How The Global Credit Crisis Will Affect You

The following was guest blogged by Alex.

The current economic downturn will mean different things to different people. No one really knows the extent of the damage quite yet as it takes time to trickle through the economy. Every time a bank fails, it is one less amplifier in the system creating and distributing money efficiently through the capital markets. If you really think about how fluid money is, then it is not unreasonable to think a new restaurant that would have opened in your neighborhood, may not anymore.

Lehman Brothers’ downfall was extraordinary for it’s speed because it had never reported a quarterly loss since it was spun off by American Express and listed publicly in the early 90s. It went from reporting its first ever quarterly loss to bankruptcy in only 3 months. In the tech world, that would be the equivalent impact of the Research In Motion we know today to it going out of business in 3 months.

AIG’s troubles back in September were even more extraordinary for it’s size. Then Treasury secretary, Henry Paulson, made it very clear the US Government was done bailing out financial institutions and that it was going to leave Lehman Brothers to a private solution (open markets). The fact that they had a change of mind and extended a bridge loan to AIG only 3 days later led many to believe that not even the US Government were completely clued in on the true state of turmoil that was on Wall St.

The general consensus is that the US Treasury made the right decision in throwing a lifeline to AIG for 2 key reasons. AIG’s business spans 130+ countries and a collapse would have accelerated the global economic downturn with mind boggling ramifications. The bigger reason for the bailout, which has been less reported on, is because AIG has a large monoline business (also known as Credit Default Swaps (CDS)). This is the business of insuring bonds (or better known as debt). Just about every mutual fund, hedge fund or institutional investor will use CDS to protect against default from the bonds they hold. If AIG had failed, all the insurance they provided to bond holders around the world would have gone with it. The result? A nuclear meltdown in the global financial markets. Every portfolio manager in the world who had bonds in their portfolio would have had to revalue their bonds lower. If AIG went under, could you still be confident the company issuing you the bond can still make payments to you for the money you lent them? So in that sense, every corporate bond on the market would have had to drop in value to reflect it’s true value (increase the yield) as did the sub-prime CDOs – that is why we hear of the ‘write downs’ from investment banks because the CDOs they continue to hold are worth less and less by the day.

To put this in perspective, the CDS market is estimated to be well over a trillion USD, as much or more than the market of CDOs for all mortgages (including sub-prime), credit cards, auto loans and etc. The reason it is only ‘estimated’ is because CDSs are traded over-the-counter and not on a regulated exchange so there is no traceable record of value or terms of each deal made except for those involved.

Today, AIG is 80% owned by the US Government and effectively nationalized. Next week, it is expected AIG will report the largest US corporate loss ever in history at around $60 billion. To make things worse, they have been selling their assets in the wrong order. AIG’s life insurance businesses globally are still great businesses on their own. Understandably they hesitated to sell them initially, likely hoping things would pass and so instead they tried to sell off their poor performing assets first. Now that there is a need to streamline the business on government pressure, there is a sense that they are desperate to sell off their good businesses. The markets know this and it is partially why they are not getting the high bids for their life insurance units in Asia.

To answer the original question, you will be affected because as less capital is available in the economy, your income is likely to depreciate nominally or intrinsically (true value). If there is one thing you and I can learn from this, which Lehman Brothers, Bear Stearns, Merrill Lynch and AIG did the hard way, it would be that there are many times more debt in the world than there is liquid money (currency). So respect money.


51 thoughts on “How The Global Credit Crisis Will Affect You”

  1. Pheak Tol says:

    true – there is more debt in the world than liquid money – so i guess it’s always been true what they say about money; the root of evil!

    1. John Chow says:

      Actually, it’s not money that is the root of all evil. It’s the love of money.

      1. Beat me to it JC, was going to reply that too

      2. Tushar says:

        Haven’t I heard that you’re evil, John?

      3. Love for money and John Chow πŸ˜› Thats where all the evilness comes from lol

    2. Anyone see that equation that uses that money = time to prove that women are evil?? lol

      too funny

      1. Tushar says:

        Yea.

        We had 2 versions of it shown to us in Math class for fun.

        It’s like:

        money=evil
        time=money
        women=time

        therefore women=evil

      2. Yup seen that, Quite kewl it is. BTW there seems to be some new colours in the comment section.

    3. Alex says:

      May I be blunt? PEOPLE are the root of all evil. Greed and fear is what drives us… and the markets.

