Banking crisis

"This American Life", from Chicago Public Radio, has an excellent show explaining the current banking crisis. They illustrate it using a dollhouse loan that goes bad:

"Mark to market, that's another phrase you might have heard. And it applies to exactly the situation Adam is in right now. He's got a dollhouse on his books for 100, but if he had to sell it now, he could only get 50 - that's the market price, what he could get right now. Marking it to market means Adam would have to enter the market price - 50 dollars - or 20 dollars - or whatever it really is - into his books.

And the bankers have all been saying 'please don't make me do that,' because if you do, I'll be declaring bankruptcy."

You can hear the podcast or read a complete transcript of the program at their website.

The Credit of Crisis visualized

Here's a clear explanation of the foundations of the financial crisis by Jonathan Jarvis

Saving

Saving Money in Plain English is a simple introduction to savings and compound interest.

Financial advice for uncertain times

Vanguard advises stock investors to avoid panic.

1. Market timing is a losing strategy.

You may be thinking you should sell now and get back into stocks later when the market "settles down" and the economy starts to recover. But this approach—called market timing—can lead to disappointing returns. In effect, it puts you at risk of selling low and buying high.

2: Investors have been rewarded for taking risk.

The steep and sudden stock market drops we've seen recently are certainly unsettling and may have done serious damage to your portfolio. But this very risk is why, over the long term, stocks have outperformed bonds or cash investments. "To take the risk of investing in stocks, people have to see a higher return potential than they would get from a typically safer asset," said Mr. Bennyhoff. "Taking risk isn't always rewarded in the short term. But, historically, risk has generally been rewarded over the long term in the form of higher average returns."

3: Playing it "safe" can lead to a shortfall.

Right about now, fleeing stocks for the safety of U.S. Treasury bills or an FDIC-insured certificate of deposit seems very appealing. For your short-term financial needs, these cash investments can be good choices. But, they may not be suitable for your long-term goals—like saving for a comfortable retirement—because the returns are likely to be too low.

Remember, your investments will need to outpace inflation over time, otherwise you'll lose purchasing power. Historically, it's been stocks that have helped investors compensate for inflation by delivering higher average annual returns than cash investments or bonds.

4: Emotional decisions often lead to regrets.

In times of market turmoil, it's difficult to take a long-term view and resist the urge to react to the latest big swing in the financial markets. Our instincts tell us we have to do something now. But Mr. Bennyhoff suggests staying calm can help you avoid making moves you later regret.

"Generally speaking, it tends to be a very bad idea to make emotional decisions in times that are already emotionally charged," he said. "If the market had a bad day yesterday and you come in today and sell, that doesn't make up for yesterday's losses. Actually, what you're doing is just capturing your losses."

Read the entire article at
http://www.vanguard.com/us/VanguardViewsArticlePublic?ArticleJSP=/freshness/News_and_Views/news_ALL_reaction_10092008_ALL.jsp

Nobel Prize

Paul Krugman was awarded the 2008 Nobel Prize in Economics this morning. To the public, the Princeton economist may be best known for his New York Times commentary. To economists, he is best known for his important insights and contributions in International Trade theory.

From the Nobel Prize press release:

"How are we affected by globalization? What are the effects of free trade? Why do increasing numbers of people flock to large cities, while rural areas become depopulated?

"These questions cannot be answered without a theoretical foundation. For a long time, the analysis of foreign trade had been based on a well-established theory which explained why some countries export certain goods and import others. After World War II, however, it became increasingly obvious that important trade patterns did not quite correspond with that theory. In 1979, the US economist Paul Krugman proposed a new model which provided a better explanation for the observed patterns.

"In later research, Krugman has shown that the model he initially developed for international trade could also be used to clarify key issues in economic geography. In the context of both foreign trade and economic geography, the objective is to explain what goods are produced where. Theories of economic geography also attempt to specify the forces whereby labor and capital become located in certain places and not others."

Financial Crisis info

Looking for good explanations of recent events in the Financial markets? Try these resources:


The F.A.Q.’s of Lehman and A.I.G.
By Douglas W. Diamond and Anil K. Kashyap
on the Freakonomics blog

"Why did these things happen?

The common denominator in all three cases [Fannie Mae/Freddie Mac, Lehman, AIG] was the ability of the firms to secure financing. The reasons, though, differed in each case."

"Fannie and Freddie were weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital was not enough to cover the losses on these subprime mortgages. The massive amount of diffusely held debt would have caused collapses everywhere if it was defaulted upon; so the Treasury announced that it would explicitly guarantee the debt."

"Lehman’s demise came when it could not even keep borrowing. Lehman was rolling over at least $100 billion a month to finance its investments in real estate, bonds, stocks, and financial assets."
"Why did the financing dry up? For months, short-sellers were convinced that Lehman’s real-estate losses were bigger than it had acknowledged. As more bad news about the real estate market emerged, including the losses at Freddie Mac and Fannie Mae, this view spread."

"A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments. While its core insurance businesses and other subsidiaries (such as its large aircraft-leasing operation) were doing fine, these contracts, called credit default swaps (C.D.S.’s), were hemorrhaging. "

read more at: http://freakonomics.blogs.nytimes.com/2008/09/18/diamond-and-kashyap-on-the-recent-financial-upheavals/

A Slate magazine article explains some basic terms

"Central bank, reserve bank: A country's central bank maintains the stability of its national currency. In the United States, the Federal Reserve functions as the central bank and acts as a last-resort lender to failing financial institutions. The Fed was created in 1913 to provide financial stability in response to the Panic of 1907.

Commercial bank: A commercial bank, also known as a business bank, takes deposits and gives loans, mostly to corporations. After the Great Depression, Congress required that commercial and investment banks be separate with the Glass-Steagall Act; that restriction no longer applies today. Bank of America is currently the largest commercial bank in the United States.

Investment bank: An investment bank raises money by selling securities to companies and to the government. They also provide advice to corporations about mergers and buyouts. With Lehman Bros. and Merrill Lynch out of the picture, Goldman Sachs and Morgan Stanley are the two largest investment banks in the United States."

see more definitions at http://www.slate.com/id/2200410/


Public radio's This American Life broadcast a special episode called "The Giant Pool of Money" which is the best and most accessible explanation I've heard.

"The thing that got me interested in all this was something called a
NINA loan. Back when the housing crisis was still a housing bubble. A guy on the
phone told me that a NINA loan stands for No Income, No Asset, as in, someone will
lend you a bunch of money without first checking if you have any income or any
assets. And it was an official, loan product. Like, you could walk into a mortgage
broker’s office and they would say, well, we can give you a 30 year fixed rate, or we
could put you in a NINA. He said there were lots of loans like this, where the bank
didn’t actually check your income, which I found confusing. It turns out even the
people who got them found them confusing. For example, a guy I met named
Clarence Nathan. He worked 3 part time, not very steady jobs, and made a total of
roughly 45 thousand dollars a year roughly. He got himself into trouble and needed
money, so he took out a loan against his house. A big one."

You can hear it (or read a transcript) at their website: http://www.thislife.org/Radio_Episode.aspx?sched=1242

Can learning about the Federal Budget be fun?

Budget Hero from American Public Radio's Marketplace lets students adjust spending and taxes in a colorful interactive budget game. It's available free at
http://marketplace.publicradio.org/features/budget_hero/