Topic: Economics
Financial Crisis 101 & Why the Bailout Will Fail If you are like most Americans your head is probably spinning right now after listening to all the attempted explanations in the news of what is going on with the economy. You are probably wondering if the pundits even understand what is going on. If this describes you I welcome you to read this article. We'll take a common sense approach so anyone can see what is going on and learn the lessons from this so we don't repeat history. This will help explain to the average hardworking American everything we need to know about this financial crisis we face.by JJJ
(libertarian)
Tuesday, October 7, 2008
If you are like most Americans your head is probably spinning right now after listening to all the attempted explanations in the news of what is going on with the economy. You are probably wondering if the pundits even understand what is going on. If this describes you I welcome you to read this article. We'll take a common sense approach so anyone can see what is going on and learn the lessons from this so we don't repeat history. This will help explain to the average hardworking American everything we need to know:
-How we got here;
-Where 'here' is;
-Who's to blame;
-Why the bailout will fail;
-What should be done;
Just when did this problem start?
To figure this out we will need to rewind time back to 1992. Congress had been pushing for affordable housing bills during this time. Basically Congress was looking at the percentage of Americans that owned vs. rented and wanted to increase how many people owned their homes. That year they had passed a new housing bill. This involved Fannie Mae and Freddie Mac being required to purchase loans from banks that included a certain percent of low-income first time home buyers. At first it was very strict. However, throughout the 90s and first part of this century Congress continued to expand this program so the requirements were lower. Sure sounded like a great idea at the time. But like with anything else, any time government gets meddling in the economy, it catches back up with us.
Every time one of these new loans are created, this involves a significant portion of that loan money to be created as well. However, this new money in the system does not mean there is more wood at the lumberyard, more oil coming out of the ground, or more corn coming out of the fields. Later we will see why this increase of the total money in the economy plays an important role in the problems that develop.
Through this bill more people were now buying houses that were not able to get loans before. These were people who didn't have money down and who didn't have a good payment history. More people buying houses created a higher demand for used houses. This higher demand caused people to be willing to pay more for a used house then before. And so used housing prices went up. So let's suppose you are average American Joe who had a used house during this time and it's half paid off. You see houses in your neighborhood getting bought up at four times what you owe on your house. You see your old neighbor at the store and he tells you he's living in a new house now. Might be worth checking into! So you go home to do a little research and find out that you could sell your old house and build a new house and still owe the same as before! So you and your spouse find a contractor and in a few months you are living in the house of your dreams.
So developers noticed their developments are filling up quickly and so they buy more land and build more houses. Every town in America had new housing developments going up.
At the same time, the high demand for used homes caused all homes to cost more. Lenders saw this and believed it would continue this way so they began loaning more people money on the 'equity' of their home. Basically, if you owed $100,000 but your house was now worth $125,000 you could get a line of equity for $25,000. People spent this line of equity on remodeling their houses, buying a new vehicle, or purchasing other consumer goods.
Some lenders even offered loans where the buyer only pays the interest for the first ten years. Sounds crazy, huh? They did this believing the value of the house would keep increasing and then the buyer could sell it after 10 years and upgrade to a bigger house and make money in the process.
There were also loans being made that had an initially lower rate and then after a year or a few years the rate would go up. However, Congress had spelled out that if the initial monthly payment was equal to 40% of the income of the borrower, then Fannie Mae and Freddie Mac would still be required to purchase it.