  2. venglish says:

    Useful information as usual. Everyone is unsure of the Future, yet I believe this time will give birth to a new way of thinking. Conservation and innovation are the tools that will be utilized to survive. Great post.

  3. 10$ to 100$ says:

    this will effect only poor people

    1. Brendan says:

      ummm…. no. It will effect everyone pretty much in some way or another.

      I know people who were pretty “rich” who have lost their jobs/business’s and are now struggling immensely.

      Remember, the more you have, the more you have to lose.

  4. Jake Stone says:

    Bit heavy on AIG, but finally got to the point of actual article title in the ending chapter. Maybe you could get Garth Turner to guest blog.

  5. Tushar says:

    The title was a bit skewed, as the content was relating to something else, but I like your style of writing Alex!

  6. Mike B. says:

    I feel like I have seen a bunch of guest posts here lately, I am not complaining just making an observation. Maybe one day I can guest post here πŸ™‚ But like venglish said above I believe this crisis will inspire new ways of thinking (innovation). So I really want to see how the innovation that takes places to fix this problem will affect me not so much the problem itself.

    @bookerx3

  7. And it will continue to get worse. So much worse before it get’s better, thanks to druken monkeys on wall street and Washington.

  8. Its not that less capital is available to people, but those with poor credit scores are now finding it harder to re-finance that 1/2million dollar home they never should have had in the first place.

    For passive, laid back people, I am sure that time will get tough and their investments will shrivel even more. But not everything can be blamed to banks and markets. Use some due diligence and find the active sectors if your investing and make some money.

    The days of free hand outs from the banks to anyone that had a pulse are over and I for one am glad to see this. Yes its sad to see homes go into foreclosure and students having harder times to get loans, but this is all a cyclical occurrence and as these variables correct themselves, we will see good time again.

    Overall, I disagree with the last paragraph of the post and wonder why your so heavy on AIG. AIG is old news and an old variable in the current situation. Its like talking about the demise of Freddie Mac and Fannie Mae. You make no mention of the pending demise of Citigroup which was averted when the US government opted to take a 40% shareholder stake in the bank nor did you mention the latest news on how banks are not really looking for as much of a bailout as originally anticipated which strongly could be interpreted as more money is starting to flow back into the lending markets.

    1. Alex says:

      I appreciate everyone’s feedback and you’re all quite right to criticize the title and content. This article was written last October and was submitted to John as reference. When he suggested he would like to post it I quickly updated it to make it still relevant – nonetheless it should help some understand more of what they hear on the news.

      AIG will be back on the news next week reporting with the largest loss ever in corporate US history. They will be the poster child of two stumbles. The early mishandling by the Treasury / TARP fund and the mismanagement in the auction of their ‘crown jewel’ bussinesses in Asia to help repay their bridge loan.

      With the blessing of John and his readers I hope to contribute future articles that will be more relevant to you with a macro economic perspective. Some ideas include the impact to online revenues / bloggers and 25 trends I see coming as a result of the unprecedented global economic downturn.

      1. your reply is appreciated and further articles a look forward to. Its nice to know that not all writers walk with a narcissistic attitude and can take replies in stride and work to more forwards.

        In terms of AIG, their numbers are basically out (unofficially ofcourse) and its already a matter of waiting to see how badly the companies break off into smaller entities.

        Citigroup today proved the expect trend when a gov;t comes in to take common shares from the rest of the investors and my assumption on my blog early in the week that this stock was a gonnner came true today after all the over anxious investors got into the market on false hope.

  9. Very good explanation of how the economy is working. Many people choose to believe whatever they hear before really listening to how it all works.

  10. The US stock market has reversed itself by 12 years. Can we say the same about the future of our incomes?

    1. Alex says:

      Good question. The stock market is not an indicator of how the economy is doing now but it is an indicator of where the market THINKS the economy will be in 6-12 months time.

      Our income should have no correlation with the stock indexes as was the case in Japan. But it is important to note that $3,000 today does not have the same purchasing value as $3,000 12 years ago.

      Somewhere between inflation, the demand for your skill and the health of the overall economy will determine the true value of your income.

  11. It is more than the respect for finances (money ) they must learn. Greed and plain stupidity. I know of many that have been impacted directly from their irresponsibility and greed. A good dose of Accountability needs to be sent their way.

    Now, the question would be: What lessons have we all learned? As this has had an impact on us in various ways, I would like to know what will you do differently or advice?

