Web Exclusive: Economic Crisis

1. **This economy "crisis" is a cyclical thing that has been proven to occur every 10-12 years. Why then, is every attempt being made to stop it rather than letting it run its course? And how much worse off will we be 5 years from now because nature was not allowed to run its course? - Beth B., Kearns**John Watkins: *Business cycles certainly occur, but not with the regularity that you suggest. Moreover, this cycle is different. This cycle began in the financial system. It's serious because this is the first crisis since the Great Depression that threatens the system of payments. If Peter cannot borrow short term to pay his employee Paul, Paul cannot pay Mary, who cannot pay Jack, and so on. It's like a game of dominos: the fall of one causes the fall of the next, and so on.* Aric Krause: *It is true Beth, our economy does typically demonstrate cycles, but this is not really a "cycle". This is a bubble in which "non-natural" forces are at work. In my opinion, the prime force behind this phenomenon is bare greed. So many people are trying to manufacture opportunities to get rich. But the big problem with this phenomenon is who could ultimately have to pay for it - you. Regular Americans' retirement and savings are at risk. Small business owners who rely on credit are threatened. We've dug a deep debt hole, no one is quite sure how best to get out.* Bruce Lefavi: *If we let nature run its course, as it is right now, without the actions that Federal Reserve Chairman Bernake is taking then there could indeed be a full-blown depression. He has made his mark as an expert on depressions and that is why the actions he is taking are absolutely necessary.* 2. **Why does the media continue to throw gasoline on this small flame? I believe that most of what is going on as far as consumer panic is from the media. This is all blown way out of proportion. Yes there is a problem but nowhere near what you are instigating. Is it to take the focus from other issues? - Kyle, Fruit Heights**Krause: *Kyle, you raise a very interesting question. Can we be sure that this problem is even a real problem given that it may be too early to judge the evidence? Perhaps it is too early to tell, but there is some interesting early evidence out there that suggests this is NOT a small problem. First, consider that banks around the world (far outside the influence of our media) are having serious liquidity problems. Second, call a local car dealer and you will find that the number of cars they are selling has dramatically decreased as has the number of lenders willing to lend for new car purchases. Third, contact anyone who deals in commercial real estate and you will find lending has been nearly shut off. It may not seem like a big deal until you see how large a role credit plays in our economy. Very few firms and businesses can operate without lines of credit - the type of credit it is increasingly difficult to get. It may not look like things are too bad from where you're standing, Kyle (and I hope you are not financially vulnerable), but this situation has the potential to devastate our living standard for a long time to come.* Lefavi: *There is no question that the media normally blows things way out of proportion. However, this is one of the few situations where it is almost impossible to blow it too far out of proportion because it is really bad.* Watkins: *It appears small, because it is only beginning to affect Main Street. It is true, that reports of the media are fueling the psychology of people. But the media is also responding to what they are told. The problem as noted is that this crisis threatens the system of payments. If business and consumers cannot borrow, expenditures will fall, which will cause profits to fall, and so on. Remember, one person's expenditure is another person's income. So as we cut our spending, we cut someone else's income. Remember too, every conflagration begins with a small fire. This fire already has resulted in a loss of over two trillion dollars in stock wealth. The decline in wealth means some people will have to delay retirement, forego financing their child's college education, cancel their trip to Europe, put off remodeling their kitchen, and so forth. Potentially, the problem is extremely serious.* 3. **How come our Congress and Senate went against the will of people and rushed through a pork laden $700 Billion Dollar bailout without holding comprehensive hearings on the matter and knowing full well from the testimony they received from Paulson and Bernanke that the $700 Billion may not do the job? Why weren't other options explored more thoroughly? - Jared S., Salt Lake City**Lefavi: *They had to act quickly because lending was drying up completely. When that happens, our economy stops and we have a depression.* Watkins: *Our congressional leaders can best answer these questions. But our congressional leaders were scared; scared our economic system might collapse and collapse soon. Other options were not explored because they did not feel there was time. With the collapse of Lehman Brothers, Lehman Brothers could not repay money that it had borrowed from other banks. That money came from people money market accounts, accounts that supposedly carried very low risk. For the first time, money market funds were worth less than the money deposited. This could have initiated panic as people withdrawal money. Moreover, with the collapse in Lehman Brothers, banks realized that loans to other banks may not be repaid. The result: banks stopped loaning each other money. Without credit the market tanks. The administration felt it had to act immediately.* Krause: *Excellent question, Jared. I won't pretend to be able to interpret the political mind, but there are extremely powerful voices out there (interpret that as you will) that stand to lose if we don't have a bailout. No matter how politically active you are, Jared, your single vote and relatively small pocket book don't stand a chance. Let's face it - we as households have been so busy consuming these last ten years that we haven't been paying attention. Because of our inattention, we may lose more than we care to think.