Finding the Source of the Problem

Before I jump into what I want to write about how about a job update.  I heard back from my recruiter on Friday and I passed my background check and drug test, as if there was any question.  My tentative start date is June 15th.  I am pretty excited to move and to explore some new fishing holes in CO,if anyone has some good suggestions I am open to them.

Now back to the matter at hand.  Recently in one of my classes we did a dramatization about the current financial crisis.  Students chose characters involved in the crisis and then researched what their characters role in the current economic situation was and is.  For example I was John Mack, the CEO of Morgan Stanley.  The point of me telling you this is that as we worked through our drama the one thing that was clear is that everyone was pointing the finger at everyone else.  Which is what seems to be the case in real life.  Democrats blame Republicans and Wall St, Republicans blame Democrats and Wall St, Wall St blames the government etc. etc.  So who’s fault really is this current problem?

Lets start off with the root of the problem, the housing market.  The first half of this decade saw unparalleled growth in new houses and home prices. Credit was loose and house prices just kept going up.  Banks and other lenders were able to write so many loans,in part due to the fact that as soon as they wrote the mortgage they could bundle and sell them in different pieces to Wall St Investment banks, while home owners were almost guaranteed to be able to sell their house for more than what they paid for it.  This worked great as long as the economy was doing good, but when things slowed down the bottom fell out.

Some people want to blame the banks for making so many loans, and Wall St for not fully understanding the risks associated with the mortgage backed securities they bought and sold.  This is not that bad of an assumption.  Banks lending standards were almost non-existent, and Wall St. has always been driven by the prospect of increasing profits.  But can we really blame banks for wanting to make more money?  Isn’t that the goal all for profit business, make more money?  Of course is is.  Adam Smith talks about how the invisible hand guides business to seek their own self-interest and as a result we are all benefited.  For example computers used to be so huge and expensive that it was a ludicrous to think that there would such a thing as a personal computer, but the desire for more profits pushed tech companies to innovate and improve.  As a result I am able to write a blog that can be viewed all over the world while I sit in bed. Wall St firms should be expected to take risks in order to achieve higher margins. 

Now I am not saying that they are blameless.  Firms over leveraged their investments in complicated securities that made it difficult to predict how they would react in certain situations.  Leading many to think and state now that this crisis is a failure of capitalism.

So, why were credit standards so loose in the first place?  That is a good question and the answer may seem like a reasonable one.  The government thought that it would be a good thing if more Americans were home owners.   Doesn’t that sound good, who doesn't want to own a house?  Starting with the Clinton administration (see here for an interesting article about that), and continuing through the Bush administration the government encouraged lenders to make mortgages more available to people with poor credit, unstable income, and other qualities that make it risky to lend them money.  Man, how could that not be a good idea?  As you can imagine this woks fine while the economy is good but when rises in interest rates cause Adjustable Rate Mortgages to increase there rates, and the economy slows enough to make the housing prices plateau, look out. All of a sudden people can’t afford to make their mortgage payments.  This hurts the banks because they have to foreclose on houses that are hard to sell, and it hurts investment banks by lowering the value of the mortgage backed securities they own. (another interesting article) 

So what is the governments answer to the problem caused by cheap money, why it’s more cheap money.  The discount rate is practically zero, and money is being thrown at banks, auto companies, and now life insurance companies like it is going out if style.  Many see these failed policies pushed by two different administration, now into a third, and two different parties as a failure of government.

What about you and I, where do we fit in?  How about us fitting in with our insatiable desire for stuff.  A friend of mine posted on his blog a transcript from NPR’s Planet Money about the staggering amount of consumer debt in America. (here)  I was blown away.  People want things now regardless of whether or not they can pay for it. Just because the bank is willing to lend you a certain amount of money doesn’t mean you have to take it all, but we want the bigger house with a huge HDTV and new stainless Steele appliances because somehow we think that the more stuff we have the more successful we are. I’m not saying that I don’t think people should have that stuff, merely that you don’t have to have it if you can’t afford it.

All of these things together created this problem.  It’s not a matter of capitalism failing, or government policies failing, it is a matter of our culture failing.  The culture of instant gratification, easy money, and minimal responsibility.  Until we can change this we will be continually plagued with bubbles that eventually burst instead of real sustainable growth and wealth.   

That’s my understanding of what’s going on.   While it’s only an overview I think that this explains, somewhat, why we are in the mess we are in today.  Feel free to comment.  I would like to hear other ideas or solutions.