    1. Alex says:

      Every single person on earth has been impacted one way or another by the questionable judgements made on wall street. From the villiger in China staying home instead of working in the city factory producing goods for America to the old car in front of you at the traffic light which could have been a new Merc if the owner had not lost his job, we all have been impacted one way or another.

      Even Mars has not escaped the credit crisis as it is unlikely now the US will send a manned mission there by 2020 (Bush’s goal).

      The prudent advice is really what John Chow has been giving us all along on this blog. Earn lots, develop self-reliance, spend wisely and be mindful of expenses while defending your quality of life. For those who have some savings, it will be a good time to begin looking at picking up ‘tangible’ assests. No leverag though. This means real estate investment is good if you don’t need a mortgage because your wealth may lose more elsewhere. When things normalize, then refinance it. The next global growth will see Chinese money inflating quality assests.

  12. John says:

    In your last paragraph, you state that “your income is likely to depreciate nominally or intrinsically (true value)” as a result of the global credit crisis. If you are referring to my income from my job, then I fail to see the logic of your statement. In a recession, people who do not lose their jobs will actually benefit in the form of lower prices and lower interest rates. I just bought a dining room set at 40% off. I almost bought the set 6 months ago but decided to wait to see if it would go on sale. Also, my line of credit interest rate has come down because rates have come down.

    1. Alex says:

      It is an arguable point depending on how you see it.

      What you describe is the dreaded deflation, where people don’t buy because they expect to pay less in the future. This is the opposite of inflation where people buy now because they worry prices go up in the future. The problem is that deflation is much harder to fix than inflation.

      I do not know what you do for a living but imagine this scenario. You sell tables. No one is buying because they expect lower prices next month. Your competitors lower prices, forcing you to do the same. Now that revenue is lower and profits are slimmer, how is your old income based on inflationary times sustainable?

      1. John says:

        You mean deflationary times, correct? In this case, I agree with you and the table seller will see his income decrease.

        My point though is that the majority of British Columbians have a “regular” job and most will not be laid off. Our unemployment rate is about 6%. That’s pretty bad considering we had 4% unemployment in 2007 in BC. It may go higher, but clearly the majority of people are working and their incomes will not change this year.

        So, with respect to the majority of working people… they are in a position to take advantage of lower prices and lower interest rates if they so choose. Unfortunately, with all the talk of gloom and doom in papers, many of these folks that have stable jobs and are probably in sound financial shape don’t want to spend money out of fear of losing their job… and clearly, these are unfounded fears. Yes, history may prove me wrong and a year from now, we may have rampant deflation and over 10% unemployment… but history suggests that this will not come to pass.

        1. Alex says:

          We’re mostly on the same page it seems. I cannot agree more that a lot has to do with unfound fears.

          What I’m not quite sure on is that BC’s regular jobs are safe. Already there have been factories shut as lumber demand has waned. Afterall, forestry related jobs make up the largest chunck of the province’s ‘regular’ jobs. Adverse affects there will inevitably trickle down to the Lower Mainland.

          Take Telus for example. Reduced demand for business lines, cell phone use and long distance calls will result to possible layoffs and certainly reduced spending. These two very real threats will devastate BC’s economy.

  13. As with anything else in our lives, any opinions on subjects like these vary so widely based on the standard of living people found themselves in before, during, and after the crisis.

    To many people, they already had issues going into this period of strife, so they continue the spiral, whether or not there was a global impact.

    Others were already very well-off and nothing, short of a disaster affecting them personally, will change that. That’s why all the chatter about recession and issues like these take on radically different ideas, depending on who you ask.

    The solution? Trick question. One person’s solution will worsen another person’s lifestyle, so it just “depends.”

    1. Jake Stone says:

      Yes, it depends. It is almost comical to observe markets plunging by 3% and that being hailed as a black hole, which will destroy everything. Unfounded property appreciation is said to be a smart investment and current market correction to be a terrible accident.

      In all this amusing reporting from left and right nobody makes clear sighted analysis of the situation. Even if someone does know what future brings the message is bound to disappear into the noise.

      Is the States really going to fall into hyperinflation like some predict? That would finally push the economy as we understand it into downward spiral.

    2. Tran Harry says:

      For once though, I would say that the disaster has equitable reach, usually the bottom 80% of America’s society get dealt the evil hand, the common worker, the middle class family, the college student stacked with loads of debt.

