When I was about five years old I got my first ‘grown up’ bike, a classic black broad-wheel pushbike. My dad told me that he intended to put side-wheels on it, but if I wanted he could hold it and I could give it a test run. ‘No thank you, no need to hold it,’ I told him. With my feet barely touching the pedals, let alone the ground, you can just picture how spectacular the fall was when I lost the less than two seconds of momentum that kept the bike upright. I waited for the side-wheels until I gave it another try. Some lessons are only learnt the hard way.

As you may have noticed, the US banking system is still taking the gravel and dirt out from under its skin after an earth-shattering fall – the greatest since the Great Depression. Some of the assets owned by US banks have dropped in value so rapidly that the market has frozen and it has become almost impossible to trade these ‘toxic’ assets. As a result, over the past year the market capitalization (number of shares in issue multiplied by the prevailing share price) of many banks has diminished three-, four- or even more than ten-fold, as is the case with the once mighty Citigroup and Barclays, for example.

But it is not only the shareholders of these financial companies that have seen their investment portfolios blasted to pieces. Ordinary citizens are suffering too. Because of their own precarious financial situation, banks are not parting with any comforting cash in the kitty right now, and have become extremely reluctant to lend to almost anyone other than those who barely need the loan. Not the kind of environment that enables entrepreneurs to start new businesses and existing businesses to expand. Economic growth and job creation has screeched to a halt.

Even more worrying, is the fact that the link between the government’s generosity towards the banks (in the form of bail-out plans and quantitative easing) and the banks opening their hands for potential borrowers, appears severed for the moment. Basic monetary policy (lowering interest rates and/or releasing more money to stimulate the system) is failing. And, unlike South Africa, the US has very little room for fiscal manoeuvring (using the national budget to invest in infrastructure or spending to stimulate the economy).

But the most disturbing is the latest plan by Geithner to effectively use tax-payers’ money to sponsor investors who are willing to take some toxic assets off the books of the largest banks. And who wouldn’t be willing if the terms are so enticing as to provide potential upside (growth in the value of the assets) with almost no downside (the US government and taxpayers will carry most of the burden if the toxic assets remain worthless)? No wonder some of the top executives of the banks have already indicated that they would be very interested in this investment opportunity in their personal capacities.

To put it bluntly, the caretakers of many US financial institutions have become spoilt brats. Not only is their sense of their own importance as inflated as their salaries (which in 2007 peaked at 181% of the average for all US domestic private industries), but they are also abusing the close political relationships between government and financial enterprise. For example, as former IMF economist Simon Johnson points out, Robert Rubin, once the co-chairman of Goldman Sachs was also the Treasury secretary under Clinton, and later became the chairman of Citigroup’s executive committee. Henry Paulson, the CEO of Goldman Sachs, was also the Treasury secretary under George W. Bush.

Expecting that their friends in government will always be there to bail them out, the upper echelons of the financial industry continue to borrow excessively, lend irresponsibly and invest in assets which they barely understand, but which satisfy their lust for continuously higher returns. But higher returns and above-average growth always comes at a price: risk. Risk is and remains the most misunderstood (and sometimes totally ignored) concept in the financial industry. When risk continually realises in your favour and you reap the higher returns, you start to believe that you’ve tamed the market. But the high-risk investment landscape is, by definition, always unpredictable and when you are surprised by the vicious, previously hibernating bear, only then do you know whether you are truly comfortable with that specific risk landscape. Unfortunately, the managers of these financial institutions did not venture into the wilderness alone; they also dragged shareholders, home owners and taxpayers along on the hunting trip.

In times like these the US government cannot afford to act like the indulgent grandparent, allowing its greedy child to run amok and create ruin without experiencing the consequences. Stronger interference, even up to the point of temporary nationalisation, is necessary. If the US financial system does not learn its lesson here and now, it may be taking even bigger risks as soon as it is back on its bike again.

You’ve got some spare cash. It could be a lump sum windfall or you may find that you consistently have some money left at the end of every month. You could invest it, but your outstanding debt is bugging you.

Should you settle your debt first?

If I was working for a big financial institution, telling you anything other than ‘Yes’ would probably get me fired – or reprimanded at the least. It’s regarded as irresponsible to encourage people to borrow to invest, which is effectively what you’re doing if you’re investing while you still have debt. But I believe the answer is not that simple and there are a few issues at stake, such as:

1. Return on investment (ROI)

What is your borrowing rate? If you owe money on your credit card at 23% interest, settling your debt would have the same effect as an investment with an ROI of 23%. (Think of it this way: If you owe R10 000, you would have needed to pay R 2 300 interest on that over the next year. By ‘investing’ R10 000 in your credit card debt, you are left with R2 300 extra in your pocket over the next year – an ROI of 23%).

Do you know of any investments that could beat your borrowing rate? According to Triumph of the Optimists, equity returned about 7% more than inflation, on average, over the past century. This makes it the best-performing asset classes over the long term. With inflation hovering just above 10% at the moment, settling your credit card (or other expensive) debt first is a no-brainer. But what about a home loan with a borrowing rate of 14%? Surely, you can find an investment with a higher ROI, you may think. But are you comparing apples with apples? With the other investment, how certain are you of your ROI?

2. Uncertainty (a.k.a. ‘risk’)

When you settle or reduce your debt, your return is guaranteed at the rate of borrowing. On the other hand, if you choose to invest in property or the stock market, there are many uncertainties. Are we heading for a long-term recession like the world’s 2nd largest economy, Japan, which could suppress the stock market for longer than you expected? Will you always have tenants providing you with steady income on your property investment? What is the next version of the current sub-prime crisis and how will it impact on your investment?

3. Cash flow

Do you have enough emergency cash in a money market unit trust or another easily accessible and stable investment product? If not, you may want to rather keep your spare cash for any unforeseen events that could really hurt you financially. Do you perhaps have a home loan account that allows you to withdraw any extra payments within 24 hours? Transferring your extra cash to this account could provide a really good, tax-free return, with the benefits of an emergency fund.

4. Tax

If you are considering investing your spare cash, how much tax will you pay on your return? Any interest and rental income over your annual allowance of R19 000 will be taxed at your marginal tax rate (the rate of your tax bracket as determined by SARS). In contrast, your return on your debt settlement is tax-free.

Have you looked at the flip-side of our tax system? Are there any investments that could provide you with some tax-relief? In other words, the more money you invest, the less tax you pay. Retirement annuities (RAs) immediately jump to mind. Liberty, for example, launched a quirky, but memorable ‘Love the Taxman’ campaign earlier this year to remind you that you can contribute 15% of your non-pension funding income to an RA and deduct those contributions from your taxable income when completing your tax return. If you’re in the 40% tax bracket, you could see an ROI of 40% due to the tax-rebate alone, and that’s before adding the growth of your RA investment over the year. I don’t know for how much longer this opportunity will be available, though. Policymakers are working on new legislation that will limit the RA contributions on which you can claim tax-relief, as there have been complaints that current legislation favours high income earners.

5. Time

Debt can keep you in a job you don’t really enjoy or make you postpone those full-time studies or travelling which you’ve been dying to undertake for so long. The sooner your debt is under control, the sooner your time is your own again.

6. Emotional benefits

Let’s face it, being debt-free can be pretty euphoric. While encouraging you to look at the hard figures like ROI and tax benefits when weighing your options, sometimes getting those shackles off is about more than just the money.