A wise friend of mine recently weighed in on the financial crisis. Here is his explanation of the consequences:

Our government is doing a poor job of explaining the stakes for our country with this bailout plan. I’ve heard the terms, “Financial Collapse”, “Financial Meltdown”, and “Seizure of the Credit Markets”. But no one is explaining what that means. Members of Congress came out of a briefing 10 days ago ashen faced, but refusing to “Reveal” what was said. Bush came on national television speaking in generalities.

Speaking as a 20-year veteran in the financial markets, my belief is that a meltdown would mean:

1. No new loans available to businesses or individuals.

2. Any existing loan that can be called due by the lender, will be called. This means the lender would force the borrower to pay back the entire loan balance immediately. Many credit lines, including home equity lines, and business lines of credit fall are callable by the lender. Read your loan documents!

3. All your credit cards could be canceled immediately, although your debit cards would continue to work. American Express has been reviewing and unilaterally lowering credit limits for some of its existing card holders for some time. What would you do if you were a credit card lender? I would cut everyone’s credit limit to reduce my risk.

4. If you need to buy a car or truck, you will need to pay cash.

5. The worst part would be a vicious cycle of job losses. People that lose their jobs don’t buy anything, forcing businesses to cut even more workers. That cycle may already be here, but it would accelerate dramatically. Businesses would start cutting jobs in anticipation of future business losses.

Wachovia Bank is huge, but won’t survive next week, unless a miracle occurs. THE white knights have turned into vultures circling, waiting for the government to shut Wachovia down.

The Bailout Plan

Everyone is hoping that it will work, because it is the only thing we’ve got that has a chance to work. I am all for passing a plan for the FULL $700,000,000,000. However, I have serious reservations about the plan, since WE don’t have any facts about the plan to consider! Why doesn’t the government trust us with the facts?

1. The banks cannot inspire confidence in the market unless they sell EVERYTHING and get some certification that their financials are completely clean.
2. The government has to pay more than the securities are currently worth, otherwise the banks won’t sell the securities.
3. It sounds like the market is currently valuing these securities at 0% to 30% of their original value. Four or five weeks ago I heard about business plans making the rounds for investors to buy up the securities at 30% of original value, then renegotiating the underlying loans at 50-60% of their original value. I wanted in on that deal!
4. If a patient investor can break even buying the securities at 50% of original value, the government could buy the securities at that level and get paid back the $700,000,000,000 completely.
5. If we are paying more than the securities are worth, we need to get something for it…even if we might come out whole.

My Advice

Save your extra money! Don’t pay down any of your debt! (except for credit cards, of course). Instead, put that money into a money market account to build up a fund for emergencies (Like a meltdown). Money market accounts are now completely insured by the US Government for the next 12 months. Expect to earn less than 1% interest on your money market account. Bank accounts are only insured up to $100,000.

Example: If you bought a house for $600,000 with a $550,000 loan. It may only be worth $300,000 when the government, or the investors that hold your mortgage contact you about a deal. The deal could be that they cut your loan down to $300,000. If you haven’t paid down your loan, the lender loses $250,000. If you paid your loan down to $400,000, the lender will lose only $100,000, but you have lost much more. Paying down your loan now, helps the lender, but not you. PUT YOUR MONEY AWAY, you will be in a stronger position to deal with the uncertain future…and take advantage of Wall Street’s mistakes.