Reasonably Logical

If you’ve been following the news this week, I’m sure you’ve heard about how the US economy is in desperate straights and that we desperately need to bail out Wall Street. Do I believe that the US economy is about to collapse? Not really. Do I think we face a serious recession and possibly even a depression? Yes. But remember folks, they happen periodically. It sucks to be one, but we will get through it and recover.

Let’s consider the reason for the economic problems we’re now facing. The price of real estate has gotten completely out of sync with its actual value and people’s ability to pay. About 10 years ago, prices started going up exponentially versus the fairly linear increases they’d followed for the last hundreds of years. Given this, it was really only a matter of time before a reset had to happen. Well, now is that time. The price of real estate has fallen dramatically and probably will keep falling for a while yet. Even the current prices are still too high. They haven’t fallen enough to get back to where they should be yet.

Before you start panicking too much folks, remember this is a good thing for most of us! Now, if you bought a home in the last ten years or so, you’re screwed. Sorry. For the rest of us though, I’m frankly looking forward to the day when I can actually afford to buy a home in Fairfield County.

However, the problem our economy is facing is a little broader than that. The brilliant folks on Wall Street decided that since real estate and mortgages were risky they were going to spread the risk around (diversify) as much as possible. (Note: By itself, that isn’t actually a bad idea.) The problem came when everyone decided that since *they* weren’t exposed to any risk, why should they be careful about who the loaned money to or how much they loaned? After all, *they* would still get their money back right? Well, once everyone started doing this, the quality of the average mortgage went *way* down and the average amount went up - which of course just helped the price explosion described above. End result, we have a lot of low quality debt (mortgages, CDOs, etc..) spread all over the US and world financial system.

Well, people finally realized that no one has any idea how much this crappy debt is actually worth. (Answer: Probably not much.) As such, no one is willing to buy it. Since a lot of businesses depended on being able to buy and sell assets to keep cash flow up, they found themselves in a bad situation. With a lot of assets they can’t sell, even if those assets were actually worth something, they can’t stay in business. This is what happened to a lot of the major investment banks which were (in)famous for their high leveraged business models.

Frankly, I wish we could just let them all hang. They got themselves into this; they should suffer the consequences. The problem with that is that they drug the rest of us in too.

On the lending side of things, since what were perfectly stable businesses are failing left and right, no one wants to loan anyone else money since there is a chance they might not get it back. End result, no one can borrow money and even more businesses go “boom”. The big worry at this point is that the bad debt is so widely held and that there is so much of it, that we could see a cascade effect well outside of the financial industry. When banks are in trouble - like now - they tend not to want to loan anyone money. End result, recession or possibly even a depression.

Now, let’s not kid ourselves, what I’ve described above could be bad. *Really bad.* As in, a lot of people loose jobs bad. (For the record, I work in the finance industry. As such, I’m definitely not ignoring this aspect.) However, in all honesty I think the $700 BILLION - nearly as much as Iraq & Afghanistan combined* - bailout of Wall Street would be worse in the long run. Bailing them out once does nothing to address the fundamental problems and frankly just encourages them to do it again. If we’re going to fix this, we need to fix the root causes.

If we absolutely must bail them out, let’s give them a loan instead. One with 10% interest a year, and first right of repayment. (In other words, let’s make a profit and minimize our – the taxpayers’ – risk.) After that though, let’s go after the fundamental causes of the crisis so this doesn’t happen again.

* This used to read “more than Iraq & Afghanistan combined”. I got this statement from someone else - don’t remember who unfortunately - and it turns out to be not quite accurate anymore. According to the Government Accountability Office, we’d spent $635.9 billion on the “War on Terror” as of December 2007. However, if you include the spending this year to Sept 15, the total jumps to $807 billion. Updated: 9-26-08

This entry was posted on Wednesday, September 24th, 2008 at 9:15 pm and is filed under Public Policy, News Events. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.