How a 'perfect storm' led to the economic crisis

[classicman]

The U.S. economy is clearly in terrible shape. What is less clear is how we got here.

Opinions vary on when and where to begin the story, but many experts trace the origins of the current economic situation to the housing bubble that came about earlier this decade.
Housing prices jumped at a rate above 6 percent in 1999 and increased rapidly and steadily as the decade turned, according to a recent study by the Brookings Institution.
"After the mid-1990s ... real house prices went on a sustained surge through 2005, making residential real estate not only a great investment, but it was also widely perceived as a very safe investment," the study said.

The prices eventually moved "out of line with fundamentals like household income" and the bubble formed, the study said. Read the complete Brookings study

There were two trends developing at that time that contributed to the housing bubble, experts said.
The Federal Reserve Board, to combat the recession of 2000-01 and the economic effects of the September 11 terrorist attacks, began drastically slashing interest rates.
Consequently, it was very easy to borrow money, especially if you wanted to buy a home.
Meanwhile, global investors -- flush with cash from the worldwide economic boom of the 1990s and '00s -- were looking to the U.S. economy to make even more money.

"You have a group of people growing richer by leaps and bounds," said Peter Rodriguez, an economist at the University of Virginia. "And they liked the idea of parking some cash in the biggest, safest economy in the world."

Enter mortgage-backed securities

Wall Street firms sought to connect the rich investors with the rapidly expanding housing market with the help of complicated financial instruments.

These instruments -- such as mortgage-backed securities we've heard so much about -- made it easier to move the investors' funds into the housing market, which fed the extraordinary price sprial, Rodriguez said.
"It began to really take on a life of its own when people saw how much money they could make in housing," he said. "Before long, everybody was pushing along the momentum of this train."
So how do these mortgage-backed securities work and what role did they play?

Let's say there are three prospective homebuyers in a neighborhood. A local bank makes mortgage loans to all three, then bundles up the mortgages and sells the bundle to a big Wall Street firm, like the now-bankrupt Lehman Brothers.
The Wall Street firm takes its bundles of mortgages and offers them to investors. The investors make money off the interest payments from the original borrowers.
These instruments helped minimize risk for the local bank because it was no longer responsible for the loans it made to the local homebuyers.

"You didn't even have to worry about a loan once you made it. You didn't have to keep it on your books," Rodriguez said. "The only limitation was how fast you could turn the loans."
It was an intoxicating era when you could make a lot of money quickly through the housing market, and you did it through the "basic idea of leverage," Rodriguez said.
He provided an example: You take out a mortgage loan for $100,000 and make a 20 percent down payment, which would equal $20,000.

If the price of the house goes up to $120,000, you've effectively doubled your money. If you sell at that price -- assuming there are no transaction costs -- you walk away with an extra $20,000.
Leverage works the same way for banks. They borrow from other banks or other institutions so that they can hand out more loans and make more money.
"This encourages all sorts of risky behavior by individuals looking to buy homes, and it encourages banks to lend because, in an environment where prices rise, they're making lots of money, too," Rodriguez said.

Very interesting read

[Aliantha]

I thought it was pretty clear how it happened.

People had too much credit in an inflated economy which couldn't be sustained so people had to start selling off assets to stay solvent.

Those that sold first did well, but then too many others thought it'd be a good deal too.

There wasn't enough real money in the market to sustain this sort of selling off and all of a sudden, things came to a grinding halt.

in a nut shell.

[TheMercenary]

Very good article.

[Griff]

It misses the point that people had no other "safe" place to invest. The currency was being rapidly devalued by run-away government spending, so they needed higher returns. Now we're going to solve same by..... run-away government spending. It is possible that many people can be put back to work on infrastructure jobs which need doing, but regarding fixing the economy, it is all a bit counter-intuitive. My savings will be devalued to keep you (some guy named you not you you) in too much house. They probably should have by-passed the banks, bought up the loans, and lengthened terms way out to where they might be paid off.

or I could just be grumpy...

