Tuesday, October 14, 2008
Who is to blame? Everyone has butter on their head for the financial crisis...
I've been pondering a post about the current economic crisis for a while but never truely commited to writing it. Then today, in an empty moment or two while I was browsing through some blogs two blogposts caught my attention and spurred me on.
The first blog is pretty new to me still: Joyful journey and the second is an 'old friend', a merry rose.
With a husband who is an economist, I can not help but follow all the economical news, and the comments of the so called 'average man on the street' (I refuse to call him Joe sixpack) that news shows feel compelled to insert.
Some people have insightful things to add or interesting testimonies. And some people just complain about Wall Street being bailed out and the poor homeowner whose house is being foreclosed is left in the cold.
Allow me to explain in very simple terms how we got into this mess. It's not just evil Wall Streets fault, borrowers and politicians are equally to blame.
It's easy to blame Wall Street. If this is all the fault of the evil magnates of Wall Street, we don't need to examine our own lives and lifestyles. As my beloved husband says however, there is plenty of blame to go around. The reason we are now in a financial crisis is, in essence, pretty simple. A lot of people borrowed a lot of money and then did not pay it back.
Well, you might say, they did not expect the money they had to pay to go up and the value of their house to go down. But that is what can happen if you do not chose a fixed rate mortgage, and anyone who reads the contracts carefully knows that. Of course a lot of it is complicated jargon and difficult to understand for people not involved in contract terms day in day out. So a lot of them just didn't bother thinking deeply about it or asking the necessary questions.
Everyone wants to own a house, which is a good goal and something worth working and saving for. Then when you, as a young couple have worked and saved for a while, you can make a downpayment on a condo or a starter home. And from there on you can work your way up on the house owner ladder.
Working and saving for a while however implies both waiting and denying yourself some other things. After all, the money that you save can not be spend on something else, though sometimes people still try to spend it twice using credit cards. This never works.
So loads of people started to buy houses they could not actually afford. According to the law of supply and demand the price of real estate went up, up up... But what goes up most come down. And when enough people had bought a house, many with a non fixed rate mortgage they could not afford to go up, the prices of houses started to fall. Now if you have a mortgage, the house is your collateral so to speak. So if that house is worth less, your lender will want you to pay more quicker so he can make sure to get his investment back. After all, if you do not pay he will have to seize the house and sell it (foreclosure) which costs him money. There are complicated formula's to calculate all this.
So far everything here has been 'Main Streets' fault. But here is where we stumble over Wall Street and Washington. Banks have played fast and loose with their formulas, only counting on a future in which housing prices kept going up, up and up. So they gave people a lot of loans which those people should not have gotten. To get the cash to lend them all this money they looked at other sources. Compagnies managing money and pension funds 'bought' these loans hoping to get a safe and steady investment with a nice interest as a return. So did other banks, lending eachother money, and so on and so on. Worldwide everyone want a piece of this mortgage deal since it seemed safe and easy money. People pay off their mortgages, right? They signed a contract and made a commitment. And since more people wanted to invest by buying these loans, banks and mortgage compagnies started to give them out even more recklessly.
When the housing market collapsed and at the same time a lot of people started to feel they had overreached and could not afford to pay their mortgage anymore... all of a sudden the steady stream of nice investment money dried up. People did not want to buy these loans anymore from banks or mortgage compagnies. And a frenzy began to get all those evil non paying mortgages out of their investment portfolio's. Of course if a lot of people want to sell something and very few people want to buy it... the prices drop and drop and drop...
And since all these banks and investment compagnies and mortgage compagnies have already lost truckloads of money, first by people not paying their mortgages then by the loans they bought having lost their resale value... there is little money anymore to go around to lend money even to people who have perfect credit scores and have been paying nicely all along.
These are the only real victims in the situation, because their pension plans (managed by people who also bought this loans) have lost a lot of money and they can not afford to buy the house for which they did save up and wait because nobody wants to lend them any money. Healthy compagnies also need to be able to borrow money to invest, for example to buy new machines or maybe expand and add new locations. The economy stands still when this money to invest and grow is not available.
There is only one group I have not yet adressed and those are the politicans. It's always easy and fun to blame the politicans, especially the ones we do not agree with. In this case politicians of both parties are to blame for refusing to enact any law or regulation that curbs all this lending to people who can not afford it. Have you not seen the horrible commercials in which people get money for their cartitle, pay day advances, or 'guaranteed aproved' housing loans? This is what is called the "subprime lending market". To use a much simpeler word: BAD LOANS. If you lend money in these situations your risk of not getting back your money, with the incredibly high interest you can charge since these people can't exactly make demands, is pretty high too. So you hire people to make intimidating collection calls or demand back cars, furniture and houses.... With no government regulation and no self regulation on greed on one side and a desire for instant gratification on the other side, the whole thing spun out of control.
There were proposals against these lending practices, but they were all rebuffed, mostly under the motto of not meddling into peoples lives or the government not interfearing into the market economy.
Now they are having to interfear to the tune more than 770 billion dollars...