Financial Crisis

As a small businessman, I personally started seeing the effects of the current financial crisis this past January when we had an opportunity to buy about $35,000 worth of used equipment at fire sale prices. The catch was that the deal had to be pulled together in 3 weeks. Regardless of the fact that I was able to show that the equipment would have paid for itself in energy savings alone within 2 years, and that the machines had a significantly increased capacity allowing us to expand our business, the banks were reluctant to go along on such short notice.
The bankers said that they just didn't have as much money, and they were tightening the standards all around. Even GOOD plans that were well collateralized were taking longer to process and were no longer sure things. You may not have noticed it, but last Christmas season, the retailers had less stock on their shelves. This was because they couldn't afford to carry as much merchandise. Most retailers get what it called "postdating" where they essentially get loans from banks or sometimes their suppliers to pack the stores to the gills for the busiest time of the year.
We were able to buy the equipment however by going to a leasing company for the machines, but at a significantly higher rate of interest. The math showed it still was a good deal, but its cost me a couple thousand more than it could have.

In the near future, I will have more banking needs. Our lease is up in April, and manufacturing space is really cheap right now. A building I looked at 5 years ago is going for significantly less, and I really need the space to expand the business. And I have several projects in the works that would double our size and add up to 4 new jobs. But if I can't get the capital, I have no space to put the work stations, and no money to invest in new equipment. While I can cash flow growth of about 10%, some of these projects are so big, I would need start up capital to carry the costs the 90 days from purchase order to receipt of payment.

This is what Bernanke is worrying about, mistakes of the past coming back to haunt us in the present and future. And with the way the loans have been sold, repackaged into bonds, and resold, combined with the drop in the value of the housing marked, nobody really knows how bad it is. FDIC insured banks are required to hold a certain ratio's of assets vs loans vs cash on hand. The 5 non-insured gigantic investment banks were supposed to hold to good business practice which would reflect similar numbers. Goldmen-Sachs did for the most part, Lehmann Bros. did not. Guess who is still in business. And now the banks are tightening lending, trying to get their balance sheets back into proper alignment.

There is a lot of blame to go around on the current crisis.
Predatory lenders, greedy and/or ignorant home owners, fraudulent and/or stupid financial services brokers. And nobody is happy being left with the bill. Some banks did the due diligence when authorizing loans, and came out of this all right. Many didn't.

Free Market Theory would say to let the banks fail. Free Market theory works very well for unregulated commodity markets, where you are comparing the same grades of raw material and are just looking for the lowest price. The further you get away from commodities the less well it works. The more complex a resource is, the greater the uncertainty of its value, and the more information is required to assess it. On top of that, its value will be different from one potential customer to another based on which attributes the customer needs. And some resources are needed by the community as a whole more than that of the individual investors involved. Lets take an electrical line for example. To a thief its worth the value of the copper. To the electric company its the value of the wire(more expensive than just the raw material), the cost of installation, and the loss of revenue while it is down. To us, the end user, it is worth major inconvenience, the possible loss of the contents of your freezer depending on how long it lasts, and maybe days and dollars of eating without an electric range or microwave. To a company like mine, its thousands of dollars of lost revenue, and possible irate customers.

When it comes to money flow in the economy, banks are like the power company. You can loose a few power sources and the others will take up the slack. If you loose a bunch more, especially big ones, you start getting "brown outs", the economy slows. The economy, like the power grid, can only support so many collapses. When a bank fails, businesses that borrowed money from them must quickly refinance, often at higher interest rates, or face going out of business themselves. This happens, and it costs people jobs, resulting in more foreclosures, resulting in more stress on the remaining banks etc... This is what happened in the Great Depression.

My point is this, whether or not there is a "bailout" of some sort, we are all paying the costs already. Some is seen in the devaluation of our homes or retirement assets. Some is seen in the increase in cost in unemployment on both the government and non-profit sectors and loss of tax base.

If I remember correctly, the rate of mortgage defaults has gone from 3% to about 7%. Back when I got my first mortgage in '94, banks would only make a loan that the housing costs(mortgage, property tax, homeowners insurance) would not exceed 30% of your household income. Any higher, and the family would be considered under "financial strain."
That number of homeowners who would fall under the description of "financial strain" are currently estimated at about 40% of the home owners out there. My guess is that many of these people will actually not default, but they may need to be refinanced, especially those with adjustable rate mortgages. But with the devaluation of their assets banks will be reluctant to do so.

One of my friends, Larry, works for a small regional bank. His job is to renegotiate with homeowners who are in trouble. He told me that if the homeowner works with him, and is up front right away, that they can usually work something out. Banks do not want to reposess unless they absolutely have to. But if the mortgage had been bought up by the big investment banks and bundled into one of these exotic bonds as had been done, and resold to someone else, who is the person on the ground to talk to and try and salvage the account? Do those managing the account have the authority to renegotiate?

One of the big problems that Wall street is dealing with is that nobody knows how to value these Mortgage backed securities. Batches of individual mortgages with differing terms on differing values of real estate that has all been falling at different rates depending on region, with homeowners in different states of financial health or distress, all bundled together, its enough to give any accountant a headache. Wall street looks at a security like that and says, "what is it worth?" and its book value is based on their confidence and what they are willing to pay. Guesses right now are anywhere from 22 to 60 cents on the dollar.

The problem is complex, and BIG, and will have repercussions for years to come.
I'll deal with proposes to fix it later.