Thursday, November 6, 2008

Word of the Day: Debt

I was an American Studies major in college, which I've lately realized does not give me the expertise in finance needed to figure out what has gone wrong with our economy.  Waiting until after the market crashes is probably not the best time for a crash course in new vocabulary terms like "credit default swaps" and "collateralized debt obligations."

If only I'd gotten an MBA instead of an MFA!

From my rudimentary research, credit default swaps (CDS) are contracts that promise to cover losses on securities in the event of default.  But apparently, as we have all learned, people who own these contracts don't necessarily have the money to cover losses should a default occur.   Apparently people bought and sold the idea of money without actually having any money to back it up.

Visualizing the Vague
In all honesty, I have not been able to uncover what it means to own a collateralized debt obligation.  But you can read more about it here in this nifty interactive explanation offered by Portfolio.com:  http://www.portfolio.com/interactive-features/2007/12/cdo.


Here you'll see water flowing into buckets in ways that succinctly illustrate how mortgage defaults can create a devastating cash-flow drought.  And today, of course, the drought is severe - with money as scarce as rain was back in the 1930s dust bowl era.  

Which brings me to my word for the day:  debt.

The Strongest Fundamental
We keep calling this a credit crisis.  As the economy lurched into a freefall, we were told that massive infusion of tax dollars was needed to capitalize banks so they could start lending to each other without fear of failure.  Because in the post-millennial era, once the ability to lend and borrow is curtailed, business as we know it fails.  

To me, a writer without an extensive background in finance, credit is just another word for money you don't have.  It's a nice word for debt.

Debt is what happens when you buy things you can't afford; credit is what you use to pay for the spree. 

So when, exactly, did debt became the only fundamental of our economy to remain strong?  Viewing it through the prism of my liberal arts background, our crisis today isn't a "credit crunch" - our crisis today is one of overwhelming reliance on debt. 

I can only hope that the smart financial minds of our country are busy solving this problem in ways that strengthen all the pillars of our economy - not just our ability to add more debt to the ledger.

No comments: