Thoughts on the Financial Crisis from an Actual Economist

Why did the current financial crisis happen?  I don't think a fully comprehensive answer could fit into a few paragraphs, but I can give some brief thoughts.

As of this morning, otherwise sound companies are encountering financial difficulties.  If we think of the current financial crisis as being a simmering pot on an oven, the water just boiled over and knocked the cover off.  Forces that were either hidden or contained were let loose, and this had a cascading effect.  Credit markets dried up further in response to the fall of Fannie Mae, Freddie Mae, and Lehman Brothers.  Businesses that otherwise were solid ran into cash flow problems.  Essentially, we saw a bank run and lenders pull back their lines of credit and new credit could not be found.

This morning we have news that a neo-Resolution Trust Corporation will be formed to handle the tranches of bad debt currently out in the market.  The market rebounded because such a move increases the certainty that at least part of the bad debt will be repaid.

But still, companies like Washington Mutual and Morgan Stanley are whispered about in the hallways.  Will they be bought?  Will they declare bankruptcy?  Just what else is out there?  And sadly, the answer is that we really don't know, because we don't have a handle on just who owns what debt in what financial instrument.

We don't know the final impact of the government's foray in this financial maelstrom.  What I'd venture to say is that the output and growth of our future economy will be slowed.  If we were to have 3% GDP growth before, maybe it's 2% now.

We know that compounding matters, so losing even fractions of a percentage of GDP growth means that, over time, we're going to lose out on a lot of wealth creation.   That impacts our children.   With the new Resolution Trust Company, our national debt will increase.  That impacts our children.  Whatever presidential candidate you support, their budget plan just went the way of the dodo.

This crisis further serves as an illustration that our actions have tangible effects on others.  Our actions affect others.  The risky behavior of many investment firms which have led to the credit crisis sent 401K values tumbling, strained home mortgages, and reduced confidence worldwide of our financial system's health.

There's going to be a lot of congressional oversight hearings on these matters shortly, along with regulation.  We're sure to hear “Where's the accountability?”  But don't expect hearings and inquisitions to solve much.  We're reacting to actions and events that started years ago.  Any regulation is likely to also be reactive.

But when this crisis does abate — and it will — we will have other problems looming.  We have in this country increasing healthcare costs, a growing national debt, and a retiring workforce.  While their impact will be felt 5, 10 years from now, perhaps now's the time to proactively address these concerns, rather than reacting.

This is, I think, where the personal finance community here and throughout the web can have a large, positive impact.

More about...Economics

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WealthBoy
WealthBoy
11 years ago

Let’s hope that the new agency that is formed will be a step in the right direction and helps to resolve the issues for which it is intended. It is sometimes a bit scary when the government intervenes, because it invariably causes new unforeseen problems.

Matt
Matt
11 years ago

Twice you call these floundering companies “sound” and “solid”, financial struggles aside. These are firms in the financial sector. In what way are they sound??

Adam
Adam
11 years ago

We have in this country increasing healthcare costs, a growing national debt, and a retiring workforce. While their impact will be felt 5, 10 years from now, perhaps now’s the time to proactively address these concerns, rather than reacting.
People have been screaming for medicare and social security reform for a very long time. Our government is only worried about what will get them elected within the next few years, not what is down the road. Even when the thing down the road will become a staggering burden on the economy.

ben
ben
11 years ago

What Is “The Economy”? Its very easy look at who is screaming the loudest that the government must do something. These are the people that have been benefiting from the distorted and over valued assets that are starting to unwind. They know that the gig is up. The profits taken over the past decade on Wall Street by hedge funds and the like are not real they are a bubble filled with nothing but hot air. They were not producing anything of real value or at least not of the value they were claiming. So, what do they do now?… Read more »

Sean
Sean
11 years ago

Stephen, if we get a slower growth rate and a larger public debt, where could that leave us in terms of interest payments as a percentage of the federal budget? We’ve heard from some in government that deficits don’t matter because we never have to pay them off. To me, that sounds like we can buy any house we want with a 100 year ARM, because we’ll be gone before we make a dent in the principle. Yeah, but… what about all the interest payments and other risks? (I found some data from prior years, but don’t know how it… Read more »

Matt_in_TX
Matt_in_TX
11 years ago

“As of this morning, otherwise sound companies are encountering financial difficulties.”

