What is the Credit Crisis, and What are its Global Effects? By Lou Harty At Isnare.com Ezine Articles

Well, let's try to keep this simple, because this runs away with a lot of people. That's because the media have made it a complex issue that is actually very basic. There's no such thing as free money.

If you are going to be given a loan, you should be able to pay it back, and you should be able to reasonably prove that you can pay it back when you apply for it. Lenders charge interest rates to compensate for their delay of being able to use that money for their own purposes of buying things they need or desire--that is, a delay in "consumption".

That's not "your" money--its other people's money that you are using with their permission so that you can secure your own ends. Yet, banks who had bound themselves to Wall Street, and at the behest of the American federal government, created derivative financial instruments that were based on the ability of "subprime" mortgage loan borrowers to pay back their loans. Bad move. What an amazing combo! Low interest rates, low inflation, and easy credit.

If they were going to be forced to lend to the risky, these lenders were going to take it easy and come up with the easiest way to make money ever known! Never before had there been low risk married to great reward...but it all depended upon one assumption, and that assumption proved to be fundamentally unsound and false.Bankers and mortgage brokers conspired together to let formerly bad risks be re-conceptualized as great clients.

Under pressure to stop being "prejudiced against" poor risk borrowers, lenders saw to it that higher risk borrowers enabled them to charge proportionately higher interest rates, and more and higher fees. Then, they would turn around and sell the loan off to unsuspecting institutions.

Now, this is not necessarily bad. It might be dangerous, but not bad. But what does make this bad, besides the lack of transparency because of all the levels of leveraging, is that it's all been built upon that faulty, unrealistic assumption: that people who have difficulty paying back loans are somehow going to pay back the particular loans that underpin all of this!

You see, if you have a lot of money to throw around, you can go a broker these days and put down $1 million; that amount can right then and there be leveraged for at least $3 million. The resulting $4 million--you now have $1 million worth of equity and $3 million worth of debt--can then be invested in a basket of funds that will turn around and leverage this $4 million several more times...and it just spirals on and on. But suffice it to say, that $1 million that individual put down could readily turn into $100 million, with $99 million of it all debt.

If you make a bad move, you now owe $99 million. Under this kind of leveraging, you can qualify for a lean margin account if you have great credit, but if you have poor credit--and now, more and more people do--you will be forced to pony up more money for your margin account to keep it open and operating.

HOW CAN YOU SURVIVE THIS CREDIT CRISIS?

Well, stop doing what all the Jones' are doing! You don't have to be a fool. Why should you be on the hook for money you can't pay back? Why go for a large margin account when you can leverage a small one for great gains?

Why invest in those totally risky subprime credit leveraged accounts when you can learn how to invest in fundamentally sound indices, indices which can make you money regardless of whether the market ends up or down on any given day?

Why not rely on the real world of real markets for a change, to make money? The credit crisis was caused by investors straying from the fundamentals. You can get back to those fundamentals with E-mini futures contracts.

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