The Great Depression
Okay. Listen up! I don't care what the media has been screaming about. This is NOT another Great Depression. I'm going to explain to you why.
Kass's Top Three Reasons Why This is Not Another Great Depression
The Great Depression began with the crash of the stock market in October 1929 (the crashes are always in October...). Many investors were trading on margin. This means that they were buying low without paying, making a promise to pay after they sold the stock. The stock market had been rallying all summer and millionaires were being made daily. It was a win-win situation as long as the stock market continued to rise which, of course, it didn't.
Sound familiar? This is analogous to what happened in the real estate market that began the current crisis.
But I'm getting away from the subject at hand. Stock players bought on margin and then the stocks fell, and they couldn't pay for them, so they jumped out of windows and there was a huge panic in the markets.
Then there was a run on the banks. I am writing this from memory and I can't remember if the bank run happened first or closely after the stock market crash. But for some reason, people were afraid that the banks were failing, so they wanted to get all their money out. Banks never hold enough cash to cover all their depositors' money. So when people demanded their money, the banks ran out and had to close. This led to a panic in the banking sector.
Reason Number One: FDIC Insurance.
One of the changes in our banking system that came out of the Great Depression was Federal Deposit Insurance Corporation insurance. This insurance insures all bank deposits up to $100,000. As a result of the "bail-out", it now insures deposits up to $250,000.
If you have more than $250,000 in a checking or savings account at an FDIC-insured bank, open another account. FDIC insurance is by account, and a person can open as many accounts as he likes.
(This does not apply to brokerage accounts purchased through a bank. Mutual Funds are not FDIC insured. Money Market accounts may or may not be. Read your account prospectus or talk to your financial advisor to be sure.)
All US banks are FDIC insured. If you are not, you cannot call yourself a "bank".
If you've been reading the real news lately, you will hear that Ireland recently decided to insure all bank deposits. Last weekend Germany made some noises about it, and this morning Austria made the move to insure bank deposits too. All of the EU will eventually jump on the bandwagon to a greater or lesser extend so that depositors won't move their money to another country. But the fact is that we've had this kind of insurance all along.
So if a bank goes out of business, you will not lose the money you have deposited there. So there is NO reason to have a run on the banks like in the Great Depression.
Moving on...
If banks aren't solid enough to make loans to businesses, businesses don't run. Businesses don't operate on a cash basis. Orders go up and down every month. As a business owner, you can't sit around and pray that you make enough money to be able to pay your employees! So you take a working capital loan from the bank.
This is the great fear of the current credit crisis. Your employer isn't announcing lay-offs because sales are dropping (necessarily). They are announcing lay-offs because the bank that typically makes up for any short months isn't willing to extend that credit anymore, and your employer can't afford to pay so many people. So people must be let go.
During the Great Depression, people lost their jobs (unemployment rose to 25%!), then they lost their houses, then they lived in tent cities and shanty towns and begged on the street corners. People who owned their homes starved in them because they couldn't pay for food.
Reason Number Two: Unemployment Insurance (et al.).
We no longer have to go it on our own when our employer lays us off. There is unemployment insurance. No, it won't pay all your bills, but it will help greatly. And if you are unemployed, there are other assistance programs for which you can apply to help you pay your bills. During the Great Depression, people had to fend for themselves entirely. We now have UI and Social Security and Welfare and a whole slough of social programs that will keep us from building tent cities in Central Park.
Reason Number Three: Personal Access to Credit.
Credit exists for a reason. It allows businesses and individuals to keep going in difficult financial times. Credit should not be used to throw a party or buy things you don't need. It should be used to back up your cash reserves in times of crisis. It should be used to keep your household (or business) on an even keel even when income has dropped.
During the Great Depression, there was no such thing as credit cards. I don't think there were even credit ratings yet. So the average American didn't have access to credit to keep his household functioning if he lost his job. And that meant that everything ground to a halt.
If you lose your job and unemployment insurance isn't enough to pay for the house, the cars, and your living expenses, do you decide not to buy food? No! You pull out the credit card. And you know what? That's okay! Not paying the phone bill because you absolutely have to have that dress from Target is a bad idea. But paying for heating oil with Visa is not a bad thing. That's what it's for! When you become re-employed, your first priority should be to pay it back.
