can result in indiscriminate selling. This leads to a situation where the stock price becomes disconnected from the securitie's fundamentals. In other words the stock price is much less than the underlying value of the stock. In much simpler words it means that that overvalued stock that you have been tracking for a time might well be undervalued right now!
No one knows for sure when the markets will end their downward spiral but no body expects that it will continue for the next 20 years as well. Somewhere along the line the markets will correct themselves (no matter how painful the correction is) and then you will be happy you bought your stocks at those dirt-cheap rates.
If you read my blog "Is this beginning of the end" you might be thinking that I am double talking. The truth is that in this era of globalization, the big corporations are an entity by themselves and are not tied to the economy of one country alone. So even if the american economy is going down (I am an optimist though :)), they will still be making handsome profits elsewhere.
So what are you waiting for? Go grab that stock!
Wrong. If you are the kind of person who invests for your retirement or your child's college savings fund or any other long-term goal, it is actually a good idea to invest RIGHT NOW. This is the perfect time to get that overvalued stock that you have been tracking for a long time but couldn't buy because you thought the price was too high.
Fear and greed are two important factors governing market fluctuations. In times like these the most important thing is to remain focused on the fundamentals, so as not to get carried away by the daily volatility and swings in emotions. The fear factor is at an all-time high now which, when backed by tightened illiquidity can result in indiscriminate selling. This leads to a situation where the stock price becomes disconnected from the securitie's fundamentals. In other words the stock price is much less than the underlying value of the stock. In much simpler words it means that that overvalued stock that you have been tracking for a time might well be undervalued right now!
No one knows for sure when the markets will end their downward spiral but no body expects that it will continue for the next 20 years as well. Somewhere along the line the markets will correct themselves (no matter how painful the correction is) and then you will be happy you bought your stocks at those dirt-cheap rates.
If you read my blog "Is this beginning of the end" you might be thinking that I am double talking. The truth is that in this era of globalization, the big corporations are an entity by themselves and are not tied to the economy of one country alone. So even if the american economy is going down (I am an optimist though :)), they will still be making handsome profits elsewhere.
So what are you waiting for? Go grab that stock!
Monday, September 29, 2008
10 reasons why you should invest in a Roth IRA
A roth IRA is an Individual Retirement Account, through which you can invest in securities, usually common stocks or mutual funds. Other investments including derivatives, notes, certificate of deposits and real estate are also possible.
The total contributions allowed per year to a Roth IRA account is limited to $5000 for adults aged 49 and below and $6000 for individuals aged 50 and above. Starting in 2009, contribution limits will increase in $500 increments based on inflation.
Unlike a traditional IRA, when you contribute to Roth IRA, the contribution is not tax-deductible or you are paying tax upfront. Likewise, in contrast to a tradional IRA where you pay income tax on the entire amount of your withdrawal, in a Roth IRA you pay no further taxes on your withdrawal. Of course some restrictions do apply, the restricitons being that at the time of withdrawal, the account must have been opened for 5 years and that the owner's age is at least 59 ½.
What are the advantages of Roth IRA?
1. Traditional retirement accounts allow you to delay paying tax and that helps the account grow faster, but you'll have taxable income later when you withdraw the money. The more the account grows, the more tax you end up paying.In a Roth account, all the money is working for you and your retirement nest egg is completely tax-free.
2. Direct contributions to a Roth IRA may be withdrawn at any time with no tax or penalty, since they have already been taxed. This means that if you contribute $5000 to your IRA account and after one year your account grew to $6000 value (the value of the underlying stocks increased or you got dividents or whatever) you can take your $5000 back anytime without any penalty or tax.
3. If you have maintained your account for 5 years and your age is 59 1/2 or above, you can withdraw your earnings(when $5000 grows to $6000 after one year, $1000 is your earnings and $5000 your contribution) as well as contributons. Unlike a traditional IRA, there are fewer restrictions and requirements for withdrawing your money. The minimum distribution rules that apply to traditional IRAs beginning at age 70½ don't apply to Roth IRAs.
4. Roth IRA is much more simple than the traditional IRA. With a traditional IRA you need to report a deduction on your 1040 form when you make a contribution and on withdrawal you need to report the entire amount as taxable income. However in Roth IRA since you are already paying your taxes, there is nothing to report.
5. You have already taken care of the taxman. This means that you need not worry if the tax rates go up in future.
6. Up to $10,000 in earnings can be withdrawn tax-free if the money is used to acquire a principal residence. This house must be acquired by the Roth IRA owner, their spouse, or their children.
7. If a Roth IRA owner dies, his/her spouse becomes the beneficiary of that Roth IRA while also owning a separate Roth IRA, and the spouse is permitted to combine the two Roth IRAs into a single account without any penalty.
