Questions about the possible economic depression

September 16, 2008 9:06 PM

Questions about the best course of action to prepare for a possible economic depression

I'm no economist, but I'm trying to learn about the possible economic depression everyone's been talking about since the recent financial upheaval. I have a number of questions.

1. I have always read that there are huge bargains to be had when the stock market tanks. If this is so, what stops investors from jumping INTO the market when there is a huge crash? For example, why not invest in an index fund as soon as the market drops off 500 points? Why *wouldn't* this be a good idea for the individual investor (assuming it isn't).

2. What would happen to people's outstanding debt if the companies they owe $ to went under? For example, did people's debts get wiped out with the banks that closed up shop during the Great Depression? What about nowadays...for example, what would happen to student loan debt if virtually nobody could afford to make payments?

3. Let's say you've got some extra cash flow right now...what's would be the best bet when preparing for a possible period of economic depression? Pay off outstanding debts? Stockpile money in order to buy up things once they've lost value? Etc.

4. How were some people able to purchase "bargains" during the great depression if indeed inflation caused money to lose most of its value?

5. Does FDIC insurance REALLY ensure that money is safe and accessible (up to the limits specified)?

6. Anyone care to venture a guess about what the next few years are going to look like economically?

posted by mintchip to work & money (12 answers total)

I'm no economist, but I'll answer the easy one.

2. What would happen to people's outstanding debt if the companies they owe $ to went under?

It's pretty unlikely to vanish, since someone (perhaps someone German or Chinese) will buy that company's debt, inheriting you as a debtor. They'd buy it at a steep discount too, which makes this a nice time to invest in likely buyer-outers.
posted by rokusan at 9:16 PM on September 16, 2008

Get to know your neighbors. You need friends in hard times.
posted by philip-random at 9:28 PM on September 16, 2008 [1 favorite]

How were some people able to purchase "bargains" during the great depression if indeed inflation caused money to lose most of its value?

Even if money loses most of its value, people still can use it as a medium of exchange. More money is more buying power, unless the entire monetary system collapses. As well, one could offer non-monetary goods. A company that's doing better could purchase with their stock. Failing that, precious metals?
posted by Lemurrhea at 9:30 PM on September 16, 2008

1. Why not invest after a crash? Simple answer: maybe the market will go down some more. Nobody knows for sure where the bottom is. Additional answer: one needs money to invest, and some people are already fully invested.

2. When a company fails, its assets are distributed to creditors. Your student loan debt is an asset to the company, and would be transferred or sold. It would not be wiped out.

3. If you truly believe there will be a depression, you should buy things you think will store value or appreciate in value. Gold is the classic example.

4. One of my great-grandfathers did fairly well during the depression. He was lucky or smart, I'm not sure which, and had bought gold before the crash, which he used to buy assets during the depression.

5. Very safe. FDIC is backed by the credit of the US government. The government is backed by the power to tax. Although there are some long-term issues that need to be solved (social security etc.), a US government default is incredibly unlikely in the short- to medium-term (and would be so apocalyptic if it occurred that the loss of FDIC insurance would be a minor issue).
posted by blue mustard at 9:34 PM on September 16, 2008 [1 favorite]

Overall answer: the sky is not falling. You probably don't need to and shouldn't do anything differently. Panicking rarely, if ever, pays.

1. Long-term investing is a good way to make money. Speculation is a good way to lose money. If you had that money just sitting around, it should have already been invested. If you can't afford to invest it, don't invest it now. Someone very rich who can afford to wait 10 years might indeed pick up some bargains during a low point like this. But, since you're asking this, I'm guessing that's not you.

5. yes.

6. Depends on some extent who wins the presidency. But even with a McCain win things will probably pick back up. There has only been one long-term depression in US history. I'm not an economist, but I'm pretty sure the conditions that created it were unique and that we learned something from it.
posted by drjimmy11 at 10:01 PM on September 16, 2008

4. How were some people able to purchase "bargains" during the great depression if indeed inflation caused money to lose most of its value?

...is a wrong question. Inflation was exceptionally low, and at some points significantly negative, during the great depression. Generally speaking, money gained value.
posted by pompomtom at 10:31 PM on September 16, 2008

Be self-reliant, grow close to your neighbors, and help your community be more self-sufficient and less dependent on the rest of the world. More specifically...

* Be Healthy. This is what really matters overall, right?
* Have real, tangible, skills. Know how things work, be able to do something (not just own something) that people need and things that decrease your dependence on others.
* Don't carry any debt.
* Own things with intrinsic value, as oppose to status items or things that depend on replacement all the time. Good examples include solid hand tools, well made books, musical instruments. Buy things for which repair is possible.

Basically, these are the things you should do anyway - it's no coincidence they'll put you ahead when times get rough. Don't be that guy who knows some incredibly specific web technology or financial trick and lives in a
posted by phrontist at 10:42 PM on September 16, 2008 [4 favorites]

I'm loading up on canned goods. I'm not looking for bargains, I'm just looking for a way to survive.
posted by wv kay in ga at 10:51 PM on September 16, 2008

1 - The biggest reason no one invests after a crash is because the rich people who can afford it lost a ton and the poor need their money for needs.

2- I'm not an economist either but I do know that someone will always own your debt. They can sell your loan to another company.

3 - I would pay off debt on things like your house and car. Things you actually need and become assets. Screw paying off credit cards. Also silver and gold is always a nice thing to have on hand.

4 - With things that will always retain value.... see above. Also if you have a really hot wife ;>)

5 - Yes the gov will ensure your money. If there comes a time when they can't then well I'm sure getting your cash out of the bank will be the least of our worries.