All of these things happening caused a demand on Wall Street for new markets to form such as derivatives, credit swaps, etc. These were really only a symptom of the problem and are not the problem so we will not focus on those. 'Whew! So you mean I don't have to understand those to understand this crisis?' Correct. Warren Buffet has even stated he doesn't understand these. If you are like 99% of Americans, you don't have any money in them and they really don't affect you in anyway. Now we'll start to look at the downhill part of this story:
The suppliers of building materials began to notice their supplies were getting low. This caused them to raise their prices so they wouldn't run out of materials. Prices rose nearly three times as much on building materials. Also, the new demand for consumer goods caused them to get scarce and their prices rose too. All of these goods had gotten dangerously low. This in turn causes their prices to spike up. However, that higher price will cause people to stop purchasing that good or service and this will cause the supply to refill and as this happens prices will ease back down. A higher price on oil, for instance, causes people to not buy as much oil. This allows for the oil extractors and refineries to catch up their production so the amounts on reserve are back to safe levels. As these resource reserves become replenished, the prices ease back down.
Three factors played a very important role in bringing the party to a halt, so to speak.
1) Too many houses. Before this, Congress kept gradually expanding the affordable housing until virtually anyone could buy a house. However, when there was no one left to sell a house to, the housing market finally began to come back down to reality. Without the demand for used houses, the market dries up and prices come back down.
2) The rising prices of building materials and the lower demand for used houses caused it to no longer be worthwhile to sell your used house and build new. Developers were still going full gear ahead building but we were no longer buying. When we can't sell our used house for enough, we can't buy a new house. And so these developers are stuck with a bunch of empty and half built developments.
3) A large number of these new home owners stopped making payments on their homes. For a financial institution, this is bad news. Without going into much detail on the way banking works, this means that they won't be able to loan out much more money and may even mean some of them will go bankrupt. Also, since the value of all houses fell, then few people still have equity in their homes and so they can't give out lines of equity. So with Americans having less money on hand and looking at higher prices for everything means they will be consuming much less.
Where does that leave us at now?
We are now in a situation where there are too many houses and too few resources. We can know there are too many houses many ways. First, take a drive through any neighborhood and count how many "For Sale" and "For Rent" signs there are. Second, just watch the trend of house prices. They are coming down. This means that there is a higher supply of houses then there is a demand for houses. So the price is adjusting to reflect that and, when it does, then houses will move again.
Also, our resource reserves have gotten dangerously low. All that new money injected into our economy did not create more building materials, oil, labor, services, or consumer goods. All it did was cause people to spend them up until there were hardly any left. This caused the prices to spike big time, first with building supplies, second oil, and third consumer goods. We all remember going to the pump when it was over four dollars a gallon. Likewise, those prices will ease back down in that order. However, they will not come back down to the previous prices but instead will settle at higher prices to reflect the new amount of total money in the economy.
This leaves our financial institutions in a position where they can't loan out as much money.
So who is to blame?
Who do we point the blame at for these things? We can point fingers at people but it's not people that are the problem. The problem is that any time force(government) is used for anything other then defense of our individual rights, property, or person, it is fundamentally criminal and will result in a bad outcome. The belief that force is the answer to all our needs has created similar problems in countries all across the world ever since governments have existed. Congress did not have any authority to mess with the housing markets. Though they may have had good intentions, the intentions do not stop the natural consequences that come from policies not authorized in The Constitution. The contract that allows for Congress to even exist forbids them from doing anything outside of that contract in the tenth amendment.
Henry Paulson(Secretary of the Treasury), Ben Bernanke(Chairman of the Federal Reserve), and their colleagues had taken actions that had furthered this problem throughout the last two years. They were only looking at the results and not looking at the whole picture. They only saw the increase in the stock market and consumer spending and did not factor in that our resources are limited and having too many houses will pop the housing boom. So when things began to turn down, they increased the incentive for borrowing by lowering interest rates. This made more money but did not make any more resources. This only accelerated the problem. People borrowed more money and the party went on a little longer. But this made our resources even more scarce and made the prices rise even more. This only made more houses and caused the price of housing to push down further.
Even as recent as eight months ago they were confronted on these problems by economists and constitutionalists. However, they said everything was fine and that the economy was in good shape. Today we can see that their assessments were not correct.
So why is this bailout going to fail?
