Obviously, there's a lot of subjectivity when it comes to economic prediction, but a lot of this makes sense to me. If you have any conflicting or supporting information and ideas, I'd love to hear them.
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Q: On a scale of 1-10, where 1 is "minor fluctuation" and 10 is "start looking for refrigerator boxes to sleep in," how bad is this crisis?
A: As far as our lifetimes are concerned? 9.5.
Q: Can you give me a concise, idiot-proof explanation of how we got into this mess? I have a decent idea that it involves mortgage companies giving loans to people who couldn't really afford them(sub-prime rates, 100% financing, etc.), and then that somehow fed back to investment banking and insurance.
A: This sub-prime mortgage mess has been building for a couple of decades and the largest financial bubble in HISTORY is popping. There are three issues you should know about.
1.) At the heart of the issue is poor lending practices to people that cannot afford mortgages. Investments that are risky typically cost more, preventing people from investing too heavily. Banks took these bad mortgages, wrapped them up into securities (think stocks), and sold off the different layers at a non-risky price. They were able to do this because rating agencies (watchdogs that give ratings based on the risk of an asset) gave really risky investments very good ratings. This allowed banks to trade and sell these assets at prices that soon ballooned and created this bubble.
2.) Another problem is lack of oversight from federal regulators. When Enron collapsed the government created stricter standards on accounting through the Sarbanes-Oxley legislation preventing abuse from CEOs. The banking industry has a HUGE lobby that has the sole purpose of deregulating the industry so they can get away with outright fraud. If you've heard of pyramid schemes, this is the mother of all pyramid schemes. Just an FYI, Obama has received $10m in campaign contributions from Wall Street and McCain accepted $7 million.
3.) Lastly, these banks were gambling with our money KNOWING the government would bail them out. If they thought for one instance they couldn't recoup their losses, this wouldn't be happening now. Banks lent out billions of dollars on these risky investments without the ability to cover their bets. They were somewhat cautious, however, taking out insurance from AIG…but who insures the insurer?
Q: The federal government has now taken control of Fannie Mae, Freddie Mac, and AIG. What exactly are they going to do to make these companies stay viable that the private sector couldn't do (other than prop them up with taxpayer dollars until they can stand on their own)?
A: The last major financial crisis involving financial institutions was the Savings and Loan scandals in the 80's and 90's. The same thing happened with S&L institutions making outrageously risky bets by lending money to unviable firms and people. Do you see any S&L companies now? Not really, because most of them tanked (WaMu is one current example, but it will soon tank as well). 747 S&L institutions fell costing a total of around $160 billion, most of which was paid by the US government (aka US people). As it stands the current fallout from this crisis is $900 billion and still counting.
When the government lends a helping hand to these institutions its first task is to keep them afloat by pursuing precisely the same policies that caused the crisis in the first place. Fannie Mae and Freddie Mac purchased these toxic mortgage securities from failing institutions and went bust as a result. What policies has the US government put in place so far? They will continue normal functioning until the end of 2009, and then consider changing course afterwards. Same with AIG. A major concern is that these companies and the government don't even know what the problem is let alone how to fix it. So they put a temporary band-aid on a huge structural issue that cannot be fixed by money. The only way to fix these companies is to let the house of cards fall.
Q: In addition to the aforementioned 3, Lehman Brothers, Bear Stearns, and Merrill Lynch have died or been absorbed by someone else in very recent memory. Washington Mutual is on the rocks and the feds are trying to find a buyer before it crashes entirely. We've got anti-trust laws for a reason, but it's looking like competition in the banking and financial services sector is evaporating because of some very, very bad investments over the last decade. The market was already dominated by a few very powerful firms: what happens when that number gets dramatically reduced?
A: The Daily Show last night had a funny skit showing one of the cast in front of a sign "Bank of America and Merrill Lynch." As the skit continued, the sign said, "Bed, Bank of America, and Beyond." Monopolies should be a huge concern to all Americans. When someone is in power, they are able to take advantage of the system at the expense of customers. Competition prevents many of these abuses by giving people a choice to pick banks that won't screw them over. I believe the larger more sturdy banks like Bank of America and Barclays will come out of this with some key purchases making them ENORMOUS institutions. B of A has already purchased LaSalle Bank, Countrywide, and now Merrill Lynch. Unfortunately for them, the credit crisis is still in full swing and the company may have buyer's regret if the asset values of the acquired companies continue to fall. As mentioned earlier, no one truly knows the full extent of the problem and this makes it difficult to put a dollar value on affected companies. Additionally, new regulations will surely cripple the flexibility of operations. Finally, a global recession is about to ensue and banks can't make money when no one wants to borrow money. Growth through acquisition may be a double-edged sword and only time will tell.
