"Financial Services"-- The Global Lexicon Misnomer

This is part 1 of a series of 3.

"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."--Mark Twain

We nod then shake our heads in complete agreement with commentators these days regarding the sad state of the "financial services" industry. But if you believe the term "financial services" defines anything, how much do you really understand about the current environment? If this makes you wonder, then I suggest it is important for you to understand the difference in what we understand as financial services, financial sales, and financial advice.

The Bill is Due

We've all been there... or at least I have. You open the mail to find a surprise bill that you cannot afford to pay. Of course it shouldn't be a surprise if you paid attention to where your money was going.

Yes prior to my wonderful wife, and understanding personal finance to ignore the indoctrination of credit companies, I had debt. And a few times I couldn't pay a bill. So like millions, I used a cash advance from another credit card to pay the bill. I was paying ridiculous interest twice on the same balance. Thankfully I learned before getting in real trouble. Some people do this until the cards are all maxed. And why not? It is good enough for the U.S. Treasury.

The Ultimate Self-Dealing Government-- not US

So GM goes sort of bankrupt... finally (see this post from November 2008), and two coincidental and seemingly unrelated events happen.

What's the real problem?

So all assets of all kinds are in a free-fall. Never to this extreme have stocks, bonds (conservative and aggressive), real estate, property (both commercial and residential), and commodities all taken it on the chin. Looking critically at this conundrum may give us insight into the root problem.

I.O.U.S.A. is available online!

Everyone needs to watch the 30 minute summary of this movie, and I mean EVERYONE...

Yes some parts seem to take a few partisan shots, but the information is factual backed up by organizations on both sides of the aisle.

Could fragility of money make this worse?

Presuming that the economic environment is not as tenuous as that of 1929 (which I think is a BIG presumption), a larger and more critical risk-factor exists today, and that is cash on hand.

To get to the core issue, I am speaking of a household's ability to cover the bottom of Maslow's pyramid if everything fell apart, or gave the appearance it might. In the early 1990's households had over $4,000 (inflation adjusted) on hand (or in checking/savings accounts) to cover bills should the worst happen to them. In the early 50's they had about $185. Today households have just over $1,000. So not quite as good as the early 90's but not as bad as the 50's right?

--WRONG... Why? You don't need an econ degree or research to figure this out. Yet instead of relying on common sense, I have done the research for you...

In the early 50's, the average household had around $300 of total debt. In the early 90's just over $30,000. Today the average household has over $128,000 of debt.

So the ratio of cash to debt declines from 65% in the 50's to less than 1% today. Why is this important? Two reasons:
1) If a household loses their income (or thinks they might), the amount of cash they need to eat and keep their house is much greater today.
2) If there were a perception of a run on banks, the fragility is much greater today.

Going into the Great Depression, people had cash in their wallets--they didn't use plastic. If today's plastic line of credit stopped working many people would be hungry in just a few days. Also in the Great Depresssion, the US was a more agriculturally based economy. Many households didn't need money because they grew and canned their own food.

So even if we make the presumption that our economy is healthier, systemic issues may promote situations that would otherwise not exist.

It is not illegal to yell fire at a movie shown outdoors at a park, but is illegal in a traditional theater. Why? Because the limitation of escape routes prompts panic that creates danger even if a fire does not exist. So the danger to our economy is not only that a fire may exist, but that people may think a fire exists with fewer escape routes and create mass hysteria.

If you think humans are more rational, realize that October 30th was the 70th anniversary of The War of the Worlds.
Aaron

Bailout Update

I too have been sick over this whole financial mess, but unlike many other people (especially financial professionals) my malady started in April (see the first post).

What are we to do???-- see below

For me, the best part is that my malady is getting better, because I believe the most likely outcome is clear. And if an outcome is known, action can be taken. I am not advocating everyone run for the hills. But in 1972, with perfect foresight, nobody would have invested in long-term bonds when interest rates and inflation were set to skyrocket over the coming decade eroding purchasing power of interest payments and maturity value.

So clarity feels good... Even on a negative basis...

If the economy can pull out of this situation by mortgaging the future, it all but ensures, there is no saving the next situation that should happen within 4 years. Next situation? As any behavioral professional will tell you, when someone is being enabled in a dysfunctional system (America's financial structure is textbook) and consequences for actions are removed, the person ALWAYS attempts to get more next time.

The enabler in this situation (China) owns almost $2 trillion of our country now, and if they choose to let this one go by continuing to hold our government, corporate, and yes, subprime debt without dumping it at any cost, they won't next time.

Even if they (who are not exactly our allies) dumped all their US debt on the market at once, and only got pennies on the dollar for their holdings, they would still be a cash positive country. They don't have debt, and own debt of other countries that are not bleeding red. I read somewhere earlier this year that in 2 years China will reach economic parity with the US--meaning we are as dependent on them as they are on us. Prior to that they needed us more (as we imported more goods and bought them).

I haven't seen the numbers, but I would bet with this crisis, 2 years to parity went by pretty fast.

So if I were China (especially with the Olympics in the books), I would aggressively dump US debt at almost any cost. Maybe they are which is why our credit markets are frozen. In reality the short-term debt (commercial notes) has been the issue in the past month, and that doesn't require sale, simply no reinvesting.

Here is some sarcasm to use with friends:

Yes the moral decline of our country led to this situation (but indirectly). After all if politicians and the public still read the Bible they would know that the borrower is servant to the lender. So keep in mind that road you are driving on, and your public water supply, and now AIG and the country's largest banks are not REALLY owned by the American government, but by China.

--So maybe I feel better because my clarity is that I plan to learn Chinese.

"Neehow"

For you, avoid the financial dysfunction. Find objectivity. And ignore everything else, especially the media. CNBC is likely increasing their price for advertising, since you all are watching.