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The Real Systemic Risk in Our Economy

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If you've paid attention to financial news lately, you've seen plenty of pundits placing blame for the mess we're in right now. The usual suspects include big Wall Street firms and the government's bumbling attempts to bail them out.

There's no denying that big banks have generated huge profits over the years. But every transaction has two sides to it. So before we lay all the blame on Wall Street, we should also take a close look at the steps that their customers have taken -- and what we can do differently to keep things from getting any worse than they already are.

The things we did wrong
Having now lived through the financial crisis for over a year, we're all too familiar with the chain of events that got us where we are today. It's almost amusing -- in a macabre kind of way -- to think back to last year, when all the problems seemed well-confined within the now-infamous industry of subprime lending.

Now, of course, it's clear the problems were more deeply rooted than they initially seemed. In particular:

  • Too many homeowners picked mortgages that were inherently unsustainable. As long as real estate prices were rising, the ability to refinance always managed to keep them afloat financially. But when the housing bubble started to pop, overextended borrowers found themselves without any viable option to pay their debts.
  • Having become addicted to the lifestyles that virtually unlimited credit made possible, people had to turn to credit cards and other expensive funding sources to sustain their spending levels.
  • In turn, businesses grew accustomed to catering to consumers' every whim, never thinking that they might eventually need to cut down on their spending. That left those companies especially vulnerable to what's happening now, as people realize that they don't have to pay premium prices at places like Starbucks (Nasdaq: SBUX  ) and Whole Foods Market (Nasdaq: WFMI  ) for things that they could get more cheaply elsewhere.

In hindsight, it certainly seems like we could have easily avoided the full extent of the crisis we now face. Despite the fact that businesses actively encouraged us to ignore our better judgment and spend more than we could afford, many of us avoided the false temptations they tried to sell.

Two easy rules
The saddest thing is that the financial education so few people get doesn't have to be complicated. You don't have to know how to navigate a financial statement or learn how to trade options to keep yourself out of trouble. To avoid financial disaster, all it takes are two simple rules:

  • If you don't have cash to pay for something now, you probably can't afford it.
  • If you rely on borrowing to support your spending, you're eventually going to get burned -- and the better an offer to borrow looks, the more suspicious you need to be.

As an example, take the credit card industry. Card companies trumpet how great it is to use plastic to buy things. But to see the true cost of credit, all you need to see are the income statements of those companies:

Card Company

Net Revenue

Net Income

Visa (NYSE: V  )

$6.26 billion

$804 million

MasterCard (NYSE: MA  )

$4.84 billion

($189 million)

Discover Financial (NYSE: DFS  )

$3.86 billion

$454 million

American Express (NYSE: AXP  )

$23.06 billion

$3.35 billion

Source: Yahoo! Finance. Figures are for past 12 months.

That's a lot of money being generated through credit cards. And at least for Visa and MasterCard, those figures only include the profits from your initial purchase. Once you've used your credit, issuing banks like JPMorgan Chase (NYSE: JPM  ) step in to collect from you. That's where the big profits for financial firms -- and the big problems for borrowers -- truly begin.

Fixing the problem
Here at the Fool, we believe that the way to solve these problems is to help stop them from every happening in the first place. Through our Foolanthropy fundraising effort for partner, we hope to help sponsor programs that will help kids get basic financial skills to help them defend themselves against predatory money practices.

We're committed to doing what we can for youth at risk, and we hope you will be, too. To see the variety of projects available for your support, click here. Anything you can spare will help make the future brighter for all of us -- so please consider making your tax-deductible donation today.

To learn more about Foolanthropy, see our basic overview of the program, now in its 12th year.

Fool contributor Dan Caplinger treats debt like a four-letter word. He owns shares of Starbucks. JPMorgan Chase is a Motley Fool Income Investor recommendation. Starbucks, Discover Financial, and American Express are Motley Fool Inside Value picks. Whole Foods and Starbucks are Motley Fool Stock Advisor selections. The Fool owns shares of Starbucks and American Express. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy always tries to help others.

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Dan Caplinger

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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