How did we get into this mess and where do things go from here? Here are five things to know about the global financial situation and what investors can do:
1 Why did U.S. markets drop last week? For months, investors have been worried about European debt problems and weak U.S. growth. Last week, the Federal Reserve gave the U.S. economy a bleak prognosis. And while the Fed will buy long-term debt, to try to push down home-mortgage and other interest rates, it already has attempted to juice the economy with two major "quantitative easing" efforts over the past two years -- with little impact. There's also little the government can do, as political and debt pressures make it impossible to launch a big spending program. As such, the U.S. economy will have to dig itself out of its hole without much help, a challenging task. Furthermore, signs are pointing to a slowdown in almost every market -- even in such once white-hot growth markets as China and Brazil -- adding to the jitters. "The world is now in a synchronized slowdown," says Mohamed A. El-Erian, chief executive of Pacific Investment Management Co.
2 Why is there so much focus on Greece? Greece is only 2 percent of the European economy. But the country has piled up enough debt to worry investors, who are growing more convinced that Greece won't be able to pay its debt -- expected to amount to nearly twice the value of its annual production -- and that those who hold Greek debt will deal with losses. The fact that Greece shares a currency, the euro, with other European nations raises questions about the future of that currency. And any Greek default could make already-skittish investors even less likely to lend to other European nations with heavy debts, such as Portugal, Ireland, Spain and Italy. That will force those nations to pay even more to borrow money.
3 Are we in for another crash? In 2008, subprime-mortgage problems infected all global markets. One thing learned from that downturn is how interconnected global economies are. If European banks take it on the chin, it could put pressure on other financial players and push an already-weak U.S. economy into a recession. "If it is not careful, Europe is getting very close to tipping into a recession and a banking crisis," El-Erian said. But optimists say Germany, perhaps along with other international bodies, could infuse European banks with cash and bail out various European nations if needed. They would need to write big checks, however, and the outcry from some German taxpayers likely would be huge.
4 Is it all bad news? Hardly. Oil and food prices are falling. Thirty-year mortgage rates are expected to drop to about 4 percent over the next week. Those looking to buy a home can find a bargain. Companies are sitting on record amounts of cash. U.S. banks have replenished their balance sheets. And U.S. and European stocks aren't at expensive levels. The most upbeat scenario: The global economy muddles along, debtor nations slowly pay down debts, the United States averts a recession and the stock market finds its legs.
5 What should investors do? John Brynjolfsson, who runs hedge fund Armored Wolf, says investors should remain cautious, hold ample cash and stick with larger, safer companies. "As long as their time horizon is at least a couple of years, individuals should be compiling a wish list of securities they'd like to buy in case prices go lower," said Darren Pollock, portfolio manager at Cheviot Value Management.
WALL STREET JOURNAL