8. You can contribute to Roth IRA even if you contribute to another retirement plan such as 401K.
9. The savings in a Roth IRA account is more beneficial to your children if you have enough wealth to be concerned about the estate tax.The estate tax applies to your total assets at death, including assets held in a traditional IRA or a Roth IRA. When your children or spouse receive a traditional IRA, they'll have to pay income tax on the amounts they withdraw. The value of what you transfer to them is reduced by the amount of the taxes. But if they receive a Roth IRA, they get to keep the amounts they withdraw.
10. Roth actually lets you to shelter more 'real' money.For example when you contribute $10000 towards your retirement income in a Roth account you can withdraw all $10000 whereas in a traditional IRA account you get only $10000 minus the tax.
The total contributions allowed per year to a Roth IRA account is limited to $5000 for adults aged 49 and below and $6000 for individuals aged 50 and above. Starting in 2009, contribution limits will increase in $500 increments based on inflation.
Unlike a traditional IRA, when you contribute to Roth IRA, the contribution is not tax-deductible or you are paying tax upfront. Likewise, in contrast to a tradional IRA where you pay income tax on the entire amount of your withdrawal, in a Roth IRA you pay no further taxes on your withdrawal. Of course some restrictions do apply, the restricitons being that at the time of withdrawal, the account must have been opened for 5 years and that the owner's age is at least 59 ½.
What are the advantages of Roth IRA?
1. Traditional retirement accounts allow you to delay paying tax and that helps the account grow faster, but you'll have taxable income later when you withdraw the money. The more the account grows, the more tax you end up paying.In a Roth account, all the money is working for you and your retirement nest egg is completely tax-free.
2. Direct contributions to a Roth IRA may be withdrawn at any time with no tax or penalty, since they have already been taxed. This means that if you contribute $5000 to your IRA account and after one year your account grew to $6000 value (the value of the underlying stocks increased or you got dividents or whatever) you can take your $5000 back anytime without any penalty or tax.
3. If you have maintained your account for 5 years and your age is 59 1/2 or above, you can withdraw your earnings(when $5000 grows to $6000 after one year, $1000 is your earnings and $5000 your contribution) as well as contributons. Unlike a traditional IRA, there are fewer restrictions and requirements for withdrawing your money. The minimum distribution rules that apply to traditional IRAs beginning at age 70½ don't apply to Roth IRAs.
4. Roth IRA is much more simple than the traditional IRA. With a traditional IRA you need to report a deduction on your 1040 form when you make a contribution and on withdrawal you need to report the entire amount as taxable income. However in Roth IRA since you are already paying your taxes, there is nothing to report.
5. You have already taken care of the taxman. This means that you need not worry if the tax rates go up in future.
6. Up to $10,000 in earnings can be withdrawn tax-free if the money is used to acquire a principal residence. This house must be acquired by the Roth IRA owner, their spouse, or their children.
7. If a Roth IRA owner dies, his/her spouse becomes the beneficiary of that Roth IRA while also owning a separate Roth IRA, and the spouse is permitted to combine the two Roth IRAs into a single account without any penalty.
8. You can contribute to Roth IRA even if you contribute to another retirement plan such as 401K.
9. The savings in a Roth IRA account is more beneficial to your children if you have enough wealth to be concerned about the estate tax.The estate tax applies to your total assets at death, including assets held in a traditional IRA or a Roth IRA. When your children or spouse receive a traditional IRA, they'll have to pay income tax on the amounts they withdraw. The value of what you transfer to them is reduced by the amount of the taxes. But if they receive a Roth IRA, they get to keep the amounts they withdraw.
10. Roth actually lets you to shelter more 'real' money.For example when you contribute $10000 towards your retirement income in a Roth account you can withdraw all $10000 whereas in a traditional IRA account you get only $10000 minus the tax.
Thursday, September 18, 2008
Is this the beginning of the end?
I have read a funny story circulating as email in the Indian software Industry. It is the year 2050 and the currency conversion rate is Rs. 1= $1000. There is a long queue in front of the Indian embassy in U.S.A. The software enginers are anxiously waitng for their visa interview.They are perfecting their Hindi and are practising Namasteys. All they want is to settle down in the land of opportunities that is India.
Although it is imagination stretched to a certain limit, I sincerely believe that the day is not far away when people in U.S.A will look outward from the safe coccoon of theirs and see that the world in which they seemed so secure, have changed. The economic crisis that is unravelling before us is proof that all is not well in the financial sector.
