As a child I can remember sitting around during a story time discussion in my first grade class. My teacher at the time who was a very kind and competent woman was telling a story, and essentially predicting the future. My teacher didn’t have a PhD in economics, or even a bachelor’s degree in any business major, yet she told my classmates and me a story that could relate to the current downfall of the United States banking system.
My teacher told a story of two squirrels. One squirrel saved all of his acorns, working diligently. This squirrel was very responsible and realized that once the winter came he would need all the acorns he could gather. The other squirrel, being the shortsighted, risk taking squirrel that he was, decided that he would just bank on the fact that if anything happened he could just borrow acorns from the responsible squirrel. When the story concludes the irresponsible squirrel finds himself with no acorns during the harsh winter and is forced to ask the responsible squirrel if he can borrow some of his acorns. Out of the goodness of the responsible squirrel’s heart he gives the irresponsible squirrel some of his acorns and all is well.
The difference between this nice children story and our current economy is that in real life banks and people for that matter are not that generous with their acorns. Washington mutual was one of the irresponsible squirrels. On Thursday September 24, Th 2008 the collapse of Washington Mutual became the largest US bank failure in history. Sadly enough it’s downfalls could have been avoided by learning from principles in a simple children’s story that is told to first graders. Washington Mutual took great risks in lending to borrowers who were less than capable of taking on the debt that they would incur. Many of these borrowers lacked the proper knowledge to interpret their mortgages and were locked into contracts that they could not possibly honor especially adjustable rate mortgages. This recurring theme plagued the United States banking institution as a whole.
People not paying their debt is something that every lender has to account for. To which rate borrowers do not pay lenders cannot always be predicted, however, a strong balance sheet with solid amounts of liquid assets and working capital can soften the blow and maybe even be used to bail lenders out of a bad situation. Just like the irresponsible squirrel not saving up enough acorns for a hard winter, Washington Mutual didn’t have a strong enough working capital to endure tough times. So who pays for the irresponsible squirrel’s errors, or in this case Washington Mutual? Once again the responsible squirrel gets the short end of the stick, having to pick up the slack. In Washington Mutual’s case 1.9 billion dollars of its assets were sold to J.P Morgan in the short term. In the long term the net effect of the failure of the United States largest bank and others like it would result in roughly a 700 billion dollar bail out…. That’s a lot of acorns. These acorns are not going to be offered though; they will be proposed by legislature, or in other words taken from tax payers.
So how does this story and the current status of the United States economy relate to the average United States citizen? First and foremost the obvious conclusion one could draw is that taxes will probably go up. But that is not the major thing that should be learned here. To me there’s much more basic lessons to be learned.
As a borrower you should never incur debt that you cannot reasonably expect to pay off. From mortgages to credit cards the average United States Citizen takes on a lot of debt. It’s easy to think that you will be able to pay off your debts when things are going great, or in an expansionary period. But you must also account for what might happen when things get bad during a recession, or possibly even worse a depression.
The other key thing as a borrower is to understand what you’re getting yourself into. Too many people can’t even interpret the wording of their contracts. If you can’t understand the contract hire someone to interpret it for you. If you can’t afford someone else to interpret it, learn how to interpret it yourself.
Lenders must also understand who their lending to and be responsible in their decisions. If you’re going to lend money you must make sure that if you don’t get it back, you can pay for the bad debt. Risky lending is a high risk high reward activity.
In short, don’t take excessive risk, plan for the future, and always have enough money to bail yourself out if times get tough.
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