$7 Trillion Meltdown 101: How We Got Here, What to Do Now
Now that the federal government is committed to spending or guaranteeing as much as $7.8 trillion to salvage the financial system, it's worth it for non-economists to better understand how got into this mess -- and how to get out of it. President-elect Obama has picked a centrist economist team that includes leaders who played a role in short-sighted decisions that exacerbated the current crisis. But, as Bloomberg News puts it:
In turning to Clinton administration veterans for his economic team, President-elect Barack Obama is banking that people who had a role in the current financial crisis will be best able to fix it.
Timothy Geithner, Obama's choice for Treasury secretary, was involved in the decision to let Lehman Brothers Holdings Inc. go bankrupt, which exacerbated a global credit-market freeze. Lawrence Summers, his pick for White House economic adviser, ran the Treasury when Congress repealed the Glass- Steagall Act, breaking down walls between commercial and investment banking.
What happened? Greed and deregulation ran amok for years, while most of the world's governments and leading financial institutions placed their bets on the shakiest of investment vehicles: securities and other intruments based on risky mortgages and a mindless faith in an ever-expanding housing "bubble."
Here's a new basic interactive MSNBC guide on who is to blame in the economic crisis -- several institutions, regulators and officials, such as Alan Greenspan.
The New York Times puts the blame squarely on the deregulatory, free-market philosophy of the Bush Administration in a new front-page article.
Given all that, it shouldn't be surprising that the Associated Press reported Monday that financial industry lobbyists worked successfully to convince the Bush administration to ignore warnings that risky loans imperiled the economy. As the AP reports:
The Bush administration backed off proposed crackdowns on no-money-down, interest-only mortgages years before the economy collapsed, buckling to pressure from some of the same banks that have now failed. It ignored remarkably prescient warnings that foretold the financial meltdown, according to an Associated Press review of regulatory documents."Expect fallout, expect foreclosures, expect horror stories," California mortgage lender Paris Welch wrote to U.S. regulators in January 2006, about one year before the housing implosion cost her a job.
Bowing to aggressive lobbying -- along with assurances from banks that the troubled mortgages were OK -- regulators delayed action for nearly one year. By the time new rules were released late in 2006, the toughest of the provisions were gone and the meltdown was underway....
The administration's blind eye to the impending crisis is emblematic of a philosophy that trusted market forces and discounted the need for government intervention. Its belief ironically has ushered in the most massive government intervention since the 1930s.
Unfortunately, as The New York Times pointed out in a Sunday editorial, now the current response to the crisis has been to throw money at the hydra-headed monster of failing financial institutions without directly aiding the homeowners most at risk of defaulting on their mortgages -- or even have officials explain clearly what they're doing, including Henry Paulson's erratic flip-flops on how he's going to use $700 billion in bailout money.
One reason that federal leaders believe they don't have to clearly explain or show what they're doing is the sure knowledge that even well-educated Americans are too befuddled by economic issues to penetrate the fog of spin. To help remedy that, I've put together some of the best explanatory journalism and resources on the current meltdown here, from This American Life's "The Giant Pool of Money" to the New York Times' series on "The Reckoning." I've also provided links to various charts, articles, bloggers such as economist Brad DeLong, and broadcast pieces. Just as valuable is this smart new article from The Atlantic bby disgraced Wall Street trader, Henry Blodgett, now a journalist, on why Wall Street doesn't learn from its mistakes. (Brad DeLong gave a clear explanation of our current economic crisis and the political fall-out as a guest on the radio show I co-host, "The D'Antoni and Levine Show," here.)
You'll also find at this resource site, for instance, 60 Minutes' "The Bet That Blew Up Wall Street" and Nobel Prize Winner Paul Krugman's explanation in a recent New York Review of Books of "What to Do."
Some excerpts from Krugman's essential points:
What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending...But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what's necessary out of fear that acting to save the financial system is somehow "socialist."
The same goes for another line of approach to resolving the credit crunch: getting the Federal Reserve, temporarily, into the business of lending directly to the nonfinancial sector. The Federal Reserve's willingness to buy commercial paper is a major step in this direction, but more will probably be necessary.All these actions should be coordinated with other advanced countries. The reason is the globalization of finance...
The next plan should [also ] focus on sustaining and expanding government spending - sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.
[On regulation:] What we're going to have to do, clearly, is relearn the lessons our grandfathers were taught by the Great Depression. I won't try to lay out the details of a new regulatory regime, but the basic principle should be clear: anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn't a crisis so that it doesn't take excessive risks...Now that we've seen a wide range of non-bank institutions create what amounts to a banking crisis, comparable regulation has to be extended to a much larger part of the system.