The United States of America is the mightiest country in the world. The only serious opponent to it's superpower status was Soviet Union, which disintegratd years ago. The best of the world drifts towards it, attracted by the tremendous opportunities it offers and the open mindedness of its people. Unlike the mighty empires of the past which relied upon their military supremacy alone, the United States reigns because it is an economic superpower too. Unfortunately the sub-prime crisis (in which banks lended recklessly to below average borrowers) has blown out to be a vast scale economic crisis and that power is threatened now.
The crisis has it's roots in the economic growth during the years 2001 to early 2007. The system was flush with liquidity and bankers looking for new avenues to disberse loans started lending to sub-prime borrowers (borrowers whose credit history is below par) for an interest rate higher than the normal lending rate. The loans were then converted in to securities which were then sold to secondary agencies. This in turn provided more liquidity to the original lenders and they lended to more sub-prime borrowers. The governemnt also encouraged it, believing that the young and the poor who otherwise would not be able to buy homes, would be benefitted.
However the bursting of the real estate boom led to a series of defaults as the value of the homes which were the collateral for the home loans went down and the borrowers were no longer motivated to pay back their loans at their higher interest rates. This led to the value of the bonds which were prmarily based on these sub-prime loans come down. This had a cascading
effect and ultimately led to the collapse of bear sterns, one of the world’s largest investment banks and securities trading firm. The crisis has led to Lehman Brothers filing for bankruptcy. Merrill Lynch was bought out by Bank of America of $50 billion.The insurance major AIG (American Insurance Group) is also under severe pressure.
The United States had always been the greatest borrower and spender. The foreign exchange reserves of most of the nations is in dollars and they invested this in the U.S bonds. This has resulted in an increase in the available funds for the average american, but instead of putting these funds to productive uses, they were often squandered away on consumer goods and
luxuries. During the good times the consumers spent every penny they possibly could and borrowed on top of that.The americans has also the highest credit cards debts. Between 1999 and 2004 household debt grew twice as fast as after-tax income. In good times it is a cause of concern but in bad times like these it is disastrous news.
So the big queston is, Is this just a temporary setback and will the economy correct itself? Or are the underlying problems so great that it is simply impossible to correct them and the system itself need to be overhauled? We the proponents of free market reign had always believed that minimal regulations will ensure a thriving economy. Is that the truth? Only time will tell.
Although it is imagination stretched to a certain limit, I sincerely believe that the day is not far away when people in U.S.A will look outward from the safe coccoon of theirs and see that the world in which they seemed so secure, have changed. The economic crisis that is unravelling before us is proof that all is not well in the financial sector.
The United States of America is the mightiest country in the world. The only serious opponent to it's superpower status was Soviet Union, which disintegratd years ago. The best of the world drifts towards it, attracted by the tremendous opportunities it offers and the open mindedness of its people. Unlike the mighty empires of the past which relied upon their military supremacy alone, the United States reigns because it is an economic superpower too. Unfortunately the sub-prime crisis (in which banks lended recklessly to below average borrowers) has blown out to be a vast scale economic crisis and that power is threatened now.
The crisis has it's roots in the economic growth during the years 2001 to early 2007. The system was flush with liquidity and bankers looking for new avenues to disberse loans started lending to sub-prime borrowers (borrowers whose credit history is below par) for an interest rate higher than the normal lending rate. The loans were then converted in to securities which were then sold to secondary agencies. This in turn provided more liquidity to the original lenders and they lended to more sub-prime borrowers. The governemnt also encouraged it, believing that the young and the poor who otherwise would not be able to buy homes, would be benefitted.
However the bursting of the real estate boom led to a series of defaults as the value of the homes which were the collateral for the home loans went down and the borrowers were no longer motivated to pay back their loans at their higher interest rates. This led to the value of the bonds which were prmarily based on these sub-prime loans come down. This had a cascading
effect and ultimately led to the collapse of bear sterns, one of the world’s largest investment banks and securities trading firm. The crisis has led to Lehman Brothers filing for bankruptcy. Merrill Lynch was bought out by Bank of America of $50 billion.The insurance major AIG (American Insurance Group) is also under severe pressure.
The United States had always been the greatest borrower and spender. The foreign exchange reserves of most of the nations is in dollars and they invested this in the U.S bonds. This has resulted in an increase in the available funds for the average american, but instead of putting these funds to productive uses, they were often squandered away on consumer goods and
luxuries. During the good times the consumers spent every penny they possibly could and borrowed on top of that.The americans has also the highest credit cards debts. Between 1999 and 2004 household debt grew twice as fast as after-tax income. In good times it is a cause of concern but in bad times like these it is disastrous news.
So the big queston is, Is this just a temporary setback and will the economy correct itself? Or are the underlying problems so great that it is simply impossible to correct them and the system itself need to be overhauled? We the proponents of free market reign had always believed that minimal regulations will ensure a thriving economy. Is that the truth? Only time will tell.
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