Worldwide Success

The end of the year is the perfect time to reflect upon the challenges and successes of the year just past.  As 2008 comes to an end, many of us are thinking that the end of this challenging year could not have come any sooner.  What a challenging year it was! 

2008 will likely go down in history as the worst financial year since the Great Depression.

For most people this means that, financially, 2008 was the worst year in their lifetime.  For people in all areas of the financial spectrum, 2008 represented a significant decrease in their net worth.  For those less fortunate, 2008 may also have brought the loss of a home, the loss of a job, or the demise of a business.  Let’s take a look at the events that lead to this financial malaise:

The Burst of the Real Estate Bubble

It is hard to believe that all the financial troubles that we are living today started with the housing market.  Housing prices peaked in mid 2006 and since then have gone on a downward spiral in an attempt to bring prices back in line with historical trends.

Historically, home prices have risen in line with the overall rate of inflation.  For most of the 20th century, from 1895 to 1995, there was no real increase in home prices in terms of inflation-adjusted dollars.  But recently home prices increased at a much higher pace than the rate of inflation, peaking in 2006.  Furthermore, in the last few decades the prices of homes have maintained a constant ratio of about 15 times the annual rent.  However, at the peak of the bubble, the ratio of home prices to annual rent was 25 to 1.  Today this ratio is much lower, but it is still not in line with the historical trends.

Disastrous Consequences of Unregulated Credit

During the 2001 recession the Fed started lowering interest rates in order to stimulate the economy.  Lower mortgage rates made houses more affordable, and lenders looked for ways to increase profits by lending to borrowers with high risk profiles.  The risks of these loans were spread to investors through creative securitization of the loans.

As home prices kept increasing, people looked for ways to get in the market quickly before prices got even higher, resulting in a buying frenzy where homes were often sold above their asking price.  To afford these increasingly expensive houses people took advantage of high risk loans such as adjustable rate mortgages (ARM), interest-only mortgages and even reverse amortization mortgages, in which you owe more on your loan with passage of time.  Moreover, these loans were often packaged with no down-payment or proof of income requirements.  Sometimes they even involved cash back that was often used by borrowers to further fuel consumerism.

Once the recession ended, the Fed started gradually increasing interest rates to combat inflation.  Higher interest rates resulted in ARM loans resetting at much higher rates than borrowers could afford.  Without the means to pay their mortgages, people started selling their homes, and foreclosures rates started increasing dramatically.  As the supply of homes increased and higher interest rates made these homes unaffordable, prices started coming down.  This resulted in many homeowners being under water, meaning they owed more money on their mortgages than their homes were worth, creating a disastrous financial predicament for many homeowners.  They could not sell their homes and at the same time could not afford the monthly payments, leaving them with no choice but to face foreclosure.  Today 1 in 7 homeowners are in this predicament.

Financial Markets Meltdown

The credit problems associated with the housing market resulted in severe losses for many financial institutions as borrowers started to default on their mortgages.  The securitized loans that were sold in the financial markets were so complicated that it was hard to assess their real risk and value.  Consequently, many financial institutions were caught unprepared to deal with the meltdown of the credit markets resulting in the demise of many well-known investment firms, several mergers, and the infamous $700 billion bailout of the Wall Street by US taxpayers in an unprecedented effort to prevent a financial Armageddon.

Troubles Spill Over to the Rest of the Economy

Troubles in the financial industry resulted in a stock market crash, with staggering losses topping 40% for many indexes.  These losses represented trillions of dollars in wealth that was wiped out from households worldwide.  The losses from real estate and the stock market lead to a level of fear by consumers that hadn’t been seen since the Great Depression.  As consumers cut back on spending, revenues decreased and companies started cutting cost, including the elimination of jobs.  Fewer jobs meant less spending, and a downward economic spiral unfolded. 

Looking at 2009

Today we are experiencing the worst financial crisis most of us have ever lived through.  To make matters worse, today’s economic troubles will likely continue for quite some time, likely through at least part of 2009, if not for most or all of it.  Our hope is that with the recent economic stimulus from governments worldwide, including the recently announced zero interest rate from the Fed, we will experience a recovery sometime next year.  That way the 2009 Financial Retrospective may not be as gloomy as this year’s.

Despite of what 2009 may bring, successful people will continue to focus on the things they can control.  This may even be an opportunity for you to become stronger and get positioned to take advantage of the eventual recovery.

We bring this year to a close by wishing you much success in 2009!

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