While many of us know the home mortgage market meltdown lies at the center of the financial crisis, it may be a surprise that only about 3 percent of all mortgages are currently in default.
It is the same high amount of borrowing and abundant liquidity that can multiply investment returns for institutions holding these loans and that makes buying homes and cars easier for individuals, but also can amplify problems when conditions in the financial world change.
This is exactly what happened in the U.S. when home loans were sold to investors around the world and then interest rates rose, housing prices began to decline, and mortgages with low teaser rates began to reset at rates that consumers could not afford.
As a result, a small number of defaults added up to losses that exceeded banks’ capital base and has caused firms to cease lending for fear they would not be repaid.
Because of investor perceptions and mistrust, the mortgage credit squeeze has spread to the stock market and other credit markets — credit cards and auto loans, for example — making it difficult for people and businesses to get short-term loans and causing stock investments to decline.
In response, the federal government and governments worldwide are acting in parallel to lower interest rates and invest directly in investment and commercial banks large and small, and are planning to buy distressed structured securities to ease the strain.
These tactics are relatively new, and uncertainty prevails. Encouraging new fiscal, monetary and regulatory policies to restore liquidity and stability while keeping a keen eye on what works and what doesn’t could help alleviate the current crisis.
Individuals can look to their own portfolios to reaffirm or adopt a long-term investment plan that features broad diversification, low expenses and consistent rebalancing rather than trying to predict when various investments might go up or down. Individuals nearing retirement may consider investing a portion of their savings in a low-cost guaranteed annuity that can provide a floor of income they cannot outlive.
These steps can help insulate individuals against continued gyrations in the markets.
