What Caused the Economic Collapse?

People like Barack Obama, Chris Dodd, Barney Frank, and Maxine Waters weren't the major causes of the financial collapse, but by their inaction and greed they certainly played major roles. They provided little or no oversight on firms who were basically bankrolling their political careers.

[Note: For those of you who have not yet seen it, please refer to Ron Devito's blog (link below) for the counter-attack against the latest smears against Sarah Palin:http://sarahs-accomplishments.blogspot.com/2009/04/salacious-coverage-of-palin-family-some.html Also see Gary Jackson's fine blog piece: http://hotrodsnitroandconservatism.blogtownhall.com/2009/03/10/with_sarah_palin,_barack_obama_shows_rod_blagojevich_how_pay_-for-play_is_done!.thtml


The best article on how the current economic disaster came about is in The Atlantic: http://www.theatlantic.com/doc/200905/imf-advice (Simon Johnson, "The Quiet Coup," The Atlantic, May, 2009)

I don't agree with it 100%, but it's still up in the A-plus category. I've been trying for months to write simply and accurately about WHAT HAPPENED? As a staunch defender of capitalism, I'm saddened that so many supposedly capitalist companies or entities borrowed a lot more money than they could repay -- and have turned to the government for bailouts that they really don't deserve.

If the economy goes bad, as it has, companies need to have the capital and other resources to survive, which many of them did not. They had no real plan for long-term sustainability. In a sense, they were something like . . . Bernie Madoff. As long as the economy was booming, Bernie could pay off his new participants. When it stopped booming, Bernie was up a creek.

The banks, insurers, and other who have essentially failed were not running classic Ponzi schemes, but were excessively leveraged and thus totally unprepared for a sharp downturn. Borrowing money to buy stocks or other products when markets are going up quickly appears to make sense. It's what led to all those huge Wall Street bonuses. It stops making sense when the markets head downward for a sustained period of time. (At the same time, credit dries up because yesterday's reliable borrowers have become un-creditworthy.)

Many big companies have borrowed money -- or engaged in contracts -- that they now can't repay. Unfortunately, millions of individuals have done the same, especially in buying houses they couldn't afford -- or chalking up credit card debts they can no longer pay.

Why weren't we told this was going on by elected officials or the media, whose job supposedly is to tell us what's happening and what lies ahead? Party because they were engaged in similar, questionable behavior, incurring huge amounts of public debt to pay off constituents (or themselves).

They, too, were "betting" that markets (including stocks and housing) would keep on going up forever. However, as Isaac Newton discovered long ago, "What goes up eventually comes down." (Of course, the financial industry was providing huge campaign "contributions" to people like Barack Obama, Chris Dodd, and Barney Frank. They weren't about to interfere with that situation.)

Does all thise prove that capitalism doesn't work? No. It proves that capitalism conducted like a Las Vegas "craps" game or "roulette" table doesn't work. Many years ago in NV I bet on red on a roulette table ten times and it came up red . . . ten times. I ended up making more than $1,110, and then I stopped. What if I kept doubling down on red? Eventually, I would have lost all my gains. It was just a matter of time. I got out before I lost everything.

What we saw from financial institituions was that they weren't just doubling down -- they were borrowing tons of money to "bet" on their (metaphoric) roulette table. They set themselves up not to lose $1,100 but rather billions. We as a country have given AIG $170 billion and the money seemingly has gone into a bottomless pit.


The following is from Simon Johnson's Atlantic article:

The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

Who Caused the Economic Crisis?

Urkel Hussein celebrates his latest economic achievements.

Who caused the economic crisis that now grips our nation? The correct answer, one we really don't want to hear, is: We did. He (The Anointed One featured in the graphics above) also did his part.

Later today (Monday), I'll be writing the first of several pieces about similarities between the current economic downturn and the 1930s. If your parents or grandparents were admirers of Franklin D. Roosevelt, I regret to inform you that most of the things they told you about FDR were false. In fact, he probably did more harm than good. Scroll down to the bottom to see an example. I hope you'll return late this afternoon or this evening to see the new column.

How? By taking on (high) levels of debt that we're now finding harder and harder to pay off. We believed that something called "inflation" would allow us to pay off debts with ever-cheaper dollars. Instead, we have something called "deflation," which is having just the opposite effect, making dollars harder and harder to come by. There's no more inflation to bail you out.

On the political front, the short -- but incomplete -- answer to who caused the problem is: Bill Clinton, Barney Frank, Chris Dodd, and various other Democrats, as well as the self-aggrandizing people at Fannie Mae and Freddie Mac. All of the above insisted that lenders offer loans to people who now can't afford them.

The longer answer is that the crisis traces back to all those people -- in the public, in the government, and in the urban caverns of Wall Street -- who engaged in, or encouraged, very risky borrowing.

One such individual is a man named Tim Geithner. In the run-up to the crisis, he headed the New York branch of the Federal Reserve. He strove to keep interest rates at extremely low levels, which of course encouraged people -- from Main Street individuals to Wall Street speculators -- to go into heavy debt. Of course, low interest levels are fine, but only as long as borrowers don't over-use them.

