What you can learn from the banks.

Posted By Paul

I am always interested when a business article makes the front page of the paper, so I couldn't pass up reading an article about how banks in the northwest were on shaky ground.

What intrigued me most was how several points made in the article were mistakes that the banks made that people could learn from:

Banks' Mistake 1: Jumped into the housing boom like it would never end
I know that the current housing boom is over, but this lesson applies to any investment boom. I learned this lesson from my experiences in the dot-com boom. During that time you were hearing stories every day from people becoming overnight millionaires by pouring all of their money into the dot-com company that was the next big thing. You seldom heard the stories about the people who put all of their money into an IPO, only to have the company go nowhere. There was so much fervor about getting rich and so much certainty that the investments couldn't fail that people got carried away. Whenever there is an explosive boom like this I try to keep in mind that super accelerated growth can't last forever, and when a boom ends it usually ends quickly and dramatically. There is no harm in trying to get your piece of the dot-com boom, or the housing boom, but if you go in too deep you could lose it all when the boom finally ends.

Banks' Mistake 2: Too much debt, not enough cash.
In the banks' case this was from approving crazy no down payment mortgages to people who couldn't afford them, but the people who signed up for these mortgages aren't without blame. When I was shopping for my first house the mortgage company wanted to sign me up for a BIG mortgage with a monthly payment that I could swing as long as I never lost my job and never had a financial emergency. Don't let yourself be one of those people living in a big beautiful house but eating peanut butter and jelly three meals a day because you can't afford anything else.

Banks' Mistake 3: Went too deep into a single investment.
When the housing market cooled the banks that had all of their money invested in crazy mortgages and property development loans were hit the hardest. This is no different from putting all of your financial eggs in one basket. I don't just mean tying up all your money in your house, but in ANY single investment. Just think of the people from Enron who lost most of their nest eggs when the scandal broke.

It just goes to show that financial institutions are susceptible to the same greed and poor judgement that people are when faced with a financial boom.