It's important to note that the same people who drafted this bailout bill are the same group of people that helped get us into this mess. They also are the same group of people who remained in denial of the problem and kept throwing logs on the fire. Likewise, the economists who predicted the consequences of this all the way back in 1992 and who continued to point out the problem that was coming are not being listened to for solutions.
The plan that Bernanke and Paulson have drafted is basically more of the same. More government intervention so more money can be created. It is to pledge tax dollars for buying up the bad loans. First, there are trillions of dollars worth of these bad loans and they are pledging $700 billion. The reality is that they are not hoping to buy them all up, but that they are hoping that this will restore lenders and borrowers confidence to keep the game going. However, it does not address the underlying problems that are making us act the way we do. This only would grow the problem even more then it already is. In fact, a letter signed by over 400 top economists nationwide was sent to Congress saying that this bailout would increase the crisis, not lessen it.
They are only attempting to treat the symptoms while ignoring the disease. This bailout, if it works in creating more confidence, will only cause people to continue to consume a little longer which will further deplete our resource reserves and cause builders to continue to build which will make more empty houses needing to be filled. That kind of foolishness will only make the backlash much greater. It's like the kid with a scab who keeps picking at it. "If you don't stop picking at that it will never heal," his mom would say. These elitists, who live far wealthier then any of us could ever imagine, need to leave our economy alone so it can mend from the damage they've already done to it.
If history repeats itself, when this bailout fails you can count on them trying a bigger one. When that fails they will try a bigger one. During that time the dollar will continue to lose value and significance in the global markets and will eventually go the path of every fiat currency that has ever existed.
If that hasn't gotten you stirred up, let me bring up some other problems with this bailout:
-it can be used to buy up the credit swaps, derivatives, etc. which are worthless
-it will be used to help foreign banks as well like Bank of Scotland, the Bank of China, and other foreign banks
-not only will we face the pain of the consequences from this folly, but we will be required to pay for it in taxes in the future
What would be a solution to this problem?
-As one person put it there is a four letter word: R-E-N-T. These people who cannot pay their bills on time or cannot afford a home need to go back to renting.
-The prices of housing needs to come down to reflect the total number of houses. Then these houses can get filled.
-People need to not spend as much for a short period until the resource reserves are replenished and prices on consumer goods come back down.
-The banks that made the risky loans need to go bankrupt and be bought up by banks that don't take such risks.
Will this mean a shortage of jobs for a while and tightened credit? Yes. But this cannot be avoided. We can either face it or prolong the agony. Like the drunk who binge drinks, we can either take another swig and risk our own lives in the process, or we can sober up, which is hard, and after a short while recover and see some true economic growth: not just booms followed by equal busts.
Some good news is that we already have begun the sobering process. The most painful part is already past. Oil prices went up and are coming back down. So are all other prices. Now we just need to let housing prices come down and the hardest part will be over. This also means the stock market will deflate, but most of this deflation has already occurred.
Many of those who found jobs in the financial sector, the housing sector, and the retail sector will need to retrain themselves and go into the exporting sector, manufacturing sector, and other sectors. The pain during that time is pushing us to redirect our activities toward things that will truly be productive for the economy as a whole. No government mandate or Act of Congress needs to be passed for this to happen. It's the natural course of the free market.
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While I agree with most of what you say I don't think the worst is over. The banking business is a pyramid of loans built on loans. When it enough borrowers default on their loans the whole thing can come crashing down. It's true that banks have FDIC insurance to cover your deposits. FDIC can cover a few bank failures but does not have enough money to cover massive bank failures. Since FDIC is backed by the full faith and credit of the government, the government will have to make good on your deposits. But government is flat broke too, so it will have to print money to cover the bank losses. That will probably cause lots of inflation.
Also if you have money in IRAs or 401ks that money is not backed by FDIC. That money could all be lost.
I foresee lots of agony before this is all over. But the country survived the Great depression and ultimately it will survive this one too.
