What you should know about the country's financial mess

This has happened before. Back in the 1920's, the Roaring 20s, there was a great party in this country. People indulged and took risks they did not fully understand and when the bill was presented the government did very little. Banks failed, credit froze, and the country was sent into the Great Depression.

UNDERSTANDING THE PROBLEM

This current crisis started with that same mindset of over indulgence with the overuse of credit by Americans and relaxed lending standards by our financial institutions. What started as a sub-prime mortgage problem, giving people home loans that were beyond their ability to repay, has turned into a pulling back of credit in all areas of our economy.

The average American may not understand that their home mortgage is no longer held by a bank. Mortgages today are packaged together into Mortgage Backed Securities (MBS) and sold back to investors. Investors bought these MBS for the interest payments and they were told by the rating agencies that they were safe.

Sub-prime loans make up only a small portion of these MBS, but they are intertwined into most MBS. Fear that sub-prime borrowers were defaulting led investors to lose faith in the value of these MBS causing their values to drop over 75 percent. Also, the market for properly trading and valuing these securities ceased to operate. Many financial institutions bought these bonds to hold on their balance sheets as assets and in order to stay in compliance with accounting rules had to value these MBS down to fire sale prices as low as 25 cents on the dollar. This has caused these institutions to be considered undercapitalized and caused some failures. These failures (Bear Stearns, Lehman Brothers, Fannie Mae, Washington Mutual, etc) have caused other healthy banks to hoard cash, tighten credit and generally pull back, not wanting to expose themselves to a similar fate.

WALL STREET AND MAIN STREET

Today the news is all about Wall Street getting a bailout, but many do not understand that Wall Street and Main Street are interconnected. Wall Street has been suffering from the poor decisions of the last decade - just look at the share prices of Fannie Mae dropping from $90 to $2, or Lehman Brothers near $0 value from a high of $86 per share. AIG, which dropped from $103 to $3, got help from the taxpayer at a great cost; they borrowed $85 billion at 11.5 percent interest and gave the government 80 percent ownership in the company for the privilege. That sounds more like a deal with the Corleone family than a bailout. The point is, Wall Street has suffered and now we have to take bold steps to be sure that Main Street does suffer the same fate.

Some believe that this is a smoke screen designed to give the Wall Street fat cats more money and the best solution is to do nothing. That is a terrible mistake. Many employers rely on short term lines of credit to fund their business operations. These credit lines cover the period between when they have to pay their bills and when they get paid for their products and services. One of these bills is payroll.

Imagine going into work and finding that your employer can't make payroll because the bank pulled the credit line. Think about how often you use your credit card to finance your expenses between paychecks and the effects you would experience if one day your credit card company declined all charges. Credit is a necessary tool in our economy. Yes, some have abused it, but we can't let the tool break.

THE BAILOUT PLAN

The solution that Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulsen have presented is for the government to buy up these mortgages that are dragging down our financial institutions. These MBS are surely worth more than 25 cent on the dollar, since 92 percent of Americans are current with their mortgage payments. The government would then hold on to these MBS waiting for them to realize their maturity value and stop this fire sale panic mindset the markets currently holds.

The $700 billion will be used to buy up these MBS at some discounted value, more that 25 cents on the dollar but less than their perceived future maturity value, and when the MBS reach their true market value the Treasury will be able to transition these MBS back to the markets and recoup most of the $700 billion.

There is also an outside chance the government may make money on this deal, but either way the final bill for this party is nowhere near $700 billion, unless all our homes drop to a value of zero. Once our nation's financial institutions have these MBS off their balance sheets they should feel more comfortable extending reasonable credit again.

This may not be the best solution, but it is the one on the table, it is reasonable, and something needs to be done quickly to restore confidence to Wall Street and bring stability to Main Street.

This is a crisis, but we have seen crises before and we have always stepped up to the challenge.

TIME TO START SAVING

Yes, your bank deposits are safe, as long as you don't keep more than the FDIC insurance limit in your account.

We know your 401(k) account is lower than it was a year ago, but if you are diversified and if you don't keep too much of your investment in your company's stock, it will recover. For most Americans this crisis is really a sideshow to a much bigger problem.

The greatest risk facing American's today is that we don't save enough of what we earn, we don't invest enough of what we save, and we don't diversify enough in how we invest. We all need to be reminded that volatility is not loss, unless we panic.

If you had all your money in Lehman Brothers bonds or Washington Mutual stock, both of which recently filed bankruptcy, you have lost and that money will probably never recover. Holding a diversified portfolio of mutual funds or index funds will protect you from these types of losses. Markets are volatile because we are emotional, and that is just part of the process.

This national crisis will be solved. The real question is, will we solve our personal financial crisis by saving more, investing more, and diversifying?

Bryant Engebretson is a Certified Financial Planner and Chartered Life Underwriter with 15 years in the financial services industry. Bryant is the owner of Tradewinds Capital Management in Bellingham, a Registered Investment Advisory Firm, which specializes in helping individuals and small business owners with their investment and planning.