Ron Paul issued a pretty good commentary for why we are in this current financial mess and what it will mean heading into the future. It’s a shame more people don’t listen to him. I’ll write more about this subject a little bit later.
…and now it’s later…
I’m not an expert on our financial system, but the people in charge can’t even get a grasp of what’s going on - so what I am offering is my opinion on the matter and try to dissect the way I see it and how it affects someone like me. The fed is currently proposing a $700 billion bailout of financial companies, and congress (being the people in charge of the budget) are debating whether to go through with the bailout, and if so, to what extent.
Let me begin by saying it upsets me as an American citizen that those in charge are not divulging all the details of what they know, and why throwing $700,000,000,000 at a problem will have us all holding hands and chasing rainbows. I think the reason may be simple: they know there’s a problem and they know something has to be done about it. Instead of starting from scratch and entertaining fresh ideas, the easy answer is to proceed with a “business-as-usual” attitude by propping up a failed system. The post gold-standard era has had a good run. It’s seen its share of successes, minor troughs, and now what I believe will be a serious depression. This is all assuming that we stay on this path.
Under the gold standard financial system, there was a somewhat finite amount of money to go around. I’m not saying it was perfect, and I’m not saying we should go back to it either. The current financial system that creates wealth by creating debt can’t stand on its own anymore. I’m going to take a crack at dissecting how we got in this mess.
Banks (used to) lend money to people with the intent of being paid back over time, and making money with interest. “Duh!”, you may say. It’s a brilliant concept. It works. It allows people to purchase assets out of their price range that will appreciate over time, creating wealth. Obviously this is good for financial growth for both consumers and national strength and solvency.
At some point, financial institutions lost their basis of reality. Money that they had created as debt wasn’t just a low-risk “asset” to be held and grown at interest rates over time. Someone, somewhere, decided that this debt money promised to them was as good as cold hard cash. So banks start trading loans, and investing promised debt money that doesn’t actually exist anywhere outside their balance sheets. Every dollar promised (debt) that is made to a bank is as good as gold.
Looking to capitalize on this newfound way to make real money through investments of fake money, bank personnel were most likely given incentives to create as much fake money (debt) as possible. This allows a bank to invest more money, create more assets, and increase their bottom line - which in turn, drives up stock prices based on an artificial reality. To accomplish this, banks had to come up with uniquely crafted “sub-prime” loans. This, in my opinion, is what created the housing bubble. These ingenious loans only work under two assumptions:
1.) That real estate market will appreciate faster than your interest rates reset (read: rise exponentially) &
2.) That people will want a sub-prime loan to make quick assets due to number one.
So banks took advantage of these two factors working in concert, created artificial money as debt, and the inflation of “good times” was spread throughout the financial world. This of course includes the stock market. Banks were in error for giving bad loans to people they probably knew couldn’t pay them back. Prospective homeowners were in error for signing loan contracts they knew they couldn’t pay back. My assumption is that most people wanted to get in on the gravy train. Buy a home with no down payment where the mortgage increases after the first year? How could I lose?! I’ll have sold the house for 15% profit by then!
So everybody bought houses they couldn’t afford, assuming that they could off-load them to some other sap for a huge profit. All the while, the banks were laughing all the way to… the bank. The construction sector (often considered an index for financial growth) was building houses faster than people could sign the dotted line. Everybody was assuming that the housing market wasn’t a “bubble” and that it was reasonable to buy a 1- bedroom fixer-upper in Compton for 1.75 million dollars. Something had to give.
And give, it did. Reason decided to rear its ugly head. All the people that wanted to flip houses had already flooded the market. Rational people who realized there was a bubble occurring were holding out for the burst so they could buy a modest home at a modest price. People aren’t buying houses as quickly as they were. Construction stalls. People who signed up for loans with outrageous terms aren’t able to find buyers. Home”owners” can no longer afford their outrageous mortgages when the interest rates reset.
People start defaulting on their loans. This fictitious money promised to the banks is gone in a flash. The money the banks had promised to their investment firms no longer “exists”. The bottom line decreases, stock prices start trickling down.
The government steps in, and they realize the root cause of the latest recession. I should note that it may not have been a “recession” in its strictest definition, but anybody with any sense knew that things weren’t right. The whole system could sustain itself as long as homeowners don’t default on their mortgages. Debt money will still exist and the whole system will continue moving forward, albeit at a slower pace. The government proposes a bailout for homeowners who signed unique mortgage contracts. The promise of keeping people “at zero” without creating promised growth to banks would cause a ripple throughout the system. This was the first sign of impending doom, and stockholders knew it.
Sell sell sell! say the stockholders. If a government bailout of homeowners is necessary to keep some of these banks solvent, then there is some underlying issue not being addressed. Banks are not as mighty when a large portion of their assets are in jeopardy of being defaulted on. By now, mortage interest rates reset even higher, and more people are defaulting. The cycle continues. Some banks have stock prices that approach zero and go out of business. It’s almost as if stockholders finally realized that banks were basing their business model entirely off of promised money that may or may not exist over time.
The two biggest loan approving, financial holdings institutions in America are in jeopardy of becoming insolvent. Fannie Mae and Freddie Mac are *the* game if you want a loan in America. They are basically the right arm of the Fed, and they keep non-existent money flowing. They keep credit going. If the two biggest institutions fail, then we have a *serious* problem on our hands that will spread past the financial sector and seep into virtually every aspect of our American lifestyle. The government bails them out. It’s doesn’t work. Again, if it’s necessary to bail out Fannie Mae and Freddie Mac while letting Lehman Brothers (an institution that’s been in business for over 150 years) sink, who knows which companies the government will let live, and which they’ll let die? Stockholders are wary, and the market plummets several hundred points in a couple days. It’s not over.
Alan Greenspan is notrious for claiming that we’re “in a mental recession”. That is to say, that people buy and sell stock because other people buy and sell stock. If there’s a big run on financial institution selling, other people will follow suit. The government takes this to heart, so to avoid more selling by stockholders - they announce the huge $700 billion bailout. Take taxpayer money (again, that doesn’t exist because we already have a hundreds-of-billions of dollars defecit), throw it at all the financial institutions that are losing fake money because of mortage defaults, and everything will be hunky dory! What they’re basically saying is this…
All the fake money (or at least a portion thereof) you have amassed by selling bad mortgages is now real money.
The only thing is… it’s NOT real money! It’s money that only exists on the federal balance sheet, and a debt that all taxpayers will have to answer to in the future. They’re just transferring debt! It was the irresponsible homeowner’s responsibility. Then it was the irresponsible bank’s responsibility. Now it’s OUR responsibility. But WE are governed by an irresponsible entity that spends more than it receives! WHERE DOES IT END? There is nowhere else for this to go.
And that is why throwing money at this problem will not make it go away. Money *is* the problem. We the people, our businesses, and our representaties need to think long and hard about a free-market money-as-debt system that allows this kind of thing to happen.
The gold standard failed because there was no opportunity for growth. The money-as-debt system can’t survive because of just this type of situation.
Or maybe I’m just pissed because supply/demand doesn’t work when the government takes it upon themselves to prop-up a bubble. Home prices won’t come down to where they would be in a truly free market because that would mean a huge loss of wealth to anyone and everyone who has a stake in these institutions. Of course I can look at this objectively since I have no assets, and I’m furious that people who received their assets through unethical means will avoid having to face the music (for now) as long as this universal bailout deal goes through.
I want to live in an affordable house, goddammit.