Financial Crisis - tip of the iceberg

These days, financial crisis seems to hog the media: governments pumping in more money into their economies, large corporations posting record losses, well known large companies filing for bankruptcies, people losing their job leading to homes being foreclosed, cars being repossessed etc.

You would think that we had seen the worse of it all in the financial crisis. How would you feel if I were to say that worse has yet to come? I do not have a crystal ball nor am I a psychic but I believe that the world has grown so tiny, thanks to globalization, that what we are seeing in the media today is just the tip of the iceberg.

The following is extracted from http://www.usatoday.com/news/nation/2008-10-16-crime-economy_N.htm :

The collapse of U.S. financial markets is forcing deep cuts in local police agencies and stoking fears among police chiefs that mass home foreclosures are bringing more crime to suburbs.

Problems created by the financial meltdown are starting to touch everything from police response times to unsolved crimes.

"As we see significant reductions, we'll be seeing increased response times, fewer cases solved and reduced services for victims of crime," says Prince William County, Va., Police Chief Charlie Deane. His $73 million budget could drop up to 30% next year because of declining property tax revenues.

Blocks of homes vacant from foreclosures are becoming magnets nationwide for gang members, drug users, prostitutes and thieves, who steal appliances and fixtures, Deane and other officers say.

At the same time, police agencies are dramatically reducing their forces as local governments struggle to allocate shrinking revenue from property and sales taxes to fund basic services.

This may very well be happening in other countries as well due to the ballooning credit crunch that many economies are now facing. A country’s economy is so heavily dependent on the well being of the financial sector; when this sector so much as sneezes (due to flu), the entire economy may suffer a seizure. The actual scenario now is the financial sector is crumbling, imagine what is happening to the economy.

When I was younger, I loved playing with dominoes. I would line them up in a long line and then I would push one tile down to see the domino effect. This is what happened in the financial crisis:

With good intentions (albeit against logic), USA Congress encourages lending to lower income people (which basically means high risk low returns instead of the conventional theory high risk high returns) resulting in the number of mortgages exposed to this group increase by a factor of 15 times (from a low of 2% high risk mortgages, it skyrocketed to 30%) (USA Congress being the 1st domino tile in a long line). Overzealous financial institutions (2nd, 3rd, 4th and more domino tiles) repackaged these high risk mortgages into low risk securities and sold them to investment banking firms (more and more domino tiles) who in turn sold them to individual and corporate investors worldwide (a whole lot more domino tiles). When the mortgages are defaulted, everyone gets burnt (and the domino tiles starts falling).

As a result, big corporations started posting record breaking massive losses, some even filed for bankruptcies, they had to reduce their costs thus they started retrenching. When people lose their jobs, that isn’t a nightmare; the nightmare begins when people find that they are no longer financially capable to continue to put food on the table or provide shelter for the family. That is when crime (blue and white collar) increases dramatically. This is just the tip of the iceberg; the domino tiles have yet to stop falling.

The corrective action for individuals is to appoint capable people to form a government and for the government to overhaul the entire financial system; never ever consider a high risk low return option.