Friday, October 10, 2008

The Meltdown

Yesterday I attended a teach-in at EWU focused on the economy and politics of the moment. The teach-in was the brainchild of the dean of the college of social and behavioral sciences. She was thinking about the market meltdown in the shower one morning a couple weeks ago, her head spinning with questions, when it occurred to her that she had a number of experts in her department who could probably explain the whole thing to her. The event was led by a panel of five people: two economists, one poli-sci professor, on finance professor, and one retired financial advisor. Each person on the panel took about 15 minutes to talk about the economic crisis from their own perspective, and then the floor was opened to questions. Here is some of what I learned.


1920s-1930s--Great Depression. The government failed to act quickly. There were very few regulations in place on the financial and banking industry and no safety nets. It snowballed out of control because the people lost faith in the markets and in the government.

1933--The markets saw huge gains and started to get back on track. The government started to regulate the financial industries and other industries as well.

1970s—In the early part of this decade there was a period of stagflation thought to be brought about by too much regulation. This began a long period of reducing government regulation and oversight of many industries.

1990s-2000s--Without regulation, there are huge profit-making opportunities that go unchecked, which is how we got into the current economic crisis. More on that below.

Why/How did it happen?

1. Failure of regulators to keep pace with financial innovation.
2. Failure of regulators and congress to enforce existing regulations.
3. After the bubble-burst of 2001, interest rates were dropped and were kept too low for too long.
4. Failure of lenders to advise home buyers about managing their own risk.
5. Consumers have been buying homes that are too big and expensive for them.
6. Institutional lenders who were buying and selling these mortgage packages amongst themselves also didn’t manage risk well.
7. Rating agencies (like Standard & Poor’s) that are responsible for rating mortgages based on their likelihood of default rated many mortgages wrong. Their probabilities and mathematical models were off.
8. Failure to maintain stable leadership over the US Treasury. The head of the treasury is an important position for managing financial crises, but it has been a bit of a revolving door in the past decade.
9. Failure of congress and the president to appreciate the connection between ‘goods & services’ markets and ‘credit’ markets. They underestimated the collateral damage that would come from a credit collapse.

The Bailout:

When it comes to the bailout, the evidence is clear. The experts are almost entirely in agreement that the bailout was a good idea. It was the general public who were against it for the most part, which is mostly because we didn’t understand it. And since the people didn’t support the bailout bill, their representatives in congress who are up for re-election next month had a hard time voting to approve it. There was a sharp failure of the political leadership to convince the public that the bailout was necessary.

So here’s what the bill is all about. As Obama said on the senate floor last week, the bailout bill is an emergency measure only, not a long-term solution. Imagine that your house is on fire. You have to put out the fire as quick as you can, you can’t waste time pointing fingers and trying to figure out who is to blame for it. That will come later, after the immediate danger has passed. The $700 billion isn’t exactly a hand-out either. The government is buying (with our tax dollars) actual assets from these floundering financial companies. We are buying up the risky mortgages and other such devalued assets so that the companies that currently hold them can get them off their books and continue to do business. The value of the assets will rise, however, with time and consumer confidence, so the bailout isn’t actually going to cost the US Treasury $700 billion in the end. We’ll be able to recoup a lot of that money. There is even a very, very slim chance that we will make money on the investment.

In the meantime, we are currently in a recession. We have a bear market. We can expect unemployment rates to rise, and with that, crime and poverty will likely rise too. Taxes will have to rise to cover the cost of our social programs, or else the programs will need to be cut. There is no way to know how long the recession will last, but the system will recover. We will make changes to the system to re-regulate the finance and banking industry to some extent. The more the recession hurts, the more likely we’ll be to learn from our mistakes.


The Imaginary Reviewer said...

That's very interesting, thanks for posting it! I'll be honest, my ignorance of the processes and causes at the heart of the current situation has been annoying me. I've also been torn by the bailout and whether it is a good thing economically (as opposed to emotionally or politically). This makes a lot of sense.

Jillian said...

I know what you mean. I don't know a lot about financial markets. I think I get the gist of it now, though.

Herbal Amanda said...

Thank you Jillian!