An unprecedent crisis requires fresh thinking and a willingness to do whatever's necessary responsibly to save the economy. Krugman concludes, "We will not achieve the understanding we need, however, unless we are willing to think clearly about our problems and to follow those thoughts wherever they lead. Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men. "
(Among those obsolete doctrines, many progressives say, are the anti-union myths and ideology being spread by opponents of both a bailout of the auto industry and of organizing rights for workers.)
All of of us need to understand, as we follow Obama's economic team and the ongoing bailouts, just what's being done with our taxpayers' dollars -- and the failed oversight that got us here in the first place.
UPDATE: David Sirota argues recently that the financial sector's $700 billion bailout was not only heedlessly out-of-control and unmonitored but based on wildly exaggerated claims about the severity of the credit crisis. That latter claim is open to debate, but it's worth reading his case against the financial bailout: "We Were Punked."
Loading comments…
Want to reply to a comment? Hint: Click "Reply" at the bottom of the comment; after being approved your comment will appear directly underneath the comment you replied to
Art great article but my question is where has Bloomberg News been? It seems to me that Bloomberg like Murdoch have benefitted the most by Reagan getting rid of laws like the Fairness Doctrine which allowed fewer and fewer individuals to control more and more media. Essentially producing monopolies with the public air ways. Again where was Bloomberg? For the past twenty years all we ever hear is how great Reagan is and was and how bad Carter is and was and how Unions are terrible and how deregulation is always the way to go. It seems to me that Reagonomics has gotten us into this mess and only anti reagonomics will get us out. So please consider your source when it comes to people like Bloomberg. In short Bloomberg like Murdoch are the problem.
Carter did much more deregulating than Reagan ever did. As for Reaganomics, our economy over the last 25 years has been substantially better (heck, infinitely better) than in the dozen years 1970-1982 before his policies started to have an economic impact.
In those eight years of Reagan, the United States moved from being the world's largest international creditor to the largest debtor nation.
Income tax rates of the top personal tax bracket dropped from 70% to 28% in 7 years
Payroll taxes increased as well
Unemployment peaked at over 10.7%
Massive increase in Cold War related defense spending that caused large budget deficits, the U.S. trade deficit expansion, and contributed to the Savings and Loan crisis.
Yeah, it was voodoo….
I see that most of the people have finally realized that Obama is no different from other politicians.
Anyway, the correct thing for the Government to do now is... nothing. The Government cannot push the economy in a certain direction. The USSR tried that for 80 years and failed. It simply does not work that way. Unnecessary Government spending is simply going to prolong the recession.
There were too many bad investments made by too many people in the economy. All those bad investments have to get liquidated, no matter how many jobs get lost and how many people become homeless. It is either going to happen now or more of it is going to happen later. That is our only choice.
In the long run, if we want to maintain our status as an economic superpower, we have to start producing more than we consume. We can't keep printing money and buying stuff from China forever.
At some point, those people are going to realize that the little green pieces of paper we give them are worthless and they will start dumping dollars on the market in large quantities. It is not going to be a gradual process either. When that happens, we will suddenly see a large drop in our purchasing power.... our wealth will shrink radically.
All these gigantic bailouts, I am afraid will cause that day to arrive sooner than anybody expected.
1. "Deep Throat of Watergate fame said it best. FOLLOW THE MONEY ! Some people have gotten much richer lately. Look there for what went wrong.
2. Former Senator and present lobbyist Phil Gramm , a PhD in economics, could talk about economics in simple terms and in an interesting way. If he had stayed at Texas A&M teaching Economics 101, he would have made a positive contribution to society.
3. In Congress and as a lobbyist, he used his didactic gifts to push deregulation resulting in the S&L failures in the '80s and '90s, ENRON (his wife was a Director), harmful oil futures trading and the subprime mortgage meltdown.
I don't think Obama appreciates the notion that he is putting in charge individuals who had roles in this financial disaster as repairment of the mess they caused. Truth be damned, don't you know!
"People may doubt what you say, but believe what you do."
Do not let them fool you; subprime, as idea to help low income Americans achieve home occupancy (no one owns their home; property taxes are forever), was not the cause of the current economic nightmare. Sure, the instrument that was the subprime mortgage was a toxic time bomb waiting to explode and its creation should have never been allowed, but the root of the problem is one of moral intent in execution of a necessary program.
Everyone who wants to and can shoulder the upkeep responsibilities of a house should be given the opportunity. A condition of the subprime loan should not have been an untenable high interest rate but a managed ownership partnership where the mortgagee and mortgager teamed up to insure the success of the transaction. The interest rate would have been fixed and low, and the mortgagee would agree to attend money management classes, utilize the mortgager as a conduit for all financial transactions and agree to periodic finance analysis and review. This would have been more a high volume retail approach that lowered initial profits but proved over the long term to be more profitable for all concerned.