There used to be an old nonsense game that college guys used to play on spring break drives to Florida. Here's one question: "On the stupidity scale, what's dumber -- a doorknob or a doorbell?" It turns out that the correct answer to that question is: Tim Geithner, the Treasury Secretary who now heads the IRS but didn't pay his taxes.

Let's be clear: It's certainly okay to borrow modest amounts of money, as long as the recipient has a reasonable chance of paying back the loan. However, if the person doing the borrowing can't survive an economic downturn, even a severe one, big loans are a bad idea.

As people try to put their arms around our dismal economic situation, they should start reading an important financial web site: MotleyFool.com. The writers there avoid financial jargon and "WallStreetspeak."

One MotleyFool piece I urge everyone to read is Matt Koppenheffer's provocatively titled essay: "Who Should Go to Jail?" You can find it at the following link: http://www.fool.com/investing/dividends-income/2009/03/06/who-should-go-to-jail.aspx?source=iflfollnk0000001

As you read the following material from Koppenheffer's piece, think of a line from an old song: "Those were the days my friend; we thought they'd never end." Of course, everything comes to an end.

Relatedly, as Sir Isaac Newton taught the world long ago, "What goes up must (eventually) come down." That's as true of economic rises and falls as it is of roller-coaster rides.

But who should we punish for economic malfeasance? In the words of Koppenheffer: "As the nation’s collective temper flares, we’re all beginning to consider tossing the people responsible for today's financial mess in the slammer and throwing away -- no, melting -- the key. And with our economy in disarray and major banks like Citigroup (NYSE: C) and Bank of America (NYSE: BAC) potentially on the brink of collapse, it's tough to fight that sentiment. . . .
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"Sometimes it just doesn't matter what your IQ is, what school you went to, or what position you hold -- idiocy can creep up and slide into bed with you. Even more irresistible is an idiocy that is supported by seemingly everyone around you. 'What? Home prices never go down?' That sounds fishy, but everyone else seems to think it's true.

"Remember when your mother asked whether you'd jump off a bridge if everyone else did it? Some people, even smart ones, have been jumping off that bridge their entire lives."

Koppenheffer's point is that, in financial matters, there are some crooks -- like Bernie Madoff -- and many fools, a group that includes nearly all of us (including me). As a nation, we jumped off bridges -- by making risky investments and buying houses that are now worth less than we ever imagined.

Can Obama bail us out? Surely you jest. He isn't going to hand over his own fortune to the American people. Remember, he's living rent free in a $100 million home. The only one who can bail us out is . . . us, the taxpayers, and, of course, the foreign lenders from whom we're borrowing trillions. Somehow it doesn't seem likely that a problem generated by over-borrowing is going to be solved by . . . massive borrowing.

Why oh why did we buy a $500,000 house when we could only afford one for $400,000 or less? We did so because the "smart people" (now known as the "dumb people") told us it was a good investment. After all, in a few years wouldn't our half-million house be worth $600,000 or $700,000?

Right now, however, our $500,000 home may be worth $390,000 -- or less. The notion that home prices would not -- could not -- go down turned out to be a foolish notion. The "housing market" ended up pricing itself out of the market.

On that $500,000 home, suppose you put down $100,000 -- one-fifth of the price. Then, suppose, you took out a home equity loan (perhaps to pay off credit card debt) of $60,000. In that case, you owe a total of $460,000 on a home that's worth $390,000 (minus the real estate commission of more than $20,000). You are out a ton of money.

With economics, the word "never" (as in, "House prices will never go down") doesn't apply. It doesn't apply if you're Citigroup, or Merrill-Lynch, or AIG. It also doesn't apply if you're you, sitting nervously in a home that you can no longer afford. You're up the creek, and your creditors are holding the "paddle."

(Note: I'll be writing the rest of the week on the economy, with emphasis on what the Obama Administration should do -- but probably won't.]

More from MotleyFool.com: "My guess is that a heck of a lot of the problems that we're facing today were born of people doing dumb things. Building a financial model that assumes housing prices will never fall? Dumb. Buying a $500,000 house with 2% down and a three-year interest-only loan? Dumb. Giving a mortgage loan to somebody putting nothing down? Yup, that's dumb too."

Did FDR really lift America out of the Depression. No, he didn't.

Barack Obama talks regularly about the inspiration he receives from the presidency of Franklin Delano Roosevelt. However, when it comes to bringing the country out of an economic crisis, FDR is a very poor model. He succeeded at getting large segments of the population to revere him. He failed at solving the country's economic disaster. Consider . . .

In November , 1933, a year after FDR's election, unemployment in the U.S. was above 23%, nearly one-in-four workers. The Dow Jones Industrial average, which had gone over 380 in fall, 1929, was at a miserable 90.

What about November, 1934, two years after Roosevelt's election? Unemployment remained exactly where it had been a year earlier -- at 23%, and the Dow had moved us a measly three points -- to 93.

By July, 1935, two-and-a-half years after his election, FDR had barely put a dent in unemployment, which remained about 21%. The Dow had moved up some -- to 119 -- but it was still at a level less than one-third the high in 1929.

Frankly, much of what we learned about FDR from old family members -- and from our history books -- was incorrect. FDR remained a dashing and popular figure, but the Depression lasted all the way through Roosevelt's first two terms.