Let them prove they aren’t insolvent.
Mark their “assets” to the market value they could reasonably be sold for.

They would rather be bought by the Chinese or propped up for more orderly dismemberment by the government than show how stupid they were.

Robert Singer
Robert Singer
11 years ago

“Give Us AIG and Keep Shopping”–keep your eyes on the Mall Melt Up, Melt Down it’s the same Story of Stuff, Robert Singer (contact me about this and other articles featured on Opednews) Kevin G. Hall in the McClatchy Newspapers writes: Why would the government bail out a company like AIG but let Lehman Brothers file for Chapter 11 bankruptcy protection? Kevin answer: Speaking frankly, the world can do without another investment firm. If an investment bank fails, any remaining investment bank can hire more people and take their jobs. AIG is not an investment bank. As a principal insurer,… Read more »

Ryan McLean
Ryan McLean
11 years ago

It is definately an interesting dilema. However it is strange, though all this turmoil is happening I feel confident about my financial future. I am going to be a full time blogger and online entrepreneur.
It is weird how the economy shifts so much. It is kind of like the weather, always changing and trying to stablise, but never stable

jerichohill
jerichohill
11 years ago

A few responses Matt, The underlying business of AIG is sound. There’s nothing wrong with their insurance arm. From what I understand, and please note that this is just from what I read, is that AIG ran into a short-term cash flow problem stemming from the credit system running dry due to its contraction in the face of the mortgage crisis. Here, AIG would be akin to an civilian casualty. That’s in part why the government stepped in and took them over. (That, and AIG’s size and that it’s not an investment bank are other reasons. I hope that helps… Read more »

jerichohill
jerichohill
11 years ago

Here’s some information on the AIG nationalization
http://www.portfolio.com/views/blogs/market-movers/2008/09/16/libor-850bp

J.D.
J.D.
11 years ago

Congressional leaders stunned by warnings

Wow

I have no idea what the best course of action is cases like this. I don’t think anyone does.

All I can think is to cling to the things that have worked in the past.

Wesley
Wesley
11 years ago

I don’t mean to sound naive, but this article mentions rising healthcare costs as a point of concern, and we all hear about it everyday (politicians, ugh!). I typically just ignore it. I’ve worked since I was 16 and had my own insurance since I hit college at 18/19. It’s always been pretty cheap, and with Wal-Mart offering generics under $5…where’s the fire? Sure, if you have some dread disease like AIDS, it’s going to be expensive and incurable…there’s no good answer there. Beyond life-ending illness, is there really a healthcare crisis? Does some horrid future await me that I’m… Read more »

Tim
Tim
11 years ago

it’s hard to imagine that the economy is doing well at all, but there are lots of companies with huge cash reserves. yes, we may get a spike in unemployment from the financial sector during this period of consolidation, but we haven’t been seeing widespread unemployment. this indicates to me the economy is doing fine, at least for now. if it only costs the govt $1 trillion to control all these assets, and with freddie and fannie alone that is $5 trillion in mortgages that the govt only had to pay about $25 billion to acquire, i’m seeing this bailout… Read more »

Mo Money
Mo Money
11 years ago

I read that our politicians think short term to get elected, and these problems are long term. Many are not new, how long have we known that SS will be in trouble when the baby boomers retire? Just one example, we need someone in charge who can think long term.

