The Crisis and Your Pocketbook

By Michael S. Rosenwald and Dina ElBoghdady
Washington Post Staff Writers
Wednesday, September 24, 2008

Readers have flooded our e-mail with questions about the financial crisis. Here are some answers. Go to submit your questions.

Q. How will the soaring budget deficit affect my investments?

A. Not positively.

"If the budget deficit grows, that means the government has to borrow a lot more money," said Reena Aggarwal, a finance professor at Georgetown University. "That means there's a lot more demand for capital because the budget deficit has to be financed somehow. Non-government entities are also competing for the same capital."

What does that spell? Higher interest rates. "It's a supply and demand thing," Aggarwal said. The more people want a certain good, the scarcer that good becomes and the more a provider can charge for that good. Put simply, the cost of the debt goes up.

"The debt has to find a buyer," said Benjamin Friedman, a Harvard University political economist.

On the bright side, investors are likely to see higher interest rates for their savings accounts.

The not-so-bright side isn't so much fun: Interest rates on everything from mortgages to car loans could go up, Aggarwal said. The higher interest rates could mean that it will cost companies more to borrow, so they may cut back on capital expenditures or take profit hits, which could hurt their stock prices, which could negatively affect already sagging 401(k) plans.

"It's not a good outlook for investments right now," Aggarwal said. "Ultimately it's the common person who gets affected by all of this."

Why is the bailout directed at financial institutions instead of ordinary citizens?

The problem the federal government is trying to address is at the macro level. An immediate concern is job loss, said Susan Wachter, a professor at the University of Pennsylvania's Wharton School of Business.

If the financial system shuts down, financial institutions will not be able to extend credit and make basic loans. Businesses would be left without cash for payrolls, which, depending on the duration, could lead to massive unemployment and possibly a deep recession.

"This intervention is an effort to turn that around," Wachter said.

Also, the idea behind the bailout is to buy the troubled mortgage assets of financial institutions so they can more freely lend money.

The ordinary citizen may benefit if everything works as planned. If money flows more freely, people looking to buy a home or refinance should have an easier time securing financing. But the bailout plan in its current form does not help the people who are in foreclosure or close to it, which is the root cause of the economic problems that have triggered these measures.

Are lenders more likely to hold on to the foreclosures they own as they wait for the federal government's bailout?

No. Under the current plan, the federal government would not buy foreclosed properties. It would buy troubled mortgages and mortgage-backed securities that may lapse into foreclosure. If they do, only then would the government actually own these properties.

The government's plan aside, it's generally not in the lender's interest to hang on to a foreclosure, said Kurt Eggert, a Chapman University law professor and a former member of the Federal Reserve Board's Consumer Advisory Council. Hiring people to secure, maintain and sell these houses gets expensive.

"Banks are not in the business of managing property," Eggert said. "They're in the business of getting money back so they can lend it."

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