This risk is LEGION so be prepared…
Joe (not his real name but a REAL life situation) was a successful entrepreneur. He owned 8 automatic car wash facilities and was generating $20k NET income a month. NET income = money that he was pocketing, thus after expenses.
He had loans outstanding to the banks because he was always looking to expand his operations. And when he researched places to which to build an operation he’d go to his bank and proceed to take a loan for the expansion.
His bank was happy because his loans were performing, meaning he was paying as per the terms of the note.
Then one day in 2008 he gets a call from his banker. His banker wants to take him to lunch. “That’s weird,” thought Joe. “Never was taken to lunch by my banker before.”
Well, the lunch meeting quickly turned into a nightmare as the banker said Joe had too much LTV, Loan-to-value, and he needed to increase his equity right away. The banker told Joe the regulators examined the bank’s loans and determined some, well many, loans was too risky. Joe’s being among the ‘”risky” ones. It needed more equity.
Now, remember, Joe had been making payments as per the agreement. He was making big money too, over $200k a year. He told the banker he could greatly increase the payments to the bank because his cash flow was so good.
“Nope.” the banker said. “We need an immediate influx of cash to bring down the LTV.”
The bank needed $250k to solidify the “strength” of the loan. Well, Joe, even with positive cash flow and even with his loans performing didn’t have that kind of money just laying around. So, the bank foreclosed.
And it cost Joe everything.
The bank proceeded to sit on the asset, the car washes, and watch them slowly decay. Bankers aren’t in the business of running car washes after all. So, the car washes sat empty. Weeds growing all around. And even worse, regular PAYING customers would have to find another place to wash their cars.
But guess what? There was no other place around! That was why Joe was successful. He was able to meet a demand that was not being met.
Can we blame the bank in this situation? Sure. Can we blame Joe, for taking on too much debt to begin with? Sure. Ultimately though it’s the regulators who caused this chaos and ruined Joe’s financial position.
They were the ones who swooped in, AFTER THE FACT, and changed the terms of the loan that Joe and the bank voluntarily agreed to.
And this situation happened ALL over the US in the late 2000’s.
I was even affected. I had a “zero percent for life” credit card with Chase bank. I consolidated all my consumer debt and put it on this card back in 2007. I had about $15k at that point on the card.
Mid 2008 rolls around and I open my statement one day and see I’m being charged extraordinary interest. I was like, “What? This has got to be a mistake.” (This is just another reason to NEVER “Go Green” and get electronic statements… They know you won’t open your email saying you have a statement and thus who knows the diabolical things that they can do you without you knowing?)
I called the bank, on hold for countless minutes. Finally get through to someone and she says in an exasperated tone, obviously she’s been saying these same words a lot,”fine print says that during times of economic instability (or something like that) we reserved the right to increase the interest rate. But you can always transfer your debt out and we will waive any transfer fees…”
Yeah, good luck with that. No other banks were offering 0%. So, not only now am I paying 14.99% on $15k, my minimum monthly payment had spiked too! Where was that money going to come from to make those payments?
We managed to make due by some serious belt-tightening but it was tough.
And, of course, the amount of people who had their home equity lines of credit taken out from under them is enormous as well. If you were relying on your home equity as a sort of operating account for short term cash flow, as MANY people did, you were now scrambling. And just like Joe, and ALMOST like me, many folks went bankrupt even though nothing on their end changed.
It was all due to the insanity of the regulations; Mark to market accounting primarily. And yet these same regulators, Henry Paulsen et al, claim it was THEY who saved us from Depression! Bull. It was the insanity of incorporating these regulations at the most inopportune time that put people Joe into bankruptcy and literally ruined his entire financial life.
Wouldn’t Happen In This Case Though, Right?
Read the next paragraph. Is this a good place to be financially?
“Net savings by the government means the government was running a budget surplus. In fact, the economy was characterized by a high savings rate, a high investment rate, a current account surplus, and a fiscal surplus. No economy could hope for anything better.
From a flow of funds standpoint, the economy could not have been in better shape, and it’s not surprising it was seen as having no rivals on the world economic stage.”
This was Japan in 1990. Things were looking good. And if you weren’t leveraged you were missing out on the boom times. Remember, leverage is just a fancy term for debt. Doesn’t matter what you’re BUYING with your borrowed money, actually. Debt is debt is debt.
Well, as we know, the Japanese miracle became a nightmare for years to come as when the bubble burst, debts had to be paid. Luckily for Japan, their Central Bank wasn’t calling in loans that were performing but had high LTV ratios, like our so-smart regulators were doing here in the U.S.. But still, a horrible recession affected the economy and countless millions of people were destroyed financially.
My friends, just look through history and you’ll see one constant variable to almost every financial malaise that has ever occurred… Wanna take a guess what it is???
Debt is the antithesis to a sound financial structure. In fact, the very first chapter in my very first book, is titled Debt Is The Enemy.
We have seen it time and time and time again. On a personal level, on a business level and even on a country level.
Do what you can to avoid it. But man, oh man, it’s easy to get seduced by it. In fact, even I have this nagging thought to borrow at a LOW 2.9% or whatever, and invest the proceeds. I will pocket the arbitrage as I expect the markets to give me well more than 2.9%.
Yeah, that’s exactly what the Japanese thought in 1990. How’d that work out for them?
And trust me, it wasn’t just the Japanese. It has been worldwide at all times. Don’t YOU fall for it!