The way subprime was implemented was as a scheme for some to get rich quick due to a mandate to make credit (affordable housing) available to the poor. The thinking was not how can I best achieve helping the poor and profitability, but how can I best make maximum coin on the backs of others. Don’t be fooled.
Obama's newly picked economic team is like putting arsonists in charge of the fire investigation, or Cheney letting the oil execs in charge of energy policy.
According to former Wall Street economist and author Michael Hudson, "Reality had to raise its ugly head. Barack Obama was elected with overwhelming approval to inaugurate an era of change. At his November 25 press conference, he said that his decisive victory gave him a mandate to change the direction in which America is moving. But recent economic and foreign policy appointments make it clear that when he chose “change” as his campaign slogan, he was NOT referring to the financial, insurance and real estate (FIRE) sectors, nor to foreign policy. These are where the vested interests concentrate their wealth and power.
The change that Mr. Obama is talking about is largely marginal to this wealth, not touching its economic substance – or its direction. No doubt he will bring about a welcome change in race relations, environmental regulations, and a more civil rule of law. And he probably will give wage earners an income-tax break (thereby enabling them to keep on paying their bank debts, incidentally). As for the rich, they prefer not to earn income in the first place. Taxes need to be paid on income, so they take their returns in the form of capital gains.
Where losses cannot be avoided, the government will bail out the rich on their financial investments, but not wage earners on their debts."
Uh... you're wrong with your arsonist and Cheney analogy. Summers and Geithner have never worked for any of the entities being bailed out right now.
Obama's damned if he does, damned if he doesn't. He could pick a relative unknown and be vilified for picking a rookie during this immense crisis. Or, he picks honest veterans, whom he controls, and directs them as to his philosophy. All while taking advice from conflicting views.
At least give the guy a chance before you hang him out to dry. It's pretty pathetic actually. Tearing the guy down before he even has a chance to work...
RnD -- that is sound advice. Mr. Obama has failed already in the minds of many (mostly those who did not vote for him). I am cautiously realistic about the president-elects’ chances to change the swamp of Washington to something that is effective for the people, because it is run by people...who are of the mind that as the people go so goes the nation. Mr. Obama has to play with the devil because Washington is all about hell. His main goal is not to be corrupted. That is why he is the right choice, I think. He showed that he could mingle with ill wind and brush it off, during the primaries. His vision, his plan, his agenda -- the horses may be tainted by whatever, but they are in a new meadow now and are given the chance by amazing events to run a better race, to live a better manifestation of themselves as dictated by the times and the importance of their lives within them. These are imperative times because we are in them...and the challenges continue to line up and demand that we have answers for the ages. Mr. Obama has asked to lead and the people responded. His choices do not raise my eyebrows, they cause me to exhale and breathe slowly so that I can fully appreciate every single moment of his presidency. I cannot fully appreciate why he moves as he does from my vantage point, so I am measured in criticism.
GIVE THE MONEY TO THE TAXPAYERS... DIRECTLY.. Each taxpayer should get a grant of twenty five thousand dollars per year for five years ... about three hundred billion, I think that is less than that proposed and let the taxpayers decide what to do with it.
Define Taxpayer?
$7 Trillion - It'll make a profit. You miss the Point. As have most others.
This is about cash flow, not face value. The sooner you understand this the sooer all will become informed. Whats the cash flow?
Overall the $7 Trillion is about an exchange of Government for Private Paper - an exchange of Risk.
Both paper has cash flow, Government less than Private, becuause Goverments are percieved to have less risk as borrowers. What was the Government's or Fed's discount off face value on the paper?
What's the cash flow? If its positive the Governent 9us) makes a profit now, and when the loans are paid.
It wasn't the war that brought us out of it, but the spending caused by the war. Spending for infrastructure and althernative energy would have the same affect.
Also the New Deal programs by Franklin D Roosevelt gave the people money to survive on and spend in the economy.
They put interest rate limits into effect. 8% was the highest that could be charged. Now credit card companies are charging 31% when they can, while our government gives them a bailout.
We seem to have forgotten the purpose of laws that were established to protect consumers during this past era of deregulation. The banking regulations imposed after the “Great Depression” were to prevent a financial collapse of that magnitude ever happening again. They need to be updated to fit our global economy and reinstated. However, I have heard no mention of anti-trust laws. As we are being blackmailed by companies “too big to fail”, I respectfully submit that hedge funds and mergers might make money for Wall St. but this sort of financial manipulation does not serve Main St. There were reasons for these laws back when government represented the people.
~We need Medicare for All ...Medicare for All would help re-capitalize business (especially manufacturing), school districts, state and local government, individual payers and the under and uninsured. Overall this could save hundreds of thousands if not millions of jobs while putting money quickly and directly into the system in the most efficient, fairest way ... taking care of people's medical bills.