      For once some of those at the 20%tile of earners is being dealt the same bad cards. They see how when everyone else’s home loses value than there is no way to sustain their own home’s value. Hedge fund managers finally see an end to infinite investment options. CEO’s (some of them) finally have to take accountability for their lavish actions.

      During the normal cycles of economics most people that get affect by anything are those in the middle class, that don’t get any help. But I feel that this disaster which may be the second Depression in the coming, is finally reaching the right people.

      But yes, everyone has different lives and levels, some saved more than others, and are less effected by it, but others spent everything even when earning $100,000k salaries.

  14. Trader says:

    Unfortunately, the article has too much emphasis on AIG. I believe the company is just a victim as it tries to provide insurance for financial instruments that are supposed to have triple-A credit ratings. As for the credit crisis, don’t worry. The Fed is printing money as fast as it can.

  15. Timon Weller says:

    If money was the root of all evil, we would all be there in some way.. πŸ™‚

    “I think this saying implies that the root of all evil is chasing money and not living a normal life or a life you want because of this. Some people dedicate there life to chasing money unhappily, but never stop until they die..”

  16. coolcoolbird says:

    Good post. My point of view, I’m thinking that the rootcause of current economic downturn is due to the greed of those top management idiots, there is no poka yoke or perfect system in this world. Human will always find all the ways to break the system inorder to achieve their greedy goal. This kind of story will keep on happen. lets see

  17. ivan says:

    Good post :)..the real problem lies in the federal reserve(not even a gov.entity went private after 1913) and our fractional reserve banking system…the FED has the power to print money and our Gov. pay’s interest on the money it borrow’s from the FED…so essentially the total amount of money owed back to the banks (principle + interest) and the money in circulation (principle) is never enough..thats why inflation is always needed…we constantly need more money to cover our growing deficits to pay the interest..so mathematically foreclosures and bankruptcies are built into our monetary system…a fiat currency has never succeeded…we need to give the power to print money back to the people…take it away from elite bankers who artificially create inflation to destroy a currency and transfer the wealth back to themselves…

  18. game-girl says:

    I think money is not evil at all,it is like a fire or any other product of civilization.The result depends on the choice of the man who solves on what to spend that money.

  19. SEO Tips says:

    Excellent review of the current economic crisis and a great report on some of the major banks and their struggle to fight through it.

    One thing I don’t agree with what the UK government did was nationalising the Northern Rock bank. They should of let Virgin take over Northern Rock and let Richard Brandson run it, he would of done a great job with the team he had lined up for the takeover.

    It would also of meant that the Government would have more money to inject in to other areas that need help at the moment like small businesses and the housing market.

    Will.

  20. Excellent article, thank you for an interesting reading.
    I guess now we have to wait and see what the world will come up to

  21. HPG Inc says:

    It’s very sad but true. The world has more debt than there is money. Even countries like the one I live in spend more money than we have. Something has got to give so we can stop spending money we dont have. Nice post as usual John, very informative!

  22. I don’t think everybody will be affected adversely by the economic downturn. The rich goes away totally scathed and may even capitalize on it business wise or personally. It’s only the lower end of the population that will be greatly hurt in some ways or another. I enjoyed your post.

    Peter Lee

  23. Not everybody gets affected the same way. The Rich will not suffer much, but the Middle class and poor class they are now suffering from the recession.

    1. Tran Harry says:

      Not if Obama gets his way without any Congress corrections. He’ll tax them til we get out of this mess. And give poor and middle income people one more reason not to work hard. And he’ll also cause rich people to work less cause they’ll take home less.

      1. Oh yes you are right Harry. seems people dont want to make any effort to get out of this mess. They want Obama to do all the hard work.
        Still I hope he can do solve the puzzle, its not only the US economy that are bad, it seems everything depends on him and his advisors.

  24. Tran Harry says:

    Bad debt is evil, only smart people know how to use debt properly. The rest sign on too much debt and live miserable lives to repay it. And when they can finally retire their youth and energy has been sucked dry.

  25. An says:

    Hey John

    Do you know anything about seg funds or Insured retirement program?

  26. Pahn says:

    good thing we are still surviving from this global crisis.. I just hope once everything is back up, I already have my business going great ^^

  27. game-girl says:

    I think the recession touches upon not only the poor and middle class,but the rich as well because they are the part of the living process.I heard about some drama events in the life of the rich .

  28. Good thing. I already have my business going great ^_^

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