Sean
Sean
11 years ago

@jerichohill Thanks for the response. It is nice to hear there is someone associated with government keeping an eye on things like that. Thanks also for the reference to GAO / Walker. I guess what makes me uneasy is, unlike Tim, not knowing how much of this is risk reduction alchemy, and how much risk is being swept under the rug of last resort. (Be careful with today’s estimates. If you need proof, look at last year’s estimates.) The government will do what they must to preserve the status quo, so odds are that they will, if they have enough… Read more »

Kim Cornman
Kim Cornman
11 years ago

I’m no great shakes about the economy, but does it seem to anyone else that WE could be the cause of our own demise? After all, we are the ones who took those loans, we are the ones who re-financed to cash out our equity to buy toys or pay down the debt our lifestyles accrued. It’s easy to blame the financial industry; some lending WAS predatory and perhaps could have been more regulated. But in the end, so many of us had our own heads in the sand. The only long term cure is to repudiate the easy credit… Read more »

jerichohill
jerichohill
11 years ago

@Wesley For those of us with insurance, we’re insulated from rising health care costs. On the other hand, we have no idea what health care costs are when we’re insured. One of the issues with rising health care costs is that they tend to bias and influence who gets health care and when. This leads to behavior like, only going when it’s dire, which is much more expensive to treat than a preventative regime. It does affect those with insurance as well, our premiums rise over time. This definitely does have an effect on our economy and its allocation of… Read more »

Robert
Robert
11 years ago

I happen to agree with Kim. The thing I keep reading on the news is how “urgent” it is for credit to flow, but no one talks about how urgent it is to someday pay that borrowed money back. The Federal Government is almost $10 Trillion in debt now, and paying almost $500 Billion each year in interest. That is more than both of our current wars combined for the last 3 to 4 years spent on just 1 year of Interest! Frankly, I suspect the future for our economy and country is very bleak. To pay off the national… Read more »

Tim
Tim
11 years ago

@Sean: don’t get me wrong, the reason the market has not found itself yet, was because of the ficticious valuations of mortgage backed securities. A large part of what is going on right now and why things are so hectic is because the market is trying to determine the proper value. @Jerichohill: I wasn’t talking about projected returns, but you are right there are some questions as to the true cost of all the mortgages; however, the actual mortgages in question are only $500 billion if you just wipe them away and count them as a loss. The remainder of… Read more »

Mark
Mark
11 years ago

Thanks for plain English description, those are hard to come by. There’s plenty of accountability to go around and I’ll happily lay plenty at the feet of financial institutions that are supposed to manage risk. However, I don’t see a lot of people placing any accountability on the consumers. Many people knowingly took on debt they knew they weren’t likely to be able to handle should any bumps in the road come up. Living beneath your means seems to be a lost art.

Matt_in_TX
Matt_in_TX
11 years ago

Re-reading, I don’t disagree with much. I do think that you stated a lot of things very, very, carefully however. I just guess I wouldn’t use the boiling over analogy and imply that the source problem was the lid not being secured tightly enough. I would blame rather all the fire turned onto the bottom of the pot and continually stoked with the Fed providing more pure oxygen when the heat flow seemed to falter. Once people can make more and more money by crawling farther and farther out onto a limb, the final end is known, but is just… Read more »

kitty
kitty
11 years ago

@Wesley: We all would like to think that we are going to be healthy with nothing but an occasional easy-to-treat illness, and then we’ll die in our sleep. But in reality, most people get sick before they die. About 1/3 of people get cancer at some point of their life. Heart disease affects even more people. Then there are other expensive items like end-of-life care (if everyone had a Do Not Resuscitate and refused futile care a lot of money could be saved). There is some unnecessary testing going on sometimes because doctors are afraid of lawsuits and sometimes because… Read more »

mwarden
mwarden
11 years ago

@19: You said: “we’ll get some inflation and slower growth, with I’m alright with if it means that americans are forced to re-evaluate their savings and purchasing behaviors”

Sorry, but inflation punishes savers and rewards spenders. So, if you are looking at inflation to cause Americans to re-evaluate their habits, I’d think again.