But let's talk about other kinds of credit. If you can get a loan against the equity in your house now in order to hire a contractor to make improvements to it, you're doing two smart things: #1 -- you are increasing the value of your biggest financial asset; and #2 -- you are creating a job in a depressed sector of the economy and therefore helping that sector recover. The key to economic recovery is to keep cash flowing, to keep buying and selling, to keep the economy moving.
I'm going to say that again: The key to economic recovery is to keep cash flowing.
Businesses close when they cannot cover their expenses, but this does not happen overnight. If businesses can move forward during a slow sales time, they will profit when the economy rebounds. Businesses move forward by reducing expenses and taking loans. If they manage to stay afloat, they will eventually hire back their staff (and possibly hire more) and prosper. But in order for them to risk an economic slowdown, there has to be the prospect of sales in the future. If people simply stop buying everything, no business will choose to weather the lean times.
The Federal Reserve Bank (and its analogs around the world) cut interest rates this morning in a move to stimulate the economy. When the Fed Funds rate drops, banks are more likely to lend to each other. When they lend to each other, they are more likely to lend to businesses and individuals. When there is more money to lend, there is more money for you to borrow. And that extra cash in the market stimulates growth. And growth pulls us out of an economic downturn.
And the economy always rebounds. It's a cycle. It event rebounded after the Great Depression. It just took ten years.
What Can I Do?
Don't panic. Save what you normally save. Spend what you normally spend. Support small buinesses. Don't buy more than you can afford. But don't hoard your money either. Act normally and everything will soon normalize.
If you can get a loan, buy a house. Housing prices are incredibly low right now and interest rates are miniscule. This is an incredibly good time to buy because houses are undervalued.
If you have a house, take a home improvement loan to add value to it and hire a contractor. They will love you for it!
Whatever you do, don't stop spending! You may think this will leave you with more money in the bank, but if everyone in the country stopped spending, the economy would grind to a staggering halt. This is no good for anyone.
Many retail businesses depend on the Christmas rush to support themselves through the winter. Don't conserve on Christmas presents this year. Buy normally. Support local businesses. Buy from small businesses. Keep the economy chugging along.
Don't go crazy. Just act normally. Don't let people upset you that the sky is falling. It's not. Only you can make the sky fall. So don't!
AND DON'T LISTEN TO TALK RADIO! If there is one thing in this country that is complete detrimental to the understanding and welfare of the public, it is those loud-mouth know-nothings on talk radio!
Kass's Top Three Reasons Why This is Not Another Great Depression
The Great Depression began with the crash of the stock market in October 1929 (the crashes are always in October...). Many investors were trading on margin. This means that they were buying low without paying, making a promise to pay after they sold the stock. The stock market had been rallying all summer and millionaires were being made daily. It was a win-win situation as long as the stock market continued to rise which, of course, it didn't.
Sound familiar? This is analogous to what happened in the real estate market that began the current crisis.
But I'm getting away from the subject at hand. Stock players bought on margin and then the stocks fell, and they couldn't pay for them, so they jumped out of windows and there was a huge panic in the markets.
Then there was a run on the banks. I am writing this from memory and I can't remember if the bank run happened first or closely after the stock market crash. But for some reason, people were afraid that the banks were failing, so they wanted to get all their money out. Banks never hold enough cash to cover all their depositors' money. So when people demanded their money, the banks ran out and had to close. This led to a panic in the banking sector.
Reason Number One: FDIC Insurance.
One of the changes in our banking system that came out of the Great Depression was Federal Deposit Insurance Corporation insurance. This insurance insures all bank deposits up to $100,000. As a result of the "bail-out", it now insures deposits up to $250,000.
If you have more than $250,000 in a checking or savings account at an FDIC-insured bank, open another account. FDIC insurance is by account, and a person can open as many accounts as he likes.
(This does not apply to brokerage accounts purchased through a bank. Mutual Funds are not FDIC insured. Money Market accounts may or may not be. Read your account prospectus or talk to your financial advisor to be sure.)
All US banks are FDIC insured. If you are not, you cannot call yourself a "bank".
If you've been reading the real news lately, you will hear that Ireland recently decided to insure all bank deposits. Last weekend Germany made some noises about it, and this morning Austria made the move to insure bank deposits too. All of the EU will eventually jump on the bandwagon to a greater or lesser extend so that depositors won't move their money to another country. But the fact is that we've had this kind of insurance all along.
So if a bank goes out of business, you will not lose the money you have deposited there. So there is NO reason to have a run on the banks like in the Great Depression.
Moving on...
