The recent developments have done more than roil financial markets — they've also roiled many Americans, who aren't sure what the developments might mean for them. Here are some common questions and answers.
Why did Lehman Bros. file for bankruptcy protection?
The simple answer is that their liabilities exceeded their assets, says Barry Ritholtz, chief executive of the research firm FusionIQ and author of the forthcoming book “Bailout Nation.”
The investment bank was weighed down by $60 billion in soured real estate holdings, and a tighter credit market made it difficult for the company to come up with the cash it needed. Lehman also was unable to find another investment company that would be willing to buy Lehman out.
What is AIG and how is it involved in the credit crisis?
American International Group Inc. is one of the world’s largest insurance companies whose business includes guaranteeing mortgage investments. The company has sustained billions of dollars in losses as those investments have gone bad, throwing it into a cash crunch.
How close is Wall Street to a complete meltdown, and what's being done besides mergers and government bailouts to stop the bleeding?
While there’s no doubt that the markets are in turmoil right now, Dean Baker, co-director of the Center for Economic and Policy Research, says that recent government intervention makes it unlikely that we will see Wall Street fall into a meltdown.
Besides government bailouts and mergers, Baker notes that the Federal Reserve has made below-market, short-term loans to help certain companies weather difficult periods.
Ritholtz also notes that, while certain banking firms have faced considerable problems, there are others who managed to avoid major real estate investments and are riding out the storm better.
Still, Ritholtz is among those who think we are likely already in a recession, and he also thinks we could end up in a difficult bear market.
"If we're lucky, we're halfway through this," he says.
What does today’s news mean for my 401 (k) and other investments?
The events of the past year or so have sent the stock markets on a roller coaster ride, and experts don’t expect that to end anytime soon.
“At this point it’s really, really hard to see how things are going to sort out,” Baker says. “Clearly, these are very uncertain times.”
Still, even as investment firms and housing-related industries suffer, Ritholtz points out that some sectors of the economy, including energy companies and industrial exporters, have held up relatively well.
Nevertheless, few expect things to stabilize soon.
“We are going to see more bad news,” Baker says. “We are going to see more banks fail, possibly big ones.”
What should I do as an investor?
It’s tempting to make rash decisions in the face of such turmoil, but experts say such moves can often exacerbate your financial harm.
“When the plane is going down and the oxygen masks have dropped and the parts of the plane are peeling off as you plummet toward the earth, that’s not the time to pull out the little card in the seat in front of you and say, ‘Gee, where are the emergency exits?’” Ritholtz says. “Everybody should have an emergency plan. The time to make these decisions is not when people are running around with their hair on fire.”
If you are stuck in a bad financial position, Ritholtz says you may have to weather some losses. Still, he suggests trying to find ways to learn from the mistakes made this time around so you are better positioned when the next market downturn hits.
“If you’re a long-term investor … you’ll have another three, four, or five times to make the same mistakes,” he notes.
Will today’s news about Lehman, Merrill Lynch and AIG impact my mortgage?
Today’s news shouldn’t directly impact anyone who has a mortgage and is paying it on time.
However, if you are unable to pay your mortgage or are looking to refinance your mortgage, the most recent developments in the credit crisis could have repercussions.
If you are facing foreclosure, Baker says banks are likely to be much more open to discussing a way to avert foreclosure than they were even a few months ago. That’s because banks are already dealing with a glut of foreclosed homes.
On the other hand, people who are looking to refinance or access a new loan may find that stricter lending requirements make it more difficult, if not impossible, even though mortgage rates are very low.
What can I do to make sure my bank accounts are safe?
While experts do expect more banks to fail as the current credit crisis continues to pay out, most banks are expected to stay solvent.
Nevertheless, it pays to take a few simple steps to ensure that your money is safe in the event of a disaster. First, make sure that your money is with an institution that is FDIC-insured, meaning that the government will back your account if the bank fails.
Second, because the FDIC will cover you for up to $100,000 per individual account, or $200,000 per joint account, make sure that your accounts at each of your banks fall below that limit. If you have large cash holdings, it may make sense to sprinkle your cash among several banks.