Posted By: Jeremiah Johnson
Date: 2008-10-08 05:17:28
David S,
The Great Depression was a continuation of bad policies by our government that furthered the economic recession we faced and turned it into a depression. Those loans will unwind, banks will fold(rightfully so for the property violations they have sown through fractional reserve banking), new ones will pop up and prices will come down. The minimum wage right now is one of the most dangerous things to our economy. Also, if our government were to make it illegal again for people to be holding silver and gold, this could create an equally devastating affect while creating a depression.
Posted By: Jeremiah Johnson
Date: 2008-10-08 05:20:56
This money is fictitious and the sooner people realize that and revert to silver and gold or decrease their prices(on labor, goods, etc.) the sooner we can get going in the right direction. Our resource reserves are building back up and that is key for true economic development. It's important that we not focus on the bubbles but focus on reality.
Posted By: Jeremiah Johnson
Date: 2008-10-08 07:37:43
One other thing to note is that by the time the government actually figures out we are in a recession, then we are already on our way out. The government is very slow at their analysis. But their delayed analysis may have a negative impact on people's activities when most people depend on the government for sound advice. Their best course of action would be to focus on things like punishing injustice which is what we hired them for anyway. That includes any injustices they have created, and let me tell you, that would be a long list to keep their hands busy and out of mischeif for a while. ;-)
Dear J., I noticed you didn't use the word inflation even once; but you are talking about the main and real cause of inflation here, yes?
I mean, afterall, it is the gov't that authorizes the banking system to increase and give out credit above the level of the current total quanity of all available, exisiting national goods and services; and that then these newly increased credit-dollars chase after the existing goods and services that were once price-stabilized (but only according the current level of the total money supply); so that now this newy increased supply of money means that the law of supply-and-demand will come into play and the current prices will rise as it naturally follows that a newly increased supply of dollars -- without a matching increase in a production or services delivered -- will result in the folks who have the new credit dollars out bidding the folks who don't have the that advantage.
I understand this concept/reality; but my question is, wouldn't at least some of these newly created credit-dollars be used to start up new factories so that all of us consumers would get more and new products in the marketplace -- or is that just a false reality and wishful thinking?
Posted By: Jeremiah Johnson
Date: 2008-10-09 16:57:56
Hi Mark,
If you read through again you may also notice I never used the words Democrat or Republican or any person's name that could be associated with either of those parties. Very intentional and I appreciate you noticing.
First, before we can ever consider subjective things like, 'wouldn't it be good for production?' we need to examine the objective. The objective is that it is a matter of injustice, a property violation when this newly created money is used to purchase things under legal tender laws that require it be accepted as payment of debt. So suppose you have worked hard putting your labor into crafting wood you bought into chairs. When someone then comes and takes those chairs with created credit-dollars, they are essentially taking something from society in which they had not contributed anything to society to take with real money.
However, let's look at the subjective too. The free market is not something opposed to new factories. They will get built with or without the new credit-dollars. Toyota is a great example of this. Everything they do on the manufacturing side is without debt creation. They just built several new factories with cash in the United States. So let's dispell that new factories will never get built without credit-dollars.
The free market has a demand for a certain amount of factories of every kind at any given time that is closest to what is most beneficial for society. If we create new money and pop up new factories, this will result in malinvestments and factories will after a period of boom and bust be liquidated. We could have avoided all of that waste just by letting the free market(the collective purchasing power of every individual based on what they contribute to society regulating price and quality within a society where justice is secured for all) determine how many factories there should be and who should own them.
Thanks Jeremiah. I see what you are saying: The gov't requires us to accept ever increasingly inflated dollars -- of ever decreasingly less purchasing power -- for the work we do; and that's not fair and is morally criminal as far I see it.
