Credit Crisis Did Not Begin with Housing Decline
October 8, 2008 (Much of the credit goes to Scott Kelley
for most of the opinions in this article, and explaining at length
what caused a majority of the problems that we are seeing today.)
Understanding the history of the credit
and liquidity market as it stands today requires looking further back
than the past several years, long before the housing market drop.
Remember the .com bust? I do. Lots of other people do. When stocks
dropped like rocks after the .com bust, the Fed panicked, certain
that we were on the verge of a recession. So they did they one of the
only things they knew how to do; dropped the Federal Interest Rate,
to an extraordinarily low rate.
What this meant for financial
institutions and corporations was that they could borrow absolutely
vast sums of money for next to nothing, and when you factor in the
effect of inflation on these loans, essentially you have huge
institutions borrowing money for negative interest. They should have
ended up owing less back than they borrowed. This could have been a
great idea, in the VERY short term, but unfortunately, the Fed
dragged its feet for far too long, leaving the interest low for a
ridiculously long time; and when the Fed was slow to act, the banks
were slow to repay these loans.
Suddenly, the Fed realized that the
short term positive effect of this interest rate drop was just that.
A short term effect. So, they do the only other thing they seem to be
good at; they raised the interest rate.
In a matter of weeks, these companies
that had borrowed so much money for nothing, now had a huge loan out
that was costing them more and more on a daily basis. They needed a
quick income fix for their steadily declining status. What to do?!?
Let's give everyone more money than they need to do and buy things
that they don't need.
Now we have a loose credit market. A
VERY loose credit market. This was the start of the sub-prime lending
that would later come back to haunt us. Banks (and others) started
hurling money at absolutely everyone who walked through the door,
with little to no checks into their personal credit history. People
with terrible credit were getting loans that were far too large,
loans that anyone should have known they'd have no capacity to pay
back.
But before the mortgage payments
stopped coming in on these houses, the banks thought they were doing
okay, so long as everyone paid and paid on time. Too bad that reality
stepped in. Payments stopped coming, banks stopped profiting. Credit
stopped coming out of these institutions like it previously was.
Stocks started falling, and we have a rather aggravating credit
crisis.
Banking giants were starting to fail,
and fail at an alarming rate. Predatory larger firms were buying out
smaller firms, the FDIC was taking banks over left and right, and in
the process, the stock market was flailing. Suddenly, we have a
larger credit crisis, which spilled over into an economic crisis.
Housing, credit, economy, nothing was
looking good. Small businesses couldn't get loans, which means no
expansion in the small business sector. People started cutting back
purchasing goods and services, which only further served to depress
our economic situation.
So our grand solution to this is to
throw seven-hundred billion dollars into the market. Sound good? It
shouldn't. We should have already figured out that throwing money at
a broken system won't do anything to repair it. You don't put a
band-aid on something that needs surgery. It might mask the problem
for a while, but it will come back. We need an overhaul of the
system, more oversight, regulation. Deregulation didn't work. We
should see that now. We take for granted that government interference
in the market is essential to preserve private power. The Great
Depression should have dispelled any belief that capitalism was a
viable economic model. I realize it sounds Socialist, but we can look
at the past and realize that the government steps in whether you
agree or not.
Remember that rate drop that I
discussed earlier? As of today, the Fed dropped the interest rate to
1.5%. It seems that they only have one solution to any crisis, and
they don't seem to see that their new solution is the same as their
old solution, the one that didn't work, the one that got us into this
mess in the first place. Henry Paulson still admits that some banks
will fail. Unless they fix the root of the problem, we're most likely
not going to get out of this mess anytime soon.
It may seem relatively bleak, but as Joe pointed out, it's not quite as bad as Black Monday in 1987.
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