* 4. **How likely is it, that the CEO's of AIG and others like them will be prosecuted? - Julie, Tooele**Watkins: *Probably none. They did not to my knowledge break a law, unless it's proven that they hid from regulators relevant data. Moreover, it was AIG's London office that made most of the bad bets that prompted the government to bail out AIG.* Krause: *In my opinion, pretty unlikely Julie. It is important to point out that everyone has guilt in this crisis. A percentage of mortgage borrowers KNEW they were getting a mortgage they couldn't afford. Some engaged in fraud in overstating their income because they were "caught up in the race". Mortgage brokers, in many cases, were paid on the quantity of loans they closed, an incentive structure that encouraged them to do whatever it took to close the deal. Banks and lenders got paid when they closed and resold loans. Companies that repackaged and sold mortgages as "commercial debt obligations" or "structured investment vehicles" got paid as well. In other words, Julie, we have a societal problem in which nearly everyone was involved. Add to this problem the number of households who took on far more non-mortgage debt than they should have. Yeah, AIG and the like played an important role in precipitating this process, but where do we end the blame when it goes so deep? Far more important, I think, is for us to address, as a society, why we've become so greedy and willing to cheat to get rich (or to impress our neighbors).* Lefavi: *Unfortunately, if history is any indication, they probably will not be prosecuted. Our Justice Department and the Securities and Exchange Commission in this area are almost completely worthless.* 5. **How do the State governments keep track of what is happening at a federal level, such as the catastrophe with Freddie Mac and Fannie Mae, and why was the public kept so in the dark? - Merle F., Salt Lake City**Krause: *Politicians get elected and reelected when the economy is doing well, Merle. That fact in itself partially explains why so few wanted to point out what should have been obvious. I myself have suggested in every forum available that the situation was out of control for the last three or four years. Who wants to listen to such things when so many were complicit? To be specific, the public was the recipient of the whole scenario, in cheap mortgages, in opportunities to speculate, in opportunities for large returns on investments. There really is no such thing as a free lunch though, and I sincerely hope we remember that going forward or we're likely to repeat the whole thing over again. State governments have very little opportunity to get involved in policy around things like Freddie and Fannie, but they definitely took advantage of low interest rates and easy credit.* Lefavi: *The way the Freddie Mac and Fannie Mae disasters were handled, virtually no one, including state governments, was aware of what was really going on. Transparency is one of the things that this latest bill is meant to provide us with.* Watkins: *The public was not kept in the dark. Regulators were kept in the dark, asleep, or both. Part of the problem is the government has pursued a policy that less regulation is better. From a business perspective, regulation raises costs. But in hindsight the costs of regulation is generally less than the costs resulting from the collapse of a major institution, such as Fannie Mae and Freddie Mac.* 6. **If push came to shove and I had to make a decision to pay my mortgage or pay my credit cards what would you recommend? Also, what can the creditors that I have unsecured lines of credit through (like a credit card) legally do to me if I stop paying my debt to them? - Tim, Clinton**Lefavi: *Both credit card companies and mortgage holders are usually willing to negotiate if you are in a tough spot. Go to one of the agencies that specialize in that area and hopefully they can help you work through your problems.* Watkins: *If you do not pay your credit cards credit card companies will cancel your cards, increase your interest rates, slap you with fees, and may repossess some of your possessions. If you default on your mortgage the creditors could foreclose on you and seize your home, although this will take some time. Your point raises an interesting question. If the government can bailout the financial sector, why can't it bailout Tim? I suggest you see a lawyer or perhaps Hank Paulson.* Krause: *Interesting question, Tim. Let me remind you that you have a legal and MORAL obligation to pay all of your debts. You bought the house; you consumed the goods you bought with your credit cards. There is no other answer. Considering anything else speaks to why we are where we are, financially. To all debt-dodgers out there (likely to be the same as the 'make a quick buck' crowd): there is always a price to be paid - you'll get yours.* 7. **What will happen when I now try to get a mortgage or auto loan? -Jodie, Clearfield**Watkins: *If you have stellar credit more than likely you will get the loan. If you borrow to obtain a jumbo loan (a loan in excess of $400,000) you will pay a higher interest rate. Those having questionable credit may be unable to obtain a loan. Banks are fearful that if they loan money, debtors will not repay. Hence, they are increasing interest rates on loans or demanding proof that you are credit worthy.* Krause: *Jodie, even if you have impeccable credit, you may find it difficult right now. If you do have impeccable credit, you'll be able to get a good price. If you go in with at least 20% cash, you should be fine. Learn from those who are currently in trouble - be thrifty, do excellent research and don't buy beyond your means. There are many excellent web resources to help you find out what you can afford, given your income and finances. Live frugally and buy wisely.