Filling Up the Money Hole

In July 2007, investors noticed the over-inflated values of securitized mortgages, which lowered investor confidence, creating a credit freeze that the U.S. government sought to prevent by injecting billions of dollars into the financial markets. Although somewhat unforeseeable, this was the beginning of the Financial Crisis of 2007-2008 (and perhaps beyond) continuing on with more frozen credit markets and toxic assets piling up in the market, leading to a stock market crash and a $700 billion dollar bailout bill by the federal government. This economic crisis we are in now is comparable to the Great Depression in 1929 in which both crises “can be traced back to property boom and sub-prime bust” (“1929 and All That”). In essence, the Financial Crisis of 2007-2008 was caused by the greed and irresponsibility of money lending institutions, specifically housing and mortgage lenders, and as a result, the people of America have been forced to ameliorate the gaffes of these avaricious corporations.

In order to discover the causes of the Financial Crisis, we must first look back to the economic conditions existing before. “As the residential real estate rose, mortgage borrowing increased even faster . . . Since 1995, home equity has fallen from 58 to 52 percent of home value”. In addition, from 2001 to 2006, low quality grouped mortgages rose from 9.7% to 33.5% of mortgages issued (Cecchetti, 3, 5), indicating the irresponsibility of lenders. Due to the growth and prosperity of the housing market, many lending institutions became more lenient with regards to repayment of mortgages in debts. Mortgage companies found this very profitable because they were able to easily lend money on relatively high priced houses, leading to an increase in interest collected; if the payer defaulted on the loan, then the mortgage company seized the house and resold it again to another unsuspecting consumer who may or may not afford to buy a home. Lenders were essentially giving out free money to people who could not afford to pay them back, resulting in an accumulation of toxic assets, or assets whose worth are undetermined. In fact, from 2004 to 2008, the number of foreclosures tripled from half a million to 1.5 million (Billitteri). The matter of the fact is, the sub-prime mortgage market arose from poor discipline or mortgage originators by investors, thus investors bought assets whose values were uncertain (Cecchetti, 5). As O’Neill puts it, “It begins with the stupid idea that you can put people in homes who have no income, wealth, or regular job history.”

Further insight into the situation reveals that much of the blame can also be put on the federal government, investors, and banks in addition to lending institutions. From 2002-2005, the federal reserve kept interest rates at below market rates and gave mandates to Fannie Mae and Freddie Mac that encouraged low-income home loans, contributing to deteriorating mortgage lending standards (Luskin). Thus, not only were corporations driven by greed to give out loans superfluously, the federal government provided further incentive for the corporations by lowering the interest rate below the market rate, making loans more easily obtained by anyone. In addition, central banks encouraged consumers to borrow instead of saving because of these low interest rates and a prospective “safety net” provided by the banks and the government (“Credit and Blame”). Although the government may have had good intentions by imposing lower interest rates, poor management and regulation have led to accumulated quantities of worthless assets. In addition, over-speculation of investments inflated home values and mortgage values which led to their collapse (Patrick). This led to a decrease in the supply of the inter-bank lending market due to substantial increase in credit risk or uncertainties due to the size of bank balance sheets (Cecchetti, 17). This effectively froze the credit market, resulting in complete panic by both investors and banks who found themselves loaded with overvalued loans and unable to borrow money.

Although it is apparent that the current Financial Crisis was caused by these rich corporations and institutions, we still find that it is the people who are suffering. Although most define a recession as two consecutive quarters of decrease in domestic product, which we have yet to see, many other market factors clearly indicate that we are in a recession. For example, since 2006, home sales have fallen 50 percent with no prospect of improvement (Gross). However, the effects of the Financial Crisis extend well beyond the borders of just the housing and credit markets. In the three months of November 2007 to January 2008, we saw housing, consumer, financial services, and luxury markets worsen with even Google, massive internet mogul, falling 26% (Gross). Also, jobs are being slashed, prices are rising, and the value of the dollar is decreasing (Gross). The unemployment rate has risen to over 5.1% with 98,000 jobs lost in March alone with an average of over 80,000 jobs lost per month since December (“The Long Hangover”). Due to major decreases in investor confidence, a frozen credit market, and rising costs, the consumer, the average Joe, is being hurt with economic pressures from all sides. Because of this, it has become imminent that the Federal Government must offer some kind of aid to these corporations that determine the financial atmosphere of our economy.