Kim Cornman
Kim Cornman
11 years ago

@kitty: I simply made an observation based on 1. that I worked in the property appraisal industry with lenders for clients, and 2. the number of ‘cash out’ refi’s on properties lenders kept pushing us to get high value for, and 3. the observation, mentioned many, many times in this blog, that we are part of a consumer society, to a negative degree. You may not have exercised bad judgment, however I believe that there ARE many who did, definitely not a minority as you propose. If that hadn’t been the case, I don’t think the financial industry would be… Read more »

kitty
kitty
11 years ago

@Kim Cornman: regarding if it was a majority or a minority who took these loans. When I say “minority” I don’t mean “small number”, I mean fewer than 50%. When you say WE, it seems to me you mean everyone, i.e. the whole population. Do you seriously think that 51% of households in the US took bad loans? I am really not sure about those who bought or took out equity loans during the bubble – it’d be interesting to see the statistics – but given that the bubble is only a few years, wouldn’t you think there are more… Read more »

kitty
kitty
11 years ago

Just to add (regarding Wesley) – when one is young and healthy one often thinks he is immortal or at least will stay healthy as long as he practices some preventive measures and then will die quietly in one’s sleep. The reality is – an expensive illness can strike anybody at any time. Low risk of having a specific condition at a young age is not the same as no risk.

Funny about Money
Funny about Money
11 years ago

Interesting post and good comments… I’d add that I think we may have to rethink the threat of a “retiring workforce.” Every issue of AARP’s magazine carries some article or short squib about where seniors can get jobs, how to retool for a new “career,” best places for seniors to work, and on and on. In those quarters, certainly, it’s expected that most people will continue to work after age 65 (or, in my cohort, 66). They pretend it’s because we want to, as if we couldn’t keep ourselves busy otherwise. Well, I for one can keep myself real busy… Read more »

John
John
11 years ago

@Wesley, The greater “healthcare crisis” is that we have created a healthcare-welfare system (Medicare) that is funded by our taxes which will cover approximately 20 percent of US citizens with baby boomers hitting age 65. This care covers them during the most expensive time to cover an individual (the 6 months before death) and creates financial incentives for physicians to literally “treat patients to death” to increase his/her own income. The healthcare system is broken! Additionally, our tax revenue cannot meet the anticipated budget (for Medicare and everything else), hence our current $10 trillion debt. If we continue to spend… Read more »

Jay
Jay
11 years ago

What I’m wondering about is how the American people are reacting to the 700 billion dollar bailout your government is pumping into the market. 1. It’s an awful lot of cash. Where does it come from? Tax payer money? or straight from the printing press, causing massive inflation? Either way, it’s not good news for the average Joe. 2. It’s hurting the free-market economy. This isn’t government or semi-government parties happily speculating along with the rest of the guys. This is a unique rescue operation for a unique problem. What’s more important? Instantly solving the situation by throwing money at… Read more »

Bill in NC
Bill in NC
11 years ago

Sorry, but I REFUSE to take blame for others’ failings. I saved nearly 7 figures over the last decade (my paid-off house is about 15% of my total net worth) My reward for that is a dollar that is worth about 40% less (in purchasing power parity), and a current return on my savings of essentially zero (go look at current Treasury rates) Our government has now made a conscious, explicit choice to prop up borrowers (retail and commercial) to the detriment of dedicated savers like myself. I feel like I ought to have “CHUMP” tattooed on my forehead. Well,… Read more »

Iain
Iain
11 years ago

Up here in Canada we went thru the 1990’s and 2000’s with a massive debt. What happens is that everything low on the bush is cut. Biggest impact was downloading. Federal level told the Provinces (States) to start paying for virtually everything. The Provinces downloaded on the counties. Could your county pay for the Highways within it’s border. Why of course it can because the new law says it has to. No wiggle room, no Special Earmarks and no Bridges to Nowhere. We hit the point that almost 50% of all Federal tax dollars were to just pay the interest.… Read more »

Mike
Mike
11 years ago

You should read Thoughts On The Financial Crisis From Rep Ron Paul Of The House Financial Services Committee:

http://www.cnn.com/2008/POLITICS/09/23/paul.bailout/index.html

It is unfortunate that so many people are ignorant of the fact that government is causing so much of our economic trouble, and that government’s solution to the problems they cause is always MORE GOVERNMENT.