6 - Not to push Obama on anyone but last time a democrat was in office... Clinton, we had a surplus, lower unemployment, gas was about a buck, no war, and the dollar was very strong. For the last 8 years we have had a total reversal. Again if you look at the facts 8 years of bush got rid of everything Clinton did. If Obama gets elected and adopts Clinton policies then I feel the economy will be better off. But if McCain is in office and adpots Bush policies then we might be in for harder times. McCain is in fact Bush 2... Bush goes West with a bitch for a VP instead of a dick.
posted by Mastercheddaar at 6:43 AM on September 17, 2008 [1 favorite]

3. The price of toys (eg boats and luxury cars that most people "own" via debt") may fall, but more useful things (like bicycles) might become subject to higher demand and bargains become scarcer, so buying that stuff now, ahead of time and getting in the habit of using it, adds another layer of independence to your life - (in this case, that you can get around without spending money, and are insulated from the price of gas. Although, in a recession, the price of gas will likely fall, since fewer can afford it so demand drops)
posted by -harlequin- at 9:39 AM on September 17, 2008

1. It is a good idea. There are two problems with it. The first is that Joe Investor generally has $X allocated to be in stocks. When the market tanks, the value of $X shrinks. Joe Investor does not have a bunch of cash on the sidelines, waiting for the market to drop; all the money that he has allocated to be in stocks is already in stocks. The other problem is the old saw about catching a falling knife. Sometimes the knife has further to fall and if you try to wrap your fingers around it you will just end up bleeding.

2. Here is the way to look at this: Your debt is your counterparty's asset. Suppose I have a business that has 10 gold bars locked up in the vault. I owe my creditors 1 jillion dollars and cannot pay. The creditors take possession of my corporate assets. Do the gold bars get thrown in the Mississippi river? No, they do not. The creditors take my assets, including the gold bars.

Suppose my corporation loaned money to Joe Schmo, who owes $1 million to my corporation. Does that loan payback agreement get thrown in the Mississippi river? No, not any more than the gold bars would. That asset goes to my creditors.

3. Stockpile cash. Even in periods of massive hyperinflation, no one has ever said "Damn, I have too much cash on hand."

4. They had a lot of cash.

5. So far. Stay tuned.

6. Rich get richer, poor get poorer. More people transformed into faceless worker drones, a non-working upperclass to enjoy the benefits reaped by this labor, and more people becoming destitute because of a healthcare or other catastrophe for which they have no safety net. Same as it's always been in history.
posted by ikkyu2 at 10:47 AM on September 17, 2008

1. Why *wouldn't* this be a good idea for the individual investor (assuming it isn't).

It may be a good time to buy, but as with any purchasing decision you don't necessarily know what the future is going to hold. Sure the Dow Jones dropped 504 points on 9/15, but it dropped another 450 points on 9/17 and no one knows if there are additional shoes to drop. That being said there can be great opportunities after a downturn: the best single day in the S&P 500 was October 21, 1987, only two days after the Black Monday market crash; the best one-month return in the S&P 500, October 1974, happened immediately after the worst one-year period.

One suggestion to combat this volatility is to dollar-cost average. This technique allows you to make regular investments where purchase more shares when prices are low, and fewer shares when prices are high.

2a. What would happen to people's outstanding debt if the companies they owe $ to went under? For example, did people's debts get wiped out with the banks that closed up shop during the Great Depression?

As other people have already responded, your debt is just sold to someone else. It is an asset to the lender and it can sell and re-sell if they want. Look in your lending agreement for more information.

2b. What about nowadays...for example, what would happen to student loan debt if virtually nobody could afford to make payments?

That would be a pretty bad thing for all the lenders, but that's not why the lenders in the news (AIG, Lehman Brothers, etc.) are having problems. Lenders plan for a certain amount of defaults, but there are numerous ways they can try to make you pay back your education loan, bad reports on your credit history, annoying calls, even perhaps garnish income, most student loans are even exempt from bankruptcy. They really really want you to pay them back and consequently they are hard to get rid of (except of paying them back what you owe them).

3. Let's say you've got some extra cash flow right now...what's would be the best bet when preparing for a possible period of economic depression? Pay off outstanding debts? Stockpile money in order to buy up things once they've lost value? Etc.

Establishing an emergency fund is always a great idea. I think at least 1-month emergency fund is an absolute necessity and 3-6 months is preferred. Once you are done with that, perhaps payoff debt or start investing for retirement (it's never to early!).

4. How were some people able to purchase "bargains" during the great depression if indeed inflation caused money to lose most of its value?

Well if you had enough money during the Great Depression to invest, you were buying at a pretty good time. ;) It's important to note that there was deflation not inflation during the great depression. This was caused by a decrease in the supply of money in the economy. But if you had enough of it--because you buried it in your back yard or had something with tangible worth (gold, silver, etc.), you could make out pretty good.

Also note that even with going through the Great Depression and all the downturns in between, you would have $3,246 (as of December 2007) for every $1 you invested in January 1926.

5. Does FDIC insurance REALLY ensure that money is safe and accessible (up to the limits specified)?

Yup, the FDIC really does cover bank accounts (Credit Unions have different coverage) up to $100,000. In 70 years since the FDIC was created, no depositor has ever lost a penny of insured deposits.

What you might be concerned about more is your broker (where you have your investments) going bankrupt. They too are covered by a Federal Corporation, this is called SIPC. They do not cover against market losses, but against the inability of your broker to give you back the shares you own.

6. Anyone care to venture a guess about what the next few years are going to look like economically?

There will probably be lots of people theorizing what the market will do in the next few years -- they have to fill those magazines and 24 hour business news channels with something! But will any of it come true? Probably, but it's not likely that it is because they are really smart.
posted by bengilbert at 2:37 PM on September 18, 2008