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Finance/Saving Tips Crunched by the credit crisis
Finance/Saving Tips Crunched by the credit crisis
| Crunched by the credit crisis |
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| Written by Administrator | |||||||
| Saturday, 24 January 2009 11:25 | |||||||
Defaulting on your mortgage payments could lose you both your home and your credit ratingThe Once Masters of the Universe are now the walking wounded. They not only seem to wander the world shell-shocked looking for jobs, but they are also being treated by their neighbours as if they are lower than slime. But before you begin to feel a sense of glee that these Once Masters are now on their knees, spare a thought: the problems created by the extreme greed of the bankers are going to get you too. When Gordon Gecko made his now-famous remark in the movie Wall Street - "Greed... is good" - the real-life Streeter took it at face value and designed financial products that would make the banks a lot of easy money in the short term. A structure based on loose sand is unlikely to stand long. Similarly, the greed that propelled the Once Masters of the Universe to structure products based on the ability of the indigent to pay home mortgages – at rates higher than those being charged to the prime borrowers – were unlikely to remain a viable proposition. And when the indigent borrowers started to default, it set off a butterfly effect that created the perfect storm in the global financial world. Isn't hindsight a wonderful financial tool – especially when it is delivered using multiple movie metaphors? We can sit back and enjoy the spectacle of this storm freezing up the credit markets, breaking up the international banking system and bringing global economies to their knees. It is, after all, awesome to watch bank after mighty bank disappear as if it never existed; to watch the extreme winds of the storm mutate once-venerated institutions into pitiful entities. All of this is fun to watch – Schadenfreude, after all, has its own cockles-warming quality. But the question is: have you become too engrossed in the show to barricade your own doors? Or do you believe this storm will not touch you because your financial structure is not built on sand? If you do, you're wrong. In one way or multiple – a tiny ripple or a nest-egg-shredding hurricane – every single one of us will feel the effects of the tsunami unleashed by a single flap of the sub-prime butterfly's wings. 1 NEGATIVE EQUITY Most countries of the world have witnessed a sharp correction in property values. The UAE has so far been immune to this particular virus, but analysts are of the view that the concept of de-coupling can only go so far. De-coupling implies that the financial and asset markets of any one county will not be affected by financial earthquakes in another county. If you own property in any of the countries where values have dropped, there is a good chance that you have moved into a financial wasteland called negative equity. This simply means that the amount you still owe the mortgage company for your property is higher than the market value of the property. If you were to sell the property now, you would recover less than what you still have to pay your lender. Equity is the term that describes ownership – whether it is of a company or of an asset such as property. A leveraged asset – such as a home bought with a loan – will always be at risk of negative equity. What can you do? Don't become dismayed and stop making the payments on your mortgage. That will ruin your credit rating and it will become extremely difficult for you to access loans in future when the markets recover. Know that the value of your asset – in this case, property – will recover as demand comes back into the system. Wait for it. 2 A PORTFOLIO OF JUNK Stock markets worldwide have plunged so deep so quickly that you probably have had little opportunity to get out unscathed or with little wounding. At the same time, interest-bearing investments have become bits of toilet paper as interest rates are reduced by governments worldwide in order to pump much-needed cash into their financial systems. Bottom line: a portfolio that you have developed with care and thought, and nurtured for several years, has overnight fallen victim to the global upheavel and is now probably worth a tenth of what you paid to acquire it. What can you do? Restructure, restructure, restructure. This is good time to think about the levels of risk that you are willing to endure in future, and get the high-risk investments out of your portfolio. Keep those investments that you are reasonably certain will recover. This includes stocks that are likely to be the first to increase when stock markets recover – and recover they will; remember; in the longer term of 10 to 15 years, equity markets have historically shown positive returns. 3 THE LOAN NIGHTMARE After the sub-prime mortgage fiasco, lenders have become extra cautious about lending. Their risk tolerance has become as low as their liquidity levels after the credit crunch bit. This means that if you are looking for a way to finance a purchase – home, car or stereo – you will run into a wall of resistance. Lenders that were willing to finance up to 125 per cent of a purchase are now refusing to lend more than 75 per cent of the value of your asset. You will need to raise the rest of the cash yourself. Credit checks have become more stringent as well. What can you do? Think: do you really need that stereo now? Will a lower-priced car do? What about a smaller home? As cash disappears from the financial system, your lifestyle will take a hit. Roll with it, knowing that in 12 to 24 months, the cash will start flowing more freely. 