[classicman]

Good points Griff, I agree. I think this bill spends a lot of money on a lot of good things. I cannot argue with the desire to do these nice things, but we're broke and this was supposed to help jump start the economy and create jobs NOW. Obama has repeatedly stated that we need to take action immediately. To see so much money spent on things that don't actually perform the functions which we were told they would is rather deflating.

[Kaliayev]

This overlooks that in part the desire to stimulate a housing bubble came on the back of the failing dotcom industry and worries about the long term viability of that particular bubble.

Also there are several other macro-economic trends to consider, such as the sheer massive amounts of money being traded internationally by such financial institutes, which has massively dwarfed the US federal reserve (and thus the ability to spend ones way out of a recession) for much longer than a decade. There also trends concerning savings and overall (if managed) decline in the dollar's worth since the 1980s.

I mean, its not bad for a medium range view. But there is a lot more feeding into this that could be discussed, but isn't. I'd really like to see a competent economist take a swing at something like this, because I remember discussing the above trends back in 2005 and being worried about the long term implications they entailed. But you know, boom and bust was buried forever back then, and so on and so forth.

[sugarpop]

Interesting article. Thanks classicman.

A couple of things I would like to point out (bear with me, this will be long), it doesn't really go into how deregulation allowed this to happen. Ultimately, it has to do with the Glass Steagall Act being repealed, which allowed banks to trade in ways that made this happen. http://www.pbs.org/wgbh/pages/frontl...ll/demise.html And this was a bipartisan effort. Congress overwhelmingly voted to overturn this legislation, and in 1999, Clinton signed it.

Personally, I don't believe mortgages should be traded unless the institution holding the mortgage goes out of business. That would make banks more accountable for the way they do business. If you know you have to hold the mortgage, you aren't going to give one to someone you know can't pay for it, and you won't lend people more than they can afford. But if you can just sell them off in bundles, that just breeds irresponsible and unethical lending practices. And these mortgages have been bought and sold so many times, and in so many different packages and in different ways, they don't even know in some cases where they originated. I even heard the other day that some mortages can't be found. Hey, if there's no paper, there's no debt, right?

In addition, the fact that banks have been allowed to become so damn huge, that is also a problem. When institutions/corporations become so big, and so many of them start merging, it consolidates their power, and allows them to gain dangerous control over the citizens of this country.

Look at how we have been held hostage by this crisis. Either we give financial institutions hundreds of billions of dollars, which ultimately will be well over a trillion (and will come from the Federal Reserve, another huge hoax that has been perpetrated on the American people,), or they all fail and our economy completely crashes. Only, we gave them money, and now they aren't using that money for the purpose for which it was intended, which was to help failing mortgages, which is where the crisis started, because of deregulation. Instead, they have held onto the money (using a huge amount to pay themselves lavish bonuses), and in some cases, banks have used that money to buy other banks. In one case, a bank that applied for the TARP funds was declined, even though it was a healthy bank, and another bank was allowed to buy it. This was a hostile takeover. What makes this significant is that Hank Paulson, the man who Bush appointed to be solely in charge of the TARP funds, had a previous relationship with the bank that took over the other bank. That was a serious conflict of interest. I find it ironic that so many of Hank Paulson's buddies from Goldman Sachs benefitted from those billions of dollars.

In addition, where was the oversight? It seems that, in the past decade, oversight has been nonexistant. Why has Congress been so lax in their duty to the American people? They all seemed so stunned that this happened, but the truth is, some people have been warning about it for several years. Why weren't the people of this country warned? Where was the press? The media?

And this comes to another point, until we change the way elections are run and funded, this problem will never go away. As long as corporations are allowed to lobby and fund politicians, and as long as they have these incestuous relationships, things will not change. As it is now, the people of this country have no power, because corporations (and a few individuals) have all the money, and money always wins.

