Oct 1, 2008
So I was actually asked recently what I thought about the whole financial mess over the last couple of weeks. I swear, I will get back to writing about the family in the very near future - but I actually had some thoughts about this.
Fundamentally the problem is that the US is a debtor nation.
I mean we've had massive balance of payments deficit for years, and over the last ten years we've also had a huge fiscal deficit. So essentially we had to borrow money from overseas (china, japan, etc) to finance those deficits. In the 90s and early 2000s most of that money was going into stock market. And when that bubble burst in 2001 - all that overseas money started looking for new places to invest, so they turned to real estate.
My understanding is that a bunch of poor policy decisions rewriting some of the financial regulations that limited oversight and transparency happened right around the same time. A bunch of financial companies had more lax regulations and a ton of money to invest and they started being really really aggressive in writing mortgages (which they would then consolidate and repackage which was supposed to alleviate the risk, but fundamentally didn't change the risk) to people who couldn't afford them. And US consumers starting buying those insane mortgages to buy houses bigger/better houses. At the end of the day they couldn't afford them - and starting defaulting.
That meant that some of the assets that were based on those mortgages started performing really bad and the whole thing exploded. Honestly, I think all that would normally be fine - I mean you make a bad decision and you have to face the consequences.
The problem is that there has been so much slicing, dicing, and repacking of those mortgages that nobody really knows what anything is worth or what they're really holding. That's where it becomes a mess - it seems that banks don't fully know how many bad assets they hold or anyone else holds for that matter - that they are not lending money to anyone.
I think that's really what causing the crisis - banks aren't lending to other banks, and the cost of borrowing for normal companies has gone through the roof because everyone is freaked with who might fail next, so companies can't grow or can't finance equipment they need to buy - which could really effect the whole economy. I just read something about McDonalds not giving its franchises any loans to upgrade their latte machines, because the costs of borrowing and the risks associated with it have gotten so high. I mean, seriously - that's messed up, their latte's aren't even that good.
And that really does need to be addressed, but I think the gov. really needs to just get transparency back in the market so companies understand what's on their balance sheet and banks relax a little and start to lend money. I even have a possible solution.
I think the government should start a company. It's charter could be rather than profit maximization, just a fair return (say higher than the 30 year note). Hire a bunch of smart laid off wall street types (hey, it's a job creation program too). They could then hold an auction on the distressed assets. Any company that wants to offload some of it's bad assets could put them up for sale. Any potential company that was interested in buying the assets could bid on them. The government company would set the price floor at what price it would buy the asset.
I mean the assets do have some value, right - as long as they generate a modest return, they could work with the homeowners of the distressed properties to rework the mortgages; it would inject liquidity into the system.That might work. Eventually the gov could spin the company off or whatever.
I don't actually have enough detail on what the governments plan, but I think they are attempting something similar for getting liquidity back in the system. It sounds like a lot about the current plan stinks - but if companies can't borrow we are talking serious recession; so you kind of have to hold your nose and vote for it. From what I understand the plan doesn't just hand over $700bn to Wall Street or anything, it is letting the government buy these assets which they might later resell and even make some money. What I personally don't like is that it's not as market efficient as it could be. The price would be negotiated rather than market determined, and no other companies are able to come in and say they might buy the assets for a higher price. Why not?
So what do I think is going to happen? A recession, and a pretty bad one. That sucks, but consumers are worried, right? So they are going to start spending a little less, and probably try to pay off some of their debt. So production decreases, which means people start to get laid off (kind of a vicious cycle there, because that just reinforces the decline in spending). It also means imports go down (good thing), and with a depressed currency our exports will start in increase improving our balance of payments position, which is well overdue. Eventually, peoples credit debt gets cleared up enough to start to spend some money - and strong exports lead us back to some growth. But that's like three years away (that's a guess, but it's something like that).
And what is even worse is that when you are in a recession, you want the government to be spending money to get some growth in the economy. But with the already huge deficit, and funds potentially tied up with the bad mortgage assets, we've kind of limited ourselves there. One of the reasons why Bush's tax cut was kind of a bad idea - you want the government to be counter-cyclical. Saving money when the economy is doing well and spending when it's doing poorly. But the current policies spent a ton of money when the economy was doing well and gave money back in tax cuts when they should have been hanging on to it when everything went pear shaped.
Okay, well - now I feel uplifted. Back to the mundane.
There's an awesome This American Life that covered this a couple months ago - if you have an hour it's really worth a listen:
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