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Financial crisis

A breakdown of how the world got into its current financial mess... And what it means for you and your money.

We are currently living through the most serious financial crisis since the Great Depression in the 1930s.

Stock markets around the world are collapsing – trillions of dollars in value wiped out in hours, almost daily.

Meanwhile, in the US and other rich countries, credit is getting scarce.

Many people wanting to a buy a house or car, get a student loan or finance their businesses can't get the money from banks. Without financing, economies can't function.

How did this happen?
The problem started with the property market in the US.

House prices went up sharply the past couple of years and banks started giving home loans to people who couldn't afford it.

Often, no proof of income, job or assets was required. Some people couldn't even afford to pay the first instalment on their loans.

Many of these "sub-prime" loans came with a low interest rate for the first few years, with rates increasing sharply thereafter.

When house prices started to falter and the prices of fuel and food rocketed, millions of households couldn't afford their home loan repayments. Also, Americans were already hugely over indebted. (The average American has nine credit cards, with a total average balance of $9 840.)

In 2007, the number of houses in the US, which were subject to foreclosure, rose by 79%.

Banks started to feel the pain – clients were defaulting and the houses they had to take back were worthless.

But that's not all. Brainboxes at the big investment banks created complex financial instruments, which chopped up these risky loans and packaged them into products, which were sold to other institutions.

Many overseas banks bought these complicated products, which very few people understood. When bad loans started to pile up, nobody knew how to value these products accurately, leaving financial institutions with huge holes on their balance sheets.

A number of banks across the world have gone belly-up because of their exposure to these products.

And now banks are refusing to lend money to each other because they are afraid they won’t get their money back.

Banks have to adhere to strict regulations regarding the cash they hold at the end of every day.

Traditionally, every night, banks lend each other money to make sure they comply with the requirements. Now banks are so scared, they are hanging on to their capital. If they do lend out money, they ask very high interest rates.

Many businesses, which need financing to tie them over, are starting to feel the pain.

What next?
Governments around the world have gone to extreme lengths to stabilise the situation. Banks have been nationalised, interest rates cut and the US plans to buy bad debts from banks to "unplug" the system.

But the financial markets have not reacted with wild enthusiasm. A new approach by the UK government, which involves taking stakes in ailing banks, has been more popular. Other governments – including the US – have vowed to copy the UK plan, which has resulted in a rally on world markets.

It may take a very long time to get the bad debts off banks' balance sheets, meanwhile house prices are continuing to fall, lending has seized and consumers are buying less – hurting all businesses.

How will this affect you?
South Africa has been fortunate. Two factors have prevented a meltdown in our banking sector.

First, the National Credit Act, which required banks and other credit providers to implement much stricter lending criteria. They couldn't lend to risky borrowers anymore.

If the US had the same system, it could have saved the world from a global credit crunch.

Secondly, foreign exchange controls. South African banks couldn't invest in the toxic US products because there are restrictions on how much money they can take abroad.

But the current crisis will affect South Africans in other ways.

Pension and investments: Your pension and unit trusts most likely are invested in shares.

You might need to sit down for this: your savings have probably lost a lot a value. This shouldn't be a problem if you are five or more years away from retirement – the markets usually correct themselves within a couple of years.

If you are worried about your pension, talk to your financial advisor. Your pension fund should offer you a choice where you can invest your savings and what risk you are willing to take on.

In the run-up to your retirement, you may choose to switch from riskier shares to cash and bonds.

But it is dangerous to switch too soon; shares offer the best growth in the long run, and if you move your money into 'safer' options too early you might miss out on much needed growth.

The SA economy: Although we don't have a banking meltdown, South Africans have their own set of problems. Because of the sharp increases in interest rates (to tame inflation), house prices are struggling.

And many people are also battling to get loans, because banks are stricter about their lending criteria. This is affecting many people and businesses – especially in construction.

If the global economy starts cooling, there will be less demand for our exports – specifically mining, cars and agricultural products. Tourism is already starting to suffer, although the 2010 Soccer World Cup could still provide a boost.

More help could come from government's planned R568bn infrastructure expansion programme, although the cost of the program (some of the money needs to be borrowed) will be affected by the credit squeeze overseas.

Most economists expect that SA will escape a recession – unlike the US and the UK – but the local economy will still slow due to the international turmoil.

Petrol price: A bit of good news. Concerns about the effect of a very weak global economy on oil demand have lowered the oil price. The oil price has fallen 40% since July.

Interest rates: More good news. Economists are expecting interest rates to be lowered by April next year.

But central banks in many countries have lowered their rates today, which could mean an earlier cut for SA. But should the rand continue to weaken, this won’t happen soon.

How to survive the crisis

  • Get thrifty: When everyone is in dire straits, it makes it easier to tighten your own belt. Cut out all unnecessary spending and start living within your means.
  • Pay off your debt: Start with the debt earning the highest interest rate (usually credit cards). If you have problems settling your debt, talk to your debtors to re-arrange payments. If they are not accommodating, get a debt counsellor on your side.
  • Invest: Once you've paid off your debts, make sure you are putting away money to invest. This is a probably not a bad time to start looking at shares. Although the market probably has not reached a bottom, prices are looking cheap compared to recent times. Explore options like unit trusts, or their cheap cousins, exchange traded funds.
  • Don't sell: Unless you don't absolutely have to, don't sell into this weak market. This is valid for everything from your house, car to your unit trusts.

www.news24.com

 

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