~We need to Nationalize the banking system and clean up those balance sheets. Nothing is too big to fail. Without restoring the trust in the system it will only get worse.
~We need to nationalize the privately owned and operated Federal Reserve and operate it in the public interest.Operational income should be used for public purposes not private gain. It is our right under the Constitution to benefit from the creation of currency and credit. The Fed should be operated as a public utility.
~We need Bankruptcy Reform, in particular, legalizing house price reductions in bankruptcy court could solve many foreclosures almost immediately. They are also necessary because so many mortgages have several owners with different " pieces" of the mortgage. . Bankruptcy reform could also be extended to the "cramdown" of valuations on cars and credit cards. This bankruptcy will not be a giveaway but a severe chastisement for credit abuse. The 2005 Bankruptcy Act was a travesty of justice.
Trying to "save" an aggregate of 50 trillion dollars in US debt is a recipe for a Depression worse than the 30's.
Sevent trillion bucks...now *that's* a lot of zeros! When does it cease to mean anything?
If you haven't considered Taleb's writings you are missing something important. http://www.edge.org/3rd_culture/taleb08/taleb08_index.html
Here's an appropriate quote for post Thanksgiving.
"By the "narrative fallacy" the turkey economics department will always manage to state, before thanksgivings that "we are in a new era of safety", and back-it up with thorough and "rigorous" analysis. And Professor Bernanke indeed found plenty of economic explanations—what I call the narrative fallacy—with graphs, jargon, curves, the kind of facade-of-knowledge that you find in economics textbooks. (This is the find of glib, snake-oil facade of knowledge—even more dangerous because of the mathematics—that made me, before accepting the new position in NYU's engineering department, verify that there was not a single economist in the building. I have nothing against economists: you should let them entertain each others with their theories and elegant mathematics, and help keep college students inside buildings. But beware: they can be plain wrong, yet frame things in a way to make you feel stupid arguing with them. So make sure you do not give any of them risk-management responsibilities.)"
"get credit flowing and prop up spending", Krugman states. So much for that Nobel prize, this is how we got into this mess to begin with. The economy is 72% consumerism, that's way out of whack. We need to get back to making things and saving money, otherwise we're done.
The value of any economy is derived 100% from consumption. The 72% refers to domestic consumption. The other 28% of our GDP is foreign consumption. This means we don't export very much. If we consume less, then either foreigners have to consume more or our economy will contract.
Our ability to have jobs and earn a living depends on consumption. As the saying does, you have to spend money to make money. But there's never enough money because of the A + B theorem. This states that the price we pay for a particular product is the sum of A) wages, salaries, dividends, etc. and B) investment, depreciation, interest, etc. The effective demand represented by A cannot account for the portion of output value represented by capital expenses B. The demand side never earns enough income to consume the supply side, even if you include the corporate executives and hedge funders.
The nature of money itself is a socioeconomic treadmill of debt slavery. Save more, produce more... it doesn't matter. Don't try to make sense out of the nonsensical. The basis of industrial civilization is a fraud from top to bottom.
"the current response to the crisis has been to throw money at the hydra-headed monster of failing financial institutions without directly aiding the homeowners most at risk of defaulting on their mortgages"
And this has been the proper response. Regarding the homeowners most at risk of default, the best solution for them would be foreclosure, to eliminate the debt and start over. It doesn't make sense to keep someone in a home they can't afford, especially when they're significantly under-water.
Many of them could comfortably afford their homes if they were financed at a reasonable market price instead of at insane bubble prices. Many of them didn't buy too much house, they just paid too much for the right amount of house, betting, along with everyone else, that it wouldn't matter because their equity would keep rising.
Many folks could afford their homes, until they lost their jobs, or had a catastrophic illness or injury that was un- or underinsured
Most folks around my neck of the woods are losing their homes primarily for these reasons - little to do with subprime borrowing
And why, were they given loads they could not afford to pay? The banker has a responsibility to be prudent to ensure loans can be repaid.
The banker. Not the borrower. Idiot.
Read the Time link article on how it all happened.
Funny thing--not one mention of Deregulation. Lot's of blaming the greedy immoral bankers--which they are in spades--but nothing on how Bush and Clinton set the stage for this holdup. Wonder why?
The deregulation brought forth by Glass-Steagall played a role, but don't forget that there was still a lot of regulation in the banking industry. Just look at how an article i just pulled up begins...
"At the end of June the five agencies that regulate federally chartered banks and their subsidiary lending corporations issued final guidance to those institutions regarding subprime lending, particularly the so-called exotic or non-traditional loans that are threatening to bring down those lenders who haven't already filed bankruptcy or shut their doors."
Did they just say there are "five" agencies that regulate federally charted banks and their subsidiary lenders?????? Apparently, the regulators did a pretty bad job too.
Excellent point.
You must be logged in to comment. Log in or connect with