An example of this goes back about 5 years, when the FCC was getting ready yet again to change the regulations regarding media ownership, and how many TV/radio stations, newspapers etc. any one corporation/person could own. Congress was bombarded with tens of millions of letters from concerned citizens, even though it was not reported in the news or on most TV stations (big surprise there, right?). People found out about it on PBS, and in other liberal media not owned by big corporations. Even though the public outcry was so enormous that it actually forced the issue out into the open, and Congress made out publicly like they would vote it down, the FCC andCongress changed the legislation anyway. Here is a timeline of FCC ownership regulations. http://www.pbs.org/now/politics/mediatimeline.html

While this may seem unrelated to the economic crisis, is it really? If the media is gagged from doing it's job, whether by a president that refuses to answer questions in any meaningful way, or whether it's because journalists have forgotten how to ask the really hard questions, and they have forgotten how to be relenting when they don't get an answer, or whether it's because of the decisions from the top (because of personsal interests), the media has fallen asleep at the wheel when it comes to serving the public interests.

Another thing we need to look at is how dependent people have become on credit, and how banks/credit card companies control us with regard to this issue, and how that contributed to this financial mess.

First of all, it boggles the mind (mine anyway) that banks/credit card companies get away with some of the things they get away with. They start out charging you a very low percentage rate, but they can change, overnight, what that rate is. Many people are paying over 30% interest on their credit card purchases. Over 30%! What is more amazing, is that many of those people don't even realize how much they are being charged, because they don't really look at their statements. (yea, yea, I know, how stupid of them.) What I want to ask though, is how is that any different than being a freaking loan shark? (silly analogy I know, but go with it for a minute.)

With a loan shark, the interest goes up astronomically (daily or weekly) as you don't pay the money (or you lose a finger). If you don't pay off the balance, you end up owing more money, until you owe so much, you become so indebted, the loan shark owns you.

With CCs, you make payments, but they keep upping the % rate, so you end up paying interest on the interest, until all you are doing is paying the interest, but the interest accumlates so fast, that before you know it, something that cost $1000 ends up costing you $5000. (that is an extreme example, but so many people buy so much crap on credit, and they only pay the minimum balance, that it is actually pretty accurate in some cases.) In addition, CC cos are also very guilty of giving CCs to people who shouldn't have them, and of giving people more credit than they should have. That's so they will make money off of you in perpetuity. So, in essence, they end up owning you, just like the loan shark. Only difference is, they won't take your finger, or make you sell drugs, they will just take your car, or your house, and put you in the poorhouse.

People in this country (and increasingly other countries) are addicted to "stuff." And it isn't just that we are addicted to stuff, it's that we constantly have to have new stuff. Because really, we can't have a 5 year old cell phone, no, we have to have the newest, coolest phone, or TV, or stereo, or whatever. And the technology is obsolete so fast, and it isn't made to last anymore. NOTHING is made to last. That's so we will be good little consumers and buy more stuff that we really don't need. And what is really shocking, is government actually colluded to make it happen that way after WWII. Check out this video to learn about how consumption really affects the world. http://www.storyofstuff.com/

The truth is, the entire banking system is a system of slavery that the Founding Fathers were well aware of. Thomas Jefferson wrote, "If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered,"

(cont...)

[sugarpop]

(cont.)
Personally, I used to be completely flabbergasted by the staggering amounts of money it cost the government to do certain things. And the fact that govt contractors got away with charging so much in overages, which were ultimately the fault of the contractor, well, that always bugged me too. Then all the reports in the 80s about hammers costing $800, or a toilet seat costing thousands, corruption rears its ugly head, and I was pissed. Even back then, I had a hard time comprehending the amounts of money being thrown about. Then in the past decade, the numbers went from millions to billions, and now, it is in the trillions. The fact that debt clock had to be taken down last year because of the drunken spending of GWB was, I thought, completely unacceptable. Then this crisis hit, and it gives me pause and makes me wonder, is there really that much money in the world? I mean, in tangible terms? In tactile terms? For the majority of people who live in the real world, I think no, probably not. To me, personally, it is completely unacceptable how much money some people make. I do not believe ANYONE deserves a salary of 50 million dollars a year, which is what a lot of Wall Street CEOs and execs make (many of them make a lot more), especially when they make it on the backs on the workforce, when people are being laid off and losing jobs, losing health care and benefits, and their salaries are shrinking. The fact that these bank executives thought it was perfectly OK to pay themselves almost 20 billion $ in bonuses, with taxpayer money, during a global economis crisis, is proof that they really have no basis of reality in the world in which we live. If we allow them to get away with this, if we allow this behavior to continue, then what does that make us?