* Lefavi: *If you try to get a mortgage or auto loan, it will of course be harder to get, but it will be available because Congress has passed the bail-out package. If they hadn't passed it, it would be unlikely you would be able to get either one.* 8. **The current economic problems, as big and looming as they are, pale in comparison to the $53 trillion public debt reported by the government as of September 30, 2007. How can we ever hope to pay the equivalent of $175,000 for every man, woman, and child in this country that the $53 trillion implies? -Marco R., Hyrum**Krause: *Marco, the US's public debt is now approaching $11 trillion, including the current bailouts. So, your figure is high, but your question is excellent. The simple answer is we can't. We have, for all intents and purposes, decided that our kids and their kids should pay these debts. Some economists will suggest that our debt isn't that bad relative to other countries and the size of our economy, but no matter: future generations will have to pay these obligations. Let's say that we were able to completely change the spending habits of our government (federal only - state debt is a whole other ballgame), such that we were able to generate $250 billion a year in surplus, from our current $500 billion deficit. With interest, we could repay our debt in approximately 70 years, without fixing social security or any of our other problems. But, here is the big question: what programs do we cut to realize such savings? Defense? Education? If you look closely at the $3 trillion federal budget, you'll quickly realize that there isn't a lot of discretionary spending to cut.* Lefavi: *The $53 trillion is a bit of a distorted number. It includes all of the future payments to social security holders and "entitlements". You need to have the cash for it now, which simply isn't true. Fortunately, the bill isn't due next year. The Government has the luxury of paying this off over any period of time it sees fit.* Watkins: *The public debt is not $53 trillion; the government debt is $10.3 trillion. The $53 trillion represents the debt required to fund the future known obligations of the US government. The problem is not the debt, but the interest payment on the debt, which currently is approximately $400 billion. An increase in the interest payment may mean an increase in taxes, a cut in programs, or an increase in borrowing. If the interest payment becomes unmanageable (meaning the government cannot raise taxes or cut spending), the government may have to inflate the money supply.* 9. **Why are some "financial guru's having people pull out of the market when we know that is causing much of the problem? -Barbara F., Little Elm**Lefavi: *So many "financial gurus" suffer from the delusion that they can time the market. Every study ever done by any accredited source shows that this strategy simply does not work. The key is to buy and hold.* Watkins: *Excellent point. If everyone would leave their money in the market the stock market would not fall. The problem is that some banks, hedge funds, and others have debts to pay, investors to pay off, and so on. They sell assets (stocks, commodities, and so on) to raise cash to pay their debts. Asset prices fall, which prompts others to sell. As prices continue to fall, people panic. It's like everyone trying to get out of a crowded theater at the same time, few if any get out.* Krause: *Interesting question, Barbara. Don't confuse the stock market with the 'real' market, though. None of us want to see the stock market fall, but it is only a representation of the real trouble in the financial market. To your point though: Long run. Pulling out of the market isn't a wise choice.* 10. **Will the stock market ever hit a low and stop there, or can it theoretically just drop to zero if it gets bad enough? -Ryan M., Logan**Watkins: *The stock market represents the monetary value of the capital stock of the country, the factories, machines, tools, buildings, and so on that business use to provide goods and services. If the market falls by 50%, it does not mean there are 50% fewer factories, machines, and so on. They remain, and can be used produce goods and services. Hence, while the stock of individual firms can go to zero, the stock market could not, not unless society itself collapsed. At some point, the market will rebound.* Krause: *It could theoretically drop to zero, but if it did, we'd have far worse problems. Zero would imply that we, as well as the rest of the world, no longer wished to hold dollar investments. Most likely, the markets will lose some value and then will begin regaining its value. As long as there is fundamental value in US firms the market will keep value.* Lefavi: *So many "financial gurus" suffer from the delusion that they can time the market. Every study ever done by any accredited source shows that this strategy simply does not work. The key is to buy and hold.* 11. **Rather than focus on the "down" stock market, wouldn't it sound better (and maybe help) if it were announced that "stocks are on sale right now!?" -Paul, South Jordan**Krause: *Very optimistic, Paul! And correct, from a long run portfolio viewpoint. Just be very wise about what you buy and the price you pay. More important, have realistic expectations about how your investments should grow and stay away from "get rich quick" schemes. If it sounds too good to be true, it most likely is. If we remember this simple point we'll save ourselves lots of pain later.* Lefavi: *I am one of the voices out there that is saying just that. Stocks ARE on sale and it is a great time to buy.* Watkins: *Well put. For those who have cash and can wait it out a few years, there are probably some excellent opportunities out there. The problem, of course, is that no one knows how low the market will go.*

- John Watkins, Ph.D. Professor, Bill and Vieve Gore School of Business, Westminster College - Aric Krause, Ph.D. Associate Professor, Bill and Vieve Gore School of Business, Westminster College - Bruce Lefavi, Founder & President of Lefavi Wealth Management