This Week on Wall Street

So it has been a crazy week with a lot of selling, buying, and an emergency stop on short selling, affecting the way hedge funds trade.

So everyone has seen the news and knows what is happening with many Wall Street financial companies, but why banks, why financials?  First of all, banks make money by borrowing money from other banks (Central Banks) and then lending that money out, charging a higher interest rate than they received on that money.  The rate that banks borrow money at is determined by their credit rating.  This is why it was so bad last Monday when AIG’s credit rating was downgraded, taking away their ability to borrow cheap money and lend it out at a higher interest rate.  Also, banks use assets on their books to leverage against the money they borrow.  When it turns out that most of their mortgage assets turn out to be worthless and the assets that they use to borrow money against are no longer their on paper, banks are forced to take huge losses and this prevents them from operating business as usual.  So, what started a year ago with sub-prime mortgages is still affecting many banks because of the “bad” debt on their books.  Some banks have been able to locate which debt was ‘bad’ and write these losses off while other banks have not been able to effectively locate and write off this debt creating huge problems.

The problem with the economy has largely been driven by this bank business model suffering.  This is called business risk and we have seen this business risk affect the entire financial sector recently.

Despite the changes seen on wall street, stocks as a whole remain intact.  The government made some very big decisions that have calmed fears on Wall Street and for the most part stopped the panic selling.

If we can take away any lessons from this last week it is that panic driven selling does not work and is not a strategy for your portfolio.  Remaining diversified again worked this week.  Below is a graph of numbers for the week.  Notice that the week looks like any other week on Wall Street.

Index Started Week Ended Week Change % Change YTD
DJIA 11421.99 11388.44 -33.55 -0.3 % -14.1 %
Nasdaq 2261.27 2273.9 12.63 0.6 % -14.3 %
S&P 500 1251.7 1255.08 3.38 0.3 % -14.5 %
Russell 2000 720.26 753.74 33.48 4.6 % -1.6 %           

Source: “Market Update” Yahoo Finance

Note: Casey T. Smith, President of Wiser Wealth Management, Inc provided many insights for this blog post

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