Explaining the Economic Collapse

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Economics / Political Commentary

I haven’t seen the movie yet, but if your recent cinematic experiences include The Other Guys, and you stayed until the very end, you probably saw this sequence, about how wealthy people hunt starving little children in Bagladesh and trade them for yachts and pigmy giraffes.

Well, Josh Tyler at cinemablend.com, I can’t say whether or not the creators of this clip are trying to explain the economic collapse, as you say, but I can assure you that the information propaganda found therein has absolutely nothing to do with it. I don’t blame you—few people really understand what the heck happened to the U.S. financial system, and why we’re still in this mess. For you, and many others, I’ll try to put this into plain english.

The Housing Oops

For decades there has been a lot of talk about how home ownership is the key to the American Dream, and how we needed to open that opportunity to more people. To make a long story short, getting more people into homes meant reducing loan requirements. Of course, that comes with huge risks… risks that companies don’t take unless they want to go out of business. No one wants to give someone a loan they can’t pay back, right? Wrong. What’s the one entity who has a virtually endless money supply, and who can never go out of business? That’s right,… the Federal Government.

You’ve probably heard of Fannie Mae and Freddie Mac. They were created and financially backed by Congress. Over time, presidents and congresses pushed these companies to take on more and more “risky” mortgages, in the name of helping the poor. In order to compete, other mortgage companies started putting their neck on the line. This pushed up the demand for homes, which also pushed up prices. And with increased prices, came more building and more bad loans. An artificial cycle had been created, and people were trying to find ways to make money from it.

Wall Street bankers and investors were packaging bad loans together and selling them off. Sometimes the buyers were intentionally buying up the risky loans—after all, home prices were skyrocketing! But not everyone who had money in the game knew exactly what they were investing in. Millions of people were just throwing their money at the stock market, through IRAs, 401(k)s and the like. But while the getting was good, the market for homes and home loans—the good and the bad—looked like a safe bet.

The Crash

By the time home builders realized that the rising prices and rising demand were artificial, it was too late. Home prices started falling fast. Like a one-two punch, people who couldn’t really afford their amazing new homes stopped making payments, and were forced into foreclosure. The result? A whole lot of banks with a whole lot of homes that were worth a whole lot less than they paid for them. Some of them went bankrupt and some got a bailout from the government. And anyone with any cash invested in housing and mortgages lost bigtime.

Banks failing left and right sent shock waves through the entire financial system, and even those who hadn’t lost money yet pulled out of the market, and stocks fell. That’s when most of us felt it. If you were a typical middle-class citizen with your own home and a decent retirement savings in your 401(k), you woke up one day to find that your net worth had decreased by 20%-30%. On top of that, you hear news of enormous bailouts, larger national debt, and higher taxes. You stop spending so much, reduced your charitable giving, and if you owned a business, you either let people go or stopped hiring.

Now What?

With so much uncertainty hanging out there about our economic future—the stability of the system, how new federal regulations are going to effect our lives, and what types of new taxes are coming our way—the economy is extremely sluggish, and is spooked every time an oil rig explodes or a European country spends its way into bankruptcy. Companies are slow to open their budgets and investors are slow to open their wallets, so to use a really sophisticated economic phrase, there ain’t much goin’ on. And when there’s nothing to do, you’ve got unemployment.

Getting employment back is the key to kick-starting the economy, and I can almost guarantee the one single issue that will determine whether the groundhog sees its shadow: the Bush Tax Cuts. If Obama and the Congress decide to extend them, things will turn around very quickly. If they allow them to expire, it will be a slow and painful growth.

Brief Remarks on Government Spending

People talk about how the government can spend billions of dollars generating jobs. But where do we get the money for this? Isn’t it just someone else’s income? It’s just been zapped out of one part of the economy and dropped somewhere else! That money would’ve been spent giving a plumber, roofer or shoe salesman a job, and the person benefitting would pay the cost. Or perhaps it would be put into an investment account where it would’ve been accessed by companies who could use it to produce goods, generate wealth, and… create jobs. This reminds me of a children’s joke: “you’re so dumb that you sold your car for gas money!” Hmmm… isn’t half of our country demanding just that?

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