I also see what you mean about a bank-credit financed factory; who wants one when a company like Toyota can build one without going into inflationary bank-financed debt and thereby becoming enmeshed into the evils of increasing the national money supply (through the use of bank created, nothing-produced, credit-dollars) while at the same time subjecting themselves to possible financial worries and becoming part of the victimization process of national inflation and the cycles of boom and bust.
~ I also now see how that any purchasing done with bank-credit dollars is actually a legalized form of theft from the society as a whole because our banks don't really lend money that represents or comes from products, goods, or valuables that they are holding for their depositors, which they then in turn simply transfer over, or lend to borrowers; but rather the situation is that what they call a loan is actually just an increase of the national money supply -- they just inflate the money supply and give you, the borrower, back a portion of it in the form of loan-created-dollars that actually never came from anything of value. So by this method, banks are in reality making profit for themselves by enabling their customers (hard to confront, but neverthe less an economic truth) to steal products, goods, and services away from the non-bank barrowing part of society, and that means from you and me, every time they give out a loan based on fractional banking, as I believe the process is called. The banks, in this process, produce no products or goods themselves but feed upon the production of those who do produce, while involving those unknowing producers in a scheme that always eats away at anmd in time destroys the national economy as it steals from it. The inflation rate measures the amount and level of that theft. The banks then take their ill-gotten gains and use it to promote the concept that the only really successful way to make a better world and a better life is to borrow more money from fractional-reserve lending banks. Joe Q. Public is handing over some hugh percent of his income to various banks each week simply because the banks and agents have convinced him that it's not really worthwhile to share, rent, save for, or wait on the things he needs and wants; but rather he can only be really happy if he buys them outright and that means now, now, now.
~ The fractional reserve banks ruin lives, retirement savings, employment stabilty, and the national economy while making ill-gotten profit for themselves, and unknowingly, we have been recruited by them (as borrowers) to be their accomplice in their moral-crime. You may think the loan you just got from them represents a chance to jump start your life, but the price you will pay is all too high; and it's not just the typical usury-level interest payments that you must pay. Without realizing what you have done, you have sacrificed part of your own future and some of the freedom to take on new roads, or a new line of work (afterall, you can't do anything that would jeopardize your ability to pay your installments, or mess with your credit rating); and you have -- another economic truth -- in your own small way, begun stealing from society, causing inflation, hardship, unemployment, and a stagnant economy. Unfortunately, until you pay off what you have borrowed the crime and the damage being done continues. If instead one borrows money from someone who has actually earned his or her money, then this is not the same kind of situation and one would then not be contributing to inflation and (unknowingly) participating in theft from the pockets of fellow citizans.
~ My new question is, what about the stock market, is their anything wrong with its basic nature? I mean, it doesn't seem very good or economicly healthy to me that people can "have money, make money" for themselves without them actually producing any product or service of real value. Haven't participants in the stock market unknowingly become "takers" who don't give anything back to society in return? Doesn't what they do also cause inflation and result in less products for everyone else? When they buy goods and services, but don't themselves (as stock market participants) produce any valuable goods or services; are they not causing for there to be less for the rest of us. In other words: they take from the pot but don't put in. Yet it is the rest of us who actually have done useful, productive work cannot afford the higher prices that they have created with their no-products stock market cash. The result is less products and services for the common good (again, they aren't producing anything -- only taking) and the law of supply and demand will force up the prices on what could be a scenario of too few goods and services marketed to a far too large hungry population.
~ At the end of the day, these folks have more cash and goods while we suffer with higher prices for less goods. We worked hard all day to produce something worthwhile and meaningful, while they on the other hand produced nothing of value and did little if anything except for perhaps the hiring of a new financial manager, even more adept at buying and selling stocks for a profit. And, what about that financial manager, how does buying low and selling high put more goods and lower prices into the economy? Sure enough, he might appear to be "working" diligently all day analyzing financial data; but isn't he just facilitating the immoral, "taking" but no-give-back, non-productive ways of his client, and in doing so he becomes a non-producer and part of the problem himself?
