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Guarding Your Wealth for Senior Citizens
How to Manage Your Money in This Crisis of
Confidence
'Economy is strong and I believe the crisis is one of
confidence'
By Jeffrey D. Voudrie, CFP
 Aug. 16, 2007 - The stock market has been
incredibly volatile since early July, with daily swings of 1% to 2% or
more. It’s enough to cause even the most seasoned investor to stop and
wonder what is going on. The news keeps talking about ‘credit swaps’,
‘CDO’s’ and sub-prime mortgages. But what does it all mean and why is
the market reacting the way it is? I want to explain why there is a
"Crisis of Confidence," and how to manage your money in the midst of it.
Since World War II, ours has become an economy that
runs on debt. In 2001, the Federal Reserve drastically lowered interest
rates to make it easier for consumers to obtain credit, especially for
homes. It worked, at least for a while.
But over time, there were only so many people that
could afford to put down 20% to buy a home. To increase their profits,
banks and mortgage companies relaxed their requirements so buyers only
had to put down 10%.
This increased the demand for housing and caused
home values to rise. Before long, fewer people were able to afford to a
10% down payment. Once again, loan standards were lowered, allowing
people with little or no credit to buy a home without putting up any
money.
Many of those ‘nothing down’ loans were done with
adjustable rate mortgages (ARMs). The initial interest rate was low, but
that rate (and the monthly payment) would increase as interest rates go
up.
Unfortunately for home owners, the Federal Reserve
has been raising interest rates lately due to inflation fears. Those
with ARMs who could barely make the payment when interest rates were low
can’t make the higher payment now and are having to default.
As the real estate market has declined, banks are
taking a loss when they try to sell these foreclosed homes. But it’s no
longer the bank that holds the mortgage paper. The bank and mortgage
companies quickly sell the mortgage paper to others, retaining a
portion. Traditionally, it was Freddie Mac and Fannie Mae that bought
many of these mortgages, packaged them into loans, and sold them to
investors.
In the last several years, large banks, insurance
companies and hedge funds saw an opportunity to increase their profits
in the same way. They turned these mortgages into Collateralized Debt
Obligations, or CDOs, and sold them in large blocks to other
institutions, including other banks, insurance companies, hedge funds,
mutual funds and pension funds
So if someone is unable to make their higher
mortgage payment, it’s not the local bank that takes the loss, it’s
these big institutions. If a big institution starts taking a loss they
are going to try to sell those bonds. But other institutions aren’t
buying.
Another problem is that many of these big
institutions, such as hedge funds, leveraged their investments. They
might borrow $9 for every $1 they have, using that money to buy more
stocks and mortgage bonds.
So when stocks or bonds drop too much, they face a
margin call. They have to sell what they have, quickly, to pay back
their lender. Of course, this causes the prices to go down further. When
many institutions are involved it results in a sharp market decline.
That’s what we’ve been experiencing.
The Crisis of Confidence is that the lenders are
concerned that they won’t be able to get their money back because those
that borrowed it won’t be able to sell what they own. This is referred
to as liquidity.
Right now, there are those that have to sell
regardless of the price, to pay back their lenders. There are those who
don’t understand what is going on (typically individual investors) who
panic and sell because they’re afraid it’s the next crash. And there are
those professionals who are calmly waiting and picking up bargains.
I don’t believe that we are on the edge of a market
crash. The economy is strong and I believe the crisis is one of
confidence. By the end of this year, the markets should have recovered.
Now would be a good time to move out of short term positions, but I
would hold on to medium and longer-term holdings that represent good
companies. You can read an expanded explanation on my website.
If you have a specific question or would like more
information, give me a call toll-free at 1-877-827-1463 or you can also reach me by email at
jeff@guardingyourwealth.com.
I will answer your financial question FREE.
About Guarding Your Wealth:
“Guarding Your Wealth” is a
nationally syndicated weekly personal finance column written by Jeffrey
D. Voudrie, CFP. Mr. Voudrie is the President of Legacy Planning Group,
a private wealth management firm that employs sophisticated proprietary
strategies designed to protect and grow its clients' investments. Visit his website,
www.guardingyourwealth.com to read past articles under the Guarding
Your Wealth Article Archive that may not have appeared in
SeniorJournal.com.
Guarding Your Wealth for Seniors, on
SeniorJournal.com, is
a collection of columns by Voudrie that deal with issues of particular
interest to senior citizens.
Click here
for all columns.
In addition to being a nationally
syndicated columnist and Certified Financial Planning Practitioner, Mr.
Voudrie provides personal, private money management services to select
private clients
nationwide.
Looking for an energetic expert who
is passionate about financial and wealth management? Mr. Voudrie is an
excellent speaker who will excite and inspire your audience. Mr. Voudrie
is available for a limited number of speaking engagements, television
appearances and radio talk shows. For bookings, email
jeff@guardingyourwealth.com.
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