4 ACCOUNTS DEPARTMENT Your bank accounts in most countries have been put at risk if they are above the state deposit guarantee. In the UAE, the state has guaranteed all bank accounts and deposits. Other countries have set guarantee limits. A state guarantee essentially means that an account balance or a bank fixed deposit of up to a certain amount will be insured and returned to the account-holder if the bank goes into liquidation. And most banks worldwide are at risk of folding up due to their exposure to junk investments structured by the Once Masters of the Universe. What can you do? For accounts and deposits outside the UAE, ensure that no single bank has more of your money than the amount guaranteed by that country's government. For instance, if the guarantee limit is $20,000, and your account holds $35,000 (Dh73,000), move $15,000 to another bank. 5 RETIRED AND TIRED Retired persons living on fixed investments will find their returns diminishing, making it difficult to survive without a new source of income or help from others in the family. Interest rates around the world – especially in developed nations such as the United States or the United Kingdom and Europe have fallen rapidly, with the spectre of a zero-rate regime looming large. Those who depend mainly on interest-based income, as most retired persons do, will find it tough to maintain current living standards. What can you do? Be proactive about seeking help from earning family members if you are retired in a country that has no state plan for people like you. If you are earning and a retired person in your family is facing financial difficulties, they could be turning to you! Reasons to celebrate There is a silver lining or two to this whole financial mess created by the world's largest economy, the United States: Asset Recovery Every single financial asset in the world has lost a large proportion of its value. These values are shrinking even as you read this. The World Bank predicted on Tuesday that falling prices of assets and commodities will result in a sharp fall-off in global trade and economic growth. Keep an eagle eye on these values and they may reach a point where they become extremely attractive to acquire. For those who have emerged from this mess only slightly wounded – and have cash to invest – the time will soon come when they can acquire assets at a tenth or less of their intrinsic value. An Interesting Arbitrage Usually, global interest rates move more or less in tandem. However, as countries scramble to protect their financial systems, there is a wild divergence today in lending rates. If your credit profile is good, you can borrow at, say, 5.25 per cent in one country and invest at 8.75 per cent in another. The Once Masters of the Universe used to call this "carry trade". ask tim KEY MAN POLICIES Tim, I have run my own business in Dubai for a number of years and recently my bankers suggested I should have a keyman policy. It is something that my auditors discussed too but I never took heed of their advice. Is this something I should have? What are its benefits? - Simran A keyman policy – or a more PC term would be keyperson policy – should certainly feature in your business planning. Many business folk are busy ensuring the books balance and the bottom line increases without analysing the real risks to their business. This is not the market forces, currency fluctuations, personnel or similar risks but the very real risk you might be unable to be in business through sickness or death. We know the markets are bad at present but it could be a lot worse could it not? Just think about that for a moment. As risk managers, we look at this particular area for businesses and it is encouraging to hear that your other financial partners have brought this to your attention. Clearly, we are all experiencing very difficult times in the current financial climate but this pales into insignificance should you not arrive in the office tomorrow through contraction of a critical illness or indeed death. One's perspective on life changes instantaneously when contracting a critical illness and the ramifications for the business, the employees and most importantly your family are huge. We cannot alleviate the trauma of this kind of life-changing event but you can plan to mitigate the financial impact. Just consider that one in three will contract cancer by the age of 60 and you are six times more likely to die in a road accident here than the UK. A keyman policy is there to pay a capital sum on death or should you contract a dread disease like cancer, heart attack, Alzheimer's, stroke, MS, kidney failure to mention but a few ailments. In the circumstances of a critical illness, the monies can be used for paying for a replacement, convalescence, covering loans, meeting similar liabilities and paying bills perhaps. In the event of death, the monies can be used to do all the above and maybe create a cash sum to pass to the family in exchange for the shares of the company. The policy can be set up in various ways so that the company owns the policy to satisfy other shareholders interests or it can be for sole use. It can be placed in trust to avoid complications with local corporate rules, to ensure your wishes or to make it Sharia friendly. Remember, it is designed to cover as stipulated; the keyperson or persons since it can be established to cover a number of staff. So if you are that person(s) in your company and you have no recovery plan in place should you be incapacitated to work or worse – keyman cover is a step in the right direction to protecting your business and family. Source business 24-7
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