We are actually in a unique position right now. For the first time, we have elected someone President who seems to get it. There have been recessions in the past, and corporate corruption, and govt corruption, bad enough to raise the ire of the people. But THIS crisis is different, because there is real possibilty of it turning into a depression. The national unemployment rate is over 7%, and in some places it is over 10%, and those are only the rates that can BE counted (some people aren't on unemployment because benefits ran out or they didn't qualify, some are working part time because they can't find full time work, etc.). We are hemorrhaging jobs at a frightening rate, and there really is no end in sight. Still, CEOs are not taking pay cuts, and many of these people are doing things so their property can't be confiscated later, if they come under investigation. They are also colluding to stop labor unions from being formed by working people so they can demand fair pay.

Because of this crisis, and because of the blatant disregard for consequences by the people who caused it, we the people actually have some power again, if we choose to use it. We need to force the government to address the disparity in income that has been growing over the past 30 years, to start regulating business again, (since it obviously won't regulate itself, something we've always known but for some reason keep forgetting), to force transparancy and independant oversight in both business AND govt, so we the people can know what our govt is up to, and so Wall Street can't cause any more damage to the public (or world) at large, and to enforce these rules. Since our govt has in the past been so reluctant to interfere with the free trade system (free trade-what a joke), now WE actually hold the cards to force them to deal with it for a change.

Is Obama's plan the right way? I don't know. I didn't want to bail out the banks, but I don't mind bailing out working people, or stopping people from losing their homes. Ultimately, the reason this happened is because the world is owned by a very small group of elite people. When we allow all the wealth to be concentrated in the hands of a few, and if we allow that to continue, then we will always be slaves to those few. for me, it comes down to a vulcan belief (from Star Trek), "the needs of the many outweigh the needs of the few, or the one."

[classicman]

In addition, where was the oversight? Why has Congress been so lax in their duty to the American people?

People are addicted to "stuff."

Agree wholeheartedly

For the first time, we have elected someone President who seems to get it.

They are also colluding to stop labor unions from being formed by working people so they can demand fair pay.

Not so sure about these two statements though.
First off I believed that Obama got it too - till the breakdowns of his proposed "stimulus plan" came out. I now have more doubts.

Colluding to prevent the mighty labor unions and their lobbyists from getting ridiculous contracts that make America less attractive in the world markets? Is that what you mean?

[sugarpop]

Originally Posted by classicman

Agree wholeheartedly

Not so sure about these two statements though.
First off I believed that Obama got it too - till the breakdowns of his proposed "stimulus plan" came out. I now have more doubts.

I have some doubts about the plan as well. I thought the whole thing was going to be about infrastructure and green technology, and maybe getting the medical records on a centralized computer system. But today I read a couple of articles that made me feel better about it. Here are links. http://www.nytimes.com/cfr/world/slot3_20090126.html. http://economix.blogs.nytimes.com/20...mulus-package/

Colluding to prevent the mighty labor unions and their lobbyists from getting ridiculous contracts that make America less attractive in the world markets? Is that what you mean?

What I mean is getting workers decent wages and working conditions, and a way to bargain with corporations when they have disputes. What I am talking about is giving some power back to the workforce. I could give a damn about lobbyists or CEOs or executives because I think they are all paid WAY too much. I think they should all be shot. (not really, but I think lobbyists are bad for the American people, but good for rich corporations.) And while the people who control labor unions might not be much better, actual unions ARE good for workers.

I'm not sure what you mean by "ridiculous contracts." If they are too high then it's because the people at the top are being paid too much.

[classicman]

Sugarpop - What in either of those articles made you feel better about this particular bill? It seems that there is a lot of spending on things that are nice, but do not provide any jumpstart or immediate stimulus.
I am more sure than ever now that there is another plan coming to actually stimulate things - that was referenced in one of the articles.

[TheMercenary]

Well this should help our economy.

JANUARY 31, 2009, 3:37 P.M. ET

General Motors Seeks to Avoid Hefty Taxes on Restructuring

http://online.wsj.com/article/SB1233..._whats_news_us