The Credit Crunch! – How You Can Protect Yourself
As the credit crunch worsens, banks are collapsing. Millions of people are facing financial ruin. Could this happen to you? Here is how you can protect yourself!
BY ROBERT R. FARRELL
Oct 29 2008

These are dangerous times! Global financial markets are in a crisis unlike any since the Great Depression. The situation is threatening to spin out of control.

Consider the following events in the United States, the world’s largest economy. In August 2008, the unthinkable happened: Two giants of the U.S. mortgage industry, Freddie Mac and Fannie Mae, were taken over by the government to prevent total collapse. These institutions, which together guarantee nearly half of the nation’s mortgages, reportedly needed a capital injection of $25 billion just to survive.

Next, financial services behemoth Merrill Lynch, fast sinking under the burden of billions of dollars in losses, desperately reached a last-minute agreement to be taken over by Bank of America for just two-thirds of its market value of one year ago.

Even worse, iconic 158-year-old investment bank Lehman Brothers shocked the financial markets by filing for bankruptcy, drowning under staggering debts totaling $613 billion. And in dramatic fashion, the U.S. Federal Reserve (the “Fed”) rushed to the rescue of the world’s largest insurance company, AIG, pumping in $85 billion for an 80% stake in the company.

All of these problems in the world’s largest and most influential economy have ignited a global firestorm. It has long been thought that, financially, as the U.S. goes, so goes the world. Europe and Japan are already in recession, and Britain will soon follow (Daily Telegraph). Financial markets are unraveling with a speed not seen since the stock market crash of 1929. Fear pervades the world’s corridors of power!

This predicament, called the “credit crunch,” has put millions of people at risk of losing their homes, and even their life’s savings.


Extending Credit

The term “credit crunch” is given to the reduction in the availability of loans (credit). Simply put, banks have been reluctant to lend money (extend credit) to others—whether to individuals, businesses or other banks.

This was not always the case. For several years leading up to summer 2007, the situation was entirely different. Banks were quite eager to extend credit, particularly mortgages, to others.

The process worked like this. After selling mortgages, retail banks passed these on to investment banks to be bundled together as bonds through a process called “securitization.” Rating agencies, such as Standard & Poor’s and Moody’s, then gave each of these bonds a rating, which were then sold to investors, particularly large ones, including pension funds, mutual funds, insurance companies and other corporations.

Once the bonds were sold, the banks had effectively taken the payment risk “off the books” and passed it on to investors, whose receipt of income depended on homeowners’ ability to pay their mortgages.


Greed Runs Rampant

The low interest rate policy of the Fed was the trigger that started frenzied buying in the U.S. housing market. Banks augmented the process by offering low “teaser rates” on mortgages to entice customers, rates that would be greatly increased two to three years later, triggering even more buying. This led to rapidly increasing housing prices, since demand exceeded the supply of homes.

Banks, making huge profits off the housing market and greedily pursuing even greater profits, then relaxed their standards for loans. Since they figured the risk was no longer on their books, they offered loans to virtually anyone who applied. This included individuals who did not meet their standards for credit (“subprime” customers). So eager were the banks, that even those with no jobs, no income and no assets were accepted.

With “easy money” to be had, everyone was in on the game. Banks aggressively pursued and loaned money to people who did not qualify. Applicants lied on their loan applications. Rating agencies passed off risky bonds as “safe”—bonds that investors rushed to purchase. Greed was in the air!

While home prices kept rising, interest rates remained low, and customers continued making their payments, this “house of cards” held up. But this was not to last.


Troubled Times

The scales tipped when the first set of interest rate increases (resets) kicked in. Around the same time, house prices fell slightly, resulting from the glut in the market. Suddenly, millions of homeowners were faced with much higher mortgage payments they could not pay. Loan delinquencies soared. Repossessions of homes skyrocketed. Investors backed away from risky bonds. Stuck with loans they could not sell, banks began to fail.

The financial carnage has been sobering. Great names from the past—Bear Stearns, Countrywide Financial and now Lehman Brothers—no longer exist.

The International Monetary Fund (IMF) estimated that losses by U.S. banks could reach as high as $1 trillion; some industry experts believe this number could even reach as high as $2 trillion. Since the beginning of 2008, over ten U.S. banks have gone bankrupt, and it is believed that number could exceed 100 financial institutions within the next 12 months (Daily Telegraph). Famous investor Wilbur Ross has placed the figure at 1,000 (Reuters)!

A grim scenario is rapidly unfolding, a financial catastrophe of epic proportions. Millions of people in Europe, the United States and the rest of the world will likely lose their homes, jobs and savings. This could include you!




Protect Yourself

So how do you protect yourself in these perilous times? First, realize that there is a cause for every effect. Everything that happens has an underlying reason.

The main motivating factors behind the credit crunch were greed and covetousness. Let’s understand. Banks were greedy for higher and higher profits, investors took foolish risks in their greed for higher returns on their investment, and individuals were greedy for loans they could not repay, to purchase the material goods they so coveted, yet could not afford. Many are way over their heads in debt.

So what about you? Here are some tips to help you survive the stormy times ahead:

• Get out of debt as soon as possible. If you need help with this, seek professional financial counseling.

• Pay off credit cards promptly; do not carry monthly balances. If you are having difficulty controlling your spending habits, consider closing your credit card accounts.

• Do not buy an item unless you really need it.

• Avoid buying on credit; pay cash whenever possible.

• Live within your means. Set up a budget and stick to it. If you have been living “high on the hog,” make and execute a plan to lower your standard of living.

• Do not borrow to pay for routine expenses.

• Before making a large purchase, think for several days before purchasing it. Ask yourself: Do I really need it?

Source: http://www.realtruth.org