Preceding the passing of the bailout bill, Congress attempted to remedy the situation of businesses teetering on the edge and the economy leaning on the brink of recession by passing a series of bills that, in essence, threw taxpayer money away into the voids of the economy. By the end of March 2008, the federal government attempted to maintain some stability by spending more than half of their $1 trillion budget to the following new programs: $100 billion to Term Auction Facility, $100 billion to 28-day repo of mortgage backed securities, $200 billion to Term Securities Lending Facility, $36 billion to foreign exchange swaps, $29 billion to help with the purchase of Bear Sterns, and $30 billion to Primary Dealer Credit Facility (Cechetti, 26). Despite the government spending over half a trillion dollars on these new programs, the economy continued to fall into a slump. Then, the government and its financial advisors decided to make an attempt to revitalize the economy through its roots. In July of 2008, pressured by the Bush administration, Congress passed a bill to give individuals making less than $75,000 and families making under $150,000 $300 per person, $600 per couple, and $300 per child. Companies also received $50 billion in tax cuts for certain business investments and allowed Fannie Mae and Freddie Mac to buy loans up to $625,000, a $208,000 increase from $417,000 previously (Gross). Despite this “economic stimulus,” the economy still did experience any reprieve from the crisis it was in. As the weeks passed, and Congress fumbled through new options and plans while the economy took a turn for the worst. By September 2008, the markets had burst open, leading to some of the worst bank failures in U.S. history: Fannie Mae and Freddie Mac had been seized by the federal government, Lehman Brothers collapsed in the biggest bankruptcy in U.S. history, Merrill Lynch avoided bankruptcy by selling to Bank of America, AIG received a $123 billion loan from the federal government, Washington Mutual failed as the biggest bank collapse in U.S. history, Wachovia sold out to Wells Fargo, and Goldman Sachs and Morgan Stanley converted to commercial banks, leaving an absence of major investment banks in the U.S. (Billitteri). Following these major financial institution disasters, Congress hurriedly drafted a Financial Bailout Package that was initially rejected in the House causing the stock market to spiral down. Thus, Congress rushed to draft a new plan, the Emergency Economic Stabilization Act, which was passed, allowing the United States Secretary of the Treasury to utilize $700 billion to “immediately provide authority and facilities that . . . can [be] used to restore liquidity and stability to the financial system of the United States” (DR). However, with this much power and leeway with this colossal amount of taxpayer money going into these corporations, Americans must question their government as to whether or not this will work.

Looking at the current situation, there are many skeptics as to the details of the bailout and its overall effectiveness on the economy. The bailout buys risky mortgage backed securities, hopefully allowing banks to lend money again, absolving the credit freeze (Patrick). However, many critics of the bailout cry out that the methods of attempting to solve the problem are flawed. The former U.S. Treasury Secretary recommends guarantees of financial instruments rather than buying them to liquefy markets (O’Neill). By doing so, the government would not directly place taxpayer money in at risk assets and still be able to achieve the financial liquidity that the economy needs. However, due to the extreme economic pressures, Congress was coerced to pass a bailout quickly to alleviate the situation without fully developing a plan to effectively tackle the issues. By spending more money on these insecure assets, the government places the burden of risk on the taxpayer and the government itself is forced to take out loans that it simply cannot repay back. In fact, by creating more financial burden on the government, the overall long-term effect may in fact harm the economy due to the financial weaknesses incurred upon the government. This is especially important because the U.S. national debt is well over $10 trillion with an expected $400 billion deficit for this year, excluding the expenses of the bailout (Bittle). Therefore, we must take into consideration the consequences of the government’s actions in addition to the actions conducted by big corporations.

The Financial Crisis brought upon economic turmoil that especially had tremendous back-lashing effects on the people and exacerbated the tumultuous market economy. House prices, credit, the labor market, and fuel and food prices are greatly hurting the consumer despite recent federal activity to help the economy (“The Long Hangover”). Troubles spread in a chain from subprime borrowers to homebuilders, to stores. Also, lenders and banks that gave out subprime mortgages suffered great losses (Gross). Due to the subprime mortgage market, there was a ripple effect across all markets, creating strain on the consumer. As more and more foreclosures occurred, home prices dropped drastically, and home builders and financial workers alike were laid off. In fact, 2008 predicts cuts of over 200,000 jobs in financial sector alone (Bogle). This increase in unemployment only aggravates the problem at hand.

Due to the greediness and irresponsibility of corporations, America is now suffering through the Financial Crisis of 2007-2008 (and beyond). Although it was mainly these mortgage and lending companies who are at fault, the people of America have been forced to pay for their errors through government action and regulation. We can only hope that by spending this money, the government is able to place a stronger hold on the remaining companies and prevent a disaster as catastrophic as this one from happening again.