If banks aren't solid enough to make loans to businesses, businesses don't run. Businesses don't operate on a cash basis. Orders go up and down every month. As a business owner, you can't sit around and pray that you make enough money to be able to pay your employees! So you take a working capital loan from the bank.
This is the great fear of the current credit crisis. Your employer isn't announcing lay-offs because sales are dropping (necessarily). They are announcing lay-offs because the bank that typically makes up for any short months isn't willing to extend that credit anymore, and your employer can't afford to pay so many people. So people must be let go.
During the Great Depression, people lost their jobs (unemployment rose to 25%!), then they lost their houses, then they lived in tent cities and shanty towns and begged on the street corners. People who owned their homes starved in them because they couldn't pay for food.
Reason Number Two: Unemployment Insurance (et al.).
We no longer have to go it on our own when our employer lays us off. There is unemployment insurance. No, it won't pay all your bills, but it will help greatly. And if you are unemployed, there are other assistance programs for which you can apply to help you pay your bills. During the Great Depression, people had to fend for themselves entirely. We now have UI and Social Security and Welfare and a whole slough of social programs that will keep us from building tent cities in Central Park.
Reason Number Three: Personal Access to Credit.
Credit exists for a reason. It allows businesses and individuals to keep going in difficult financial times. Credit should not be used to throw a party or buy things you don't need. It should be used to back up your cash reserves in times of crisis. It should be used to keep your household (or business) on an even keel even when income has dropped.
During the Great Depression, there was no such thing as credit cards. I don't think there were even credit ratings yet. So the average American didn't have access to credit to keep his household functioning if he lost his job. And that meant that everything ground to a halt.
If you lose your job and unemployment insurance isn't enough to pay for the house, the cars, and your living expenses, do you decide not to buy food? No! You pull out the credit card. And you know what? That's okay! Not paying the phone bill because you absolutely have to have that dress from Target is a bad idea. But paying for heating oil with Visa is not a bad thing. That's what it's for! When you become re-employed, your first priority should be to pay it back.
But let's talk about other kinds of credit. If you can get a loan against the equity in your house now in order to hire a contractor to make improvements to it, you're doing two smart things: #1 -- you are increasing the value of your biggest financial asset; and #2 -- you are creating a job in a depressed sector of the economy and therefore helping that sector recover. The key to economic recovery is to keep cash flowing, to keep buying and selling, to keep the economy moving.
I'm going to say that again: The key to economic recovery is to keep cash flowing.
Businesses close when they cannot cover their expenses, but this does not happen overnight. If businesses can move forward during a slow sales time, they will profit when the economy rebounds. Businesses move forward by reducing expenses and taking loans. If they manage to stay afloat, they will eventually hire back their staff (and possibly hire more) and prosper. But in order for them to risk an economic slowdown, there has to be the prospect of sales in the future. If people simply stop buying everything, no business will choose to weather the lean times.
The Federal Reserve Bank (and its analogs around the world) cut interest rates this morning in a move to stimulate the economy. When the Fed Funds rate drops, banks are more likely to lend to each other. When they lend to each other, they are more likely to lend to businesses and individuals. When there is more money to lend, there is more money for you to borrow. And that extra cash in the market stimulates growth. And growth pulls us out of an economic downturn.
And the economy always rebounds. It's a cycle. It event rebounded after the Great Depression. It just took ten years.
What Can I Do?
Don't panic. Save what you normally save. Spend what you normally spend. Support small buinesses. Don't buy more than you can afford. But don't hoard your money either. Act normally and everything will soon normalize.
If you can get a loan, buy a house. Housing prices are incredibly low right now and interest rates are miniscule. This is an incredibly good time to buy because houses are undervalued.
If you have a house, take a home improvement loan to add value to it and hire a contractor. They will love you for it!
Whatever you do, don't stop spending! You may think this will leave you with more money in the bank, but if everyone in the country stopped spending, the economy would grind to a staggering halt. This is no good for anyone.
Many retail businesses depend on the Christmas rush to support themselves through the winter. Don't conserve on Christmas presents this year. Buy normally. Support local businesses. Buy from small businesses. Keep the economy chugging along.
Don't go crazy. Just act normally. Don't let people upset you that the sky is falling. It's not. Only you can make the sky fall. So don't!
AND DON'T LISTEN TO TALK RADIO! If there is one thing in this country that is complete detrimental to the understanding and welfare of the public, it is those loud-mouth know-nothings on talk radio!