What does this have to do with ME?

My Muse likes to remind me that most of the things that occur in the financial world should boil down to one question: What does this have to do with ME? To that end, I want to answer that question as it pertains to the evolving story of Merrill Lynch, Citigroup and the credit crunch.

You may have heard that two CEOs are out of jobs -- E. Stanley O’Neal of Merrill Lynch and Charles Prince III of Citigroup. They both got canned because under their helms, their respective companies lost a boatload of money in mortgage-related securities. To better understand the ripple effects of this mess and what it’s got to do with you, we need to review what has happened.

For a long period of time, the Fed left interest rates low, which encouraged lots of people to borrow. Some bought houses or condos, while others refinanced and spent the proceeds on new kitchens. This period was highlighted by the expansion of lending parameters to include those who had previously had a difficult time acquiring mortgages, or so-called “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation).

The Wizards of Wall Street professionals created new ways to put cheap money to work and earn more than the cost of money borrowed. They created complex packages of mortgages or financial instruments based on mortgages, which they erroneously believed would help defray the risk of the risky loans. When housing prices were rising and interest rates remained low, everything was fine. But as the housing market dipped, the ability of some of the borrowers to repay their loans changed, causing delinquencies and defaults.

As soon as investors realized that there were significant problems with the loan repayments, it raised questions about the value of mortgage-backed securities and the credibility of the ratings that enabled the securities to be sold. As investors were spooked by the uncertainty about where credit losses were hidden, the lending business simply stopped, making it more difficult for companies and individuals to borrow. Additionally, for the companies holding the loans or the securities that were collateralized (backed up) by the loans, there was no stock exchange to determine value. Therefore, the companies kind of guessed about how much they were losing. As the real numbers have come in, the true losses were worse than expected, which caused 2 guys (so far) to get axed.

Now that you have the back story, here is why two super-rich, Wall Street execs losing their jobs actually might have something to do with you:

1) If you need to borrow money, the rules have changed. My friend Mike Raimi, President of WCS Lending, tells me that lenders are practically asking for DNA to qualify borrowers. If your credit is even a shade sketchy, it is very difficult to secure a loan. However, if you have sterling credit and you are applying for a conventional, not a jumbo loan (less than $417,000) there should not be a big problem.

2) The ability to borrow is like lubricant to the US economy. When it becomes more difficult for individuals and companies to borrow, it could stall business and consumer spending, potentially leading to a recession. The “R” word is never good for anyone, nor is it good for any asset class.

3) If you are an investor, markets are gyrating hourly on this news. This volatility can sometimes spook investors, but the main thing to remember is that being an investor of any type requires the ability to withstand ups and downs from time-to-time in order to enjoy the periods of rising asset values. Chances are, if you have a diversified portfolio, you should be able to weather the swings without fear or panic and instead you can approach volatile markets as a time to seize potential opportunities. If that is not the case, you have a strong indication that your allocation is out of whack with your risk tolerance.