Time for Finance 101

It has been a pretty amazing couple of weeks on financial markets, particularly the ones in the United States.  We've seen all the major independent investment banks get flushed down the toilet bowl with a few surviving with a different governance model.  Yesterday a large regional bank in the US, the largest such bank, Washington Mutual - WaMu - was bought out by JPMorgan Chase.  Complicated deals being brokered by government and corporate executive teams.  The root cause....basics.

The whole problem has been looming for years.  The lack of governance within these institutions and also in external regulatory is partly to blame.  The lack of responsibility and accountability.  The extreme focus on short-term results as opposed to longer-term financial health is another place to lay blame.  Behind all of this however lies another cause -  the lack of knowledge and understanding of basic finance that individuals have, whether acting as consumers or as decision makers in an organization.  This is, in my opinion, the root cause.  So here it goes, Finance 101.  Better all listen up, this is important!

LESSON 1

You need food (apples, since they keep the doctor away) and shelter (a roof) to survive in our world.  To acquire apples and a roof you need to exchange something for them (unless of course you grow your own apples and know how to build your own roof - another subject).  You could attempt bartering (I'll build you a porch if you supply me with apples) but that is too complex because most people have a porch or don't care for one.  So you need something that holds its value, that can be exchanged for apples and roofs, and that, consequently, everyone wants.  Money.  So you work every day and sell your porch making services for money which you, in turn, use to buy your apples and roof.  Life is good.  One day, however, you will not be able to carry the planks of wood around anymore as you will get weak, frail and may have some sort of illness.  Your porch making abilities will plummet.  You will still need apples and a roof though.  Before that day though you may also want to vary your diet a bit.  So you need to save some of the money you make.

SAVINGS.

SAVINGS.

SAVINGS.

one more time.

SAVINGS.

OK...so now the word should be a known word for you.  Remember it as it is the most important financial word you will ever learn.  You need to save money for a rainy day when you will no longer be able to earn money making your porches.  You should also save something for a few luxuries...treats.  Don't depend on others.

LESSON 2

Walking around town you will see that some people are eating oranges in addition to apples.  But they are twice the price.  They are juicy, have loads of vitamin C.  You want some.  But how?  All your money is going towards apples and the roof and (remember Lesson 1?) savings.  No worries!  There is another citizen, the banker, who can solve all your problems.  He'll lend you money so that you can buy oranges and not have to worry about reducing your apple consumption or worry about paying for your roof.  To boot, you have 30 years to pay him back.  You are amazed.  "A few pennies every week?  That's it?  What a deal!"  You borrow from the banker (long-term) and you buy your oranges.  They were good eh (short-term)?  Let's introduce another word now:

CREDIT

CREDIT

CREDIT

one more time.

CREDIT

Borrowing money to buy things you can't afford in the present.  Think long-term.  Do you really need those oranges?  Could you spend less on apples to buy oranges instead?  How will you pay the banker back?

LESSON 3

For the first few years of the thirty years after you had your oranges you are able to pay the banker his pennies a week.  One day, maybe six years later, when you no longer even remember why you borrowed the money, you realize that you no longer have any savings left.  How could this possibly have happened?  It only cost pennies a week.  Life has been good.  You were content.  You've eaten well.  The roof has held up.  But now you can't pay the banker his pennies without either eating less apples every week or, even worse, having to get a smaller roof.  The banker gives you a few weeks to figure your problems out.  You decide to buy less apples.  This works for a few months.  One day you start feeling weaker and realize that an apple a day really did keep the doctor away.  You go to the doctor and he says that you have chronic fatigue syndrome and must take three weeks off work.  The banker dude is not happy with this, thought he is empathetic.  He takes possession of your roof.

DEFAULT

DEFAULT

DEFAULT

one more time.

DEFAULT

Oh well.....the banker dude now owns you and can decide whether you eat an apple this week or not.  You are now dependent on him.

SUMMARY

Save, live within your means.  Don't borrow to buy luxuries.  Be ambitious, work hard, learn, get more efficient, make more money.  Since this was about finance I won't expand on working hard, learning and being efficient here....but let's just say that laziness could easily be another one of the root causes of the mess we are in.

I hope you all get it.  Another of my themes of this blog is for people to step up, to be confident, to not abdicate responsibility.  Get on with it.  Don't just blame Wall Street you deserve some of the blame as well.