The government is also purchasing companies so you have to wonder what's worse, a socialized or monopolized economy?
Q: Who's next?
A: The fallout is just beginning and you'll see effects on the real economy soon enough. First, regional banks will start closing as people borrow less money. They operate on smaller margins than these behemoths and are more susceptible to fluctuations. Second, the auto industry has been asking for bailouts and will likely not receive anything as the core of our economy (Finance, Insurance, Real Estate or FIRE compose 30% of our economy) is shutting down. Any other company that has big ticket and luxury items such as cars, consumer electronics, appliances, etc. will surely feel the effects as consumers buckle down and purchase only necessities. Starbucks and retail operators are closing down stores and will continue until the slump abates. As houses go into foreclosure, property taxes will decrease and local government services will be hurt as a result. The airline industry will have less business and personal travelers and the local tourism industries may see a boost.
From an international perspective, countries that have invested heavily in the US or have exported large amounts to our consumer culture will be hurt dramatically. China's sovereign wealth fund, the largest in the world, is mostly composed of US dollars. They have been inflating the value of the American dollar through their sale of cheap goods for a decade. Not only will their investment in US dollars decrease in value, their export-based economy will suffer accordingly. The US is the largest economy in the world so the ripples will be far-reaching. Already international markets are greatly affected by this credit crisis.
Q: What's going to be the effect of these billions of dollars of bail-outs on the federal deficit, and will it have any appreciable effects on the economy from that end?
A: The bailouts are merely band aids on a mortal wound. The million dollar question is what will happen to the value of our money? Sadly there are both inflationary and deflationary concerns and a coin toss can tell you how it will end up. Inflationary concerns are based on the assumption that the US government will continue to bail out institutions or incur large costs from the current bailouts. To cover expenses, the US can either borrow or print more money. Both will lead to the devaluing of the dollar and cause prices to increase. Oppositely, as consumers and business spend and borrow less, the velocity of money will decrease allowing fewer dollars to circulate in our economy. Fewer dollars increases the value of dollars outstanding and your current savings should be fine (given that you still have a job, and the bank that holds your money doesn't collapse).
To combat inflation, you should invest in gold and silver and other commodities that consistently hold their value. Dollars are paper and are inherently worthless except by popular misconception (fiat money). I have put a little money into gold and silver just in case. If there's deflation, make sure to kiss your boss' ass now so that you retain your job through bad times.
Q: Is there anything I didn't ask that you feel it's necessary to comment on?
A: This is fundamentally an issue of class and neo-liberal capitalism. If our economy were purely capitalistic things might be different. However, the current system provides a reinforcing mechanism for the wealthy and elite through various transfers of wealth. Big business and their lobbyists retain control over our elected leaders pushing through policies that benefit them at the cost of the average American. Wall Street, the Military-industrial complex, and the Healthcare Industry have created an economic system that transfers a majority of people's earnings into a few pockets. Indeed inflation itself is caused by the careless borrowing of our government to fight wars overseas and creates an indirect tax in the form of less bang for your buck. The Federal Reserve is a private company (really a consortium of privately held banks) that creates our money and enacts policies to hurt the average American. Alan Greenspan (former Fed Chair) was a huge supporter of adjustable rate mortgages (ARMs) that were a partial cause of the current credit crisis. John McCain's former financial advisor Phil Gramm pushed through legislation that allowed banks to pursue these risky investments. Our credit card companies and educational institutions encourage debt-spending graves that people are unable to dig themselves out of. Our army and emergency services are composed of private companies. Our prison systems are built and monitored by private companies.
There is no magic bullet or well-spoken leader that can bring about the change that is needed. The only change that matters is from an educated populace. Internet bloggers and other grass-roots organizations will help expose lies and bring together communities to enact change.
Buy a gun, read more, spend within your means, and get involved.
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1 comment:
This just terrified me. I do not have direct control over my retire savings (invested in the market) so i feel like i can kiss it goodbye. Thanks for the links and the information, though, mind if i repost with a link to your site?
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