Wall Street's Out on Bail - But Not Quite For Free

Full-length SIFE Sense article from week of October 20

Across the country, the common citizen has been struck with uncertainty regarding a bailout bill which would provide financial capital to investment banks and mortgage originators who approved thousands of defaulted subprime loans. Although many were skeptical about providing money to those corporate officers and firms responsible, most felt that some government assistance was needed to abate further bankruptcies and protect embattled homeowners. On September 22, President Bush proposed a $700 billion “rescue plan” in the wake of Lehman Brothers’ and Merrill Lynch’s failings, and the Dow Jones Industrial Average declined below 9000 points for the first time since 2003 on October 9. However, due to apparent political maneuvering in the House, the bill failed there on September 27 by a vote of 228 to 205 (with one representative abstaining). The Senate came to a resolution on Wednesday, October 1, approving an immediate $250 billion rescue package by a 74-25 vote and an additional $100 billion for use by Bush at his discretion as well as an additional $350 billion on hold for future consideration, and the House followed on October 3 by approving the reworked package by a vote of 263 to 171.

The package was passed on several conditions, including the provision of stock warrants to the government from companies selling bad securities and the renegotiation of mortgages issued by these companies. In addition, in order to receive bailout money, corporations would be required to limit “golden parachute” packages for departing corporate officers. The executives of firms receiving aid of greater than $300 million would also face steeper income taxes. The issue at the forefront of the “toxic loan crisis”, as it has come to be known, is the solicitation and approval of subprime loans, which are loans and mortgages provided to those with bad credit or little collateral. While the mass media has stoked the flames of the crisis by largely broadcasting images of despair, only 2 percent of U.S. mortgages are currently under default. Consumer and investor fear is counterproductive to market stabilization because it discourages investing and reduces purchasing, therefore reinforcing the market slack.

While it is tenuous to conclude what the ultimate solution may be, individuals can lessen the effects of “toxic lending” by ensuring that their loans and mortgages equate to no more than four times their annual income and ensure financial security against stock market dips by diversifying their assets. A general rule of thumb to follow is that one should hold no more than fifty percent of their net worth in common stocks, placing the remainder in savings accounts, bonds, property, and other low-risk securities. As you grow older and near retirement, your stock assets including those in a 401(k) plan should gradually be divested into more stable securities such as bonds and money-market accounts to protect against market fluctuations. Historically speaking, amongst types of securities common stocks have been the most variable and therefore the riskiest.

Recently, Congress repealed a long-standing regulation requiring a minimal credit rate for loan and mortgage applicants, resulting in many who would have previously been unqualified for such provisions receiving them. Many of these people later defaulted on their credit due to their inability to finance them, and ultimately found their property repossessed. Credit ratings exist for a reason – to ensure that people pay back their debts and do not cost the government or businesses excess funds to finance “toxic loans”. You can protect your ability to receive loans by paying credit card bills on time, repaying student loans, and avoiding excessive credit card purchases which you will have difficulty repaying on time. While mortgage originators and loan financing institutions may hold ultimate responsibility for the current credit crisis, we can each play a role in preventing future economic pitfalls.