Posted By: Jeremiah Johnson
Date: 2008-10-10 09:30:46
Mark,
Have you thought about writing an article on these charts? :-P You seem to like to write! j/k
To answer your question about the stock market, if you are talking about what we have in the United States, absolutely I see a great many injustices brought about by the government granting special privileges to Wall Street. They ought not favor anyone because in doing so they must take from someone else. To get into the details would take plenty of books and I'm sure they've all been written already.
However, there is nothing inherently wrong with a stock market if the government is not involved in it(except in securing justice, i.e. ensuring contracts are not breeched, making sure people aren't stealing, killing, etc.). What a stock market involves is people voluntarily putting their past hard work(or that of their ancestors) into investments like new factories and other things of value to society as a whole. That is the proper avenue for new factories and other large investments to take place. No injustice is occurring through the process. No new money is being created.
That brings us to corporations. The ability of individuals to organize is perfectly fine. However, when government grants these organizations special privileges, then injustice is occurring.
Regarding the modern day state-chartered corporation, most of our laws are directed at such institutions since they were chartered by the government. For instance, suppose at your request the state of Florida charters a limited liability corporation for you called Mark L.L.C.,. There are certain taxes and regulations that then apply to your corporation such as the retail tax. As the principal officer of a corporation you are liable to keep any and all laws that have been imposed on such corporate persons(Mark L.L.C.). Many of our laws are derived from and directed at such legal entities.
Thanks, again, Jeremiah. And, yes, I have thought about writing a acticle; I do like to write. My question is, Is it healthy to have the gov't create any new money at all? I mean, is some creation required to keep up with increasing population, or increased GNP? And, how about barter: Do you think more folks should join up with a computerized barter system in order to receive at least some payments in the form of non-inflated barter-money?
Posted By: Jeremiah Johnson
Date: 2008-10-11 21:48:41
The interesting thing about money is that any amount will do. As goods become more plentiful, supply and demand will push down the amount of money to purchase goods. That's a stable money supply. But you will run into serious problems when the money supply is manipulated by a government and artificially expanded or contracted. Then there are so many factors that come into play when determining the value of fiat money that it makes even the brightest have no way of calculating decisions with accuracy that would reward them for helping society. Here are just some of the factors that can change the value of fiat money:
political trust/distrust
consumer confidence or lack of
rumor of war
increase/decrease in money supply through fractional reserve banking
debt repayment
central bank interest rate manipulation
government selling more bonds/not selling bonds
The list could go on and on. It's not easy for people to make sound decisions when the commodity used as a reference or all other commodities(money) is so volatile in value.
If it's gold or silver, then those at least can only grow as quickly as any other good can be produced. So the net effect is zero.
Either slow deflation or constant prices allow people to make sound economic decisions.
As far as barter goes, are you talking about sites like e-gold? The primary reason people desire federal reserve notes(and why there are taxes) is because they are required by the government for payment of taxes. Beardsley Ruml, Federal Reserve director(1937-1947), pushed for this system back in 1942 and 1943 when he helped implement the withholding tax. It's primary purpose was to keep federal reserve notes as the preferred currency. Since you could be fined heavily for holding gold or silver at that time, people were finding other means of barter and this was problematic for the government and central bank. They would prefer to just print the money and not tax at all, but then people find other things to use instead. So the taxes were to keep people scrambling to get federal reserve notes and also for socialist political agenda to even the earning field/progressive taxation. At least this is according to Ruml himself.
Anyway, we still have the same exact system in place that he designed until this day.
Yes, Jeremiah, I looked at the site for e gold and I like what I heard. There are some other companies that specificly deal with barter trades, like Trade Away, which will give you electronic trade credits so you can trade with others without using cash. I think I'll start getting into this and see if it is viable. I suspect as time goes on and more and more people become fed up with inflated federal money; electronic barter and other alternative systems will more likely become fast, and easy to use.
~~ Thanks for your input!
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