But the central planners can never create an economy as robust as all of us can, knowing our own circumstances, and acting in our own best interests.

Tim
Tim
11 years ago

@Bill in NC: it seems you think the european economy is isolated from the US economy and that the economic fundamentals of the europe are better than the US simply from the current exchange rate. i feel like a chump too, but a chump because i am not getting any part of the $300b home owner bailout or the proposed $700b bailout. I hate these stupid buzz words like predatory lending. instead of going after “predatory” lenders (and you really have to get a true definition of who is predatory or not, or is it just marketing?), why not educate… Read more »

Peter Fane
Peter Fane
11 years ago

It is amazing how everyone has missed the simplicity of this crisis, including our esteemed economist. The crisis was caused by poor lending practice by financial institutions, who allowed garage based agents to source mortgages on their behalf. Commissions were paid to these people if the mortgagors did not default within the first 3 months, after which the mortgages were packaged into bonds and sold to the investing public. 3 months? A seasoned mortgage? The investors were foolish to buy these bonds. The credit rating agencies should be sued for negligence. How could a bond with mortgages that were only… Read more »

david
david
11 years ago

If a company spent its money the way the U.S. government spends our money, the CEO’s would be in jail.

You spend a trillion dollars here, a trillion there, and eventually it starts to add up.

Bill
Bill
11 years ago

While there is no ‘decoupling’, the Euro countries have agreed to fiscal and budgetary constraints – that has resulted in a much stronger currency vis a vis the U.S. dollar. I expect that trend to continue even if economies weaken both here and in Europe. We have had NO such constraints or voluntary restraints here. At this point we’ll essentially have to monetize the upcoming trillion dollar bailout as no new taxes are politically palatable. Even the Canadian dollar is siginificantly more attractive than the U.S. dollar given the high-demand resources backing it (oil sands & natural gas). The Canadians… Read more »

Andrew
Andrew
11 years ago

A very interesting alternative to the Paulson Plan is here: http://www.rgemonitor.com/roubini-monitor/253783/is_purchasing_700_billion_of_toxic_assets_the_best_way_to_recapitalize_the_financial_system_no_it_is_rather_a_disgrace_and_rip-off_benefitting_only_the_shareholders_and_unsecured_creditors_of_banks In general, it seems to me that if the objective is to keep the credit market from freezing up, it is far more efficient for the govt to give out loans directly to businesses (maybe using Fannie and Freddie as proxies, or nationalizing the next bank that goes belly up). In order to prevent more mortgage defaults, they can force a renegotiation of some of the riskier mortgages or buy up homes that are about to foreclose (as suggested above). It seems like these would be much cheaper and… Read more »

Mason
Mason
11 years ago

It’s amazing to me that the goverment is quick to bailout the big shots and not realize that the everyday person is suffing on a daily basis. Nobody talks about the republican montra of de-regulation as one of the causes. Why? It’s is common sense that greed kills capitalism. And the republican montra of de-regulation allows that to happen. No body talks about if we don’t change the fundamentals of the system (by the way trickle down economics is the most dangerous thing to believe in)we’ll be right back here in less than ten years. Can one person in the… Read more »

mwarden
mwarden
11 years ago

@Mason: Congrats on your attempt to politicize this. I must correct a few things, though. “Nobody talks about the republican montra of de-regulation as one of the causes. Why? It’s is common sense that greed kills capitalism.” I suggest you read a couple books on capitalism. Not only is it not “common sense” that greed kills capitalism, but it’s precisely the opposite. Given that humans are greedy by nature and you cannot legislate this nature away, our capitalistic system is designed to be FUELED by greed rather than hindered by it. It is not regulation that is the problem. The… Read more »

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