Hey all! I’m SO sorry about the lack of posts recently. I’m still adjusting a new school/internship/theatre/a cappella schedule… so things have been crazy. BUT, that’s no excuse for skipping out on posts and I apologize. I did spend some good time on this new video blog episode so I hope you enjoy it (especially my slideshow/video effort). This is more of a conversation starter than anything else, so I hope you all respond! These numbers continue to blow my mind…
So let me know what you think! Do you agree with the way in which the Government is approaching the financial crisis? Do you think they are spending too much or too little?
Sometimes, I feel like there is a lot of focus on how to solve this in the short term, even though the roots of this crisis might only be solved with a long term approach. But, I’m no economist and I think it’s tough for most of us to wrap our heads around a lot of these issues.
I’d like to hear what everyone else thinks–especially those of you that have studied business and economics!
YES, the T-Shirt contest is still alive! I PROMISE, I will be giving one out this saturday! So get the comments in!
what about the auto industry bailout? can’t forget about that gem.
while these numbers are all mind-boggling, another way to look at it is this: if the government thinks that it is worth spending $6,667 per citizen on a bailout, then the government is indirectly implying that without this bailout we would all be at least $6,667 worse off. In other words, if we are on track to loose $6,668 dollars per citizen ($1 more than the cost per citizen of the bailout), then it is worth $6,667 to each of us so that we can at least come out $1 better off than if we had done nothing.
In a more extreme case, let’s say that you are going to loose $2,000, unless you pay $1,000 now, in which case you will only loose $500. If you pay $1,000 now and still have to pay $500 later, you are still better off than if you had done nothing and lost the full $2,000. The government is essentially saying that we will loose a lot more than $6,667 per citizen unless we pay that amount now.
Which brings up the real scary issue: the banks have become such an intertwined part of the economy that they can cause (and have caused) at least $2,000,000,000,000 worth of damage to our domestic economy alone, not to mention the damage caused abroad as well.
Good points phil, and it’s good to see you are at least trying to get people to think about it. If only everyone could get past the bad news that cable news loves to report and try to find the real story behind what is reported.
nick whalen
smg 2009, finance
econ minor
Nick, your cost/benefit analysis with regards to government spending is right on. If Washington is willing to but a burden this large on the taxpayer, it must think that this investment is absolutely necessary (and will help us out by more than $2 Trillion in the long run).
However, I think there’s a more important conclusion that can be reached from this bailout: Banks have become way too important. I think about the bailout like this – the government is taking from the taxpayer and giving to the banks! Shouldn’t the private sector be able to take care of itself? I thought taxes were around so we could all support public spending, not bailouts of private companies and institutions.
Why doesn’t the shareholder, AKA the taxpayer decide which banks should fail? The answer is because too few banks have gotten way too important and credit has become such a large part of the American lifestyle. If we can’t get loans, then how are we supposed to buy stuff before we have the money to pay for it??? But joking aside, families need to take out loans for assets like cars and HOMES, so the government needs the banks to keep lending. So Washington’s answer is to keep giving the large banks money until they start lending again. And by the way, this isn’t really happening. Banks are hurting in terms of liquidity, so they’re pocketing the money which follows with being in the best interest of their shareholders.
Here’s another problem with the bailout. Since the big banks now know that they’re too big to fail, what happens to the small time bankers who own local credit unions and want to expand? They were smart with their money and didn’t make risky sub-prime mortgage loans. Since capitalism, apparently, no longer prevails in this crisis, these small timers won’t reap the benefits of actually being smart with customers’ savings…
This crisis and bailout is constantly “to be continued…” so I’m actually not arriving at any type of conclusion in my post. I thought a couple of points were worth making, but I’ll leave you with this: capitalism can’t only prevail in times of economic expansion, because failures must occur for the strong institutions to rise from the rubble.
yeah, i agree with everything dave has said. banks became too powerful. but the next problem is to figure out whose fault that was. I think there are three entities that can take the blame.
first, the government is certainly partially responsible. Financial innovation far outpaced financial regulation, and in some cases the government encouraged banks to loan to people who couldn’t afford it. the Community Reinvestment Act, revised in 1995, set up strict standards that banks had to meet regarding the distribution of mortgages to geographic and demographic borrowers, including special focus on making mortgages available to low-income families. At first banks resisted this, but once they realized that home values had been increasing dramatically and were expected to continue to do so, they realized they could make money lending to under-qualified borrowers, and began to comply with the government requests.
obviously, another party at fault is the banks. although in capitalism you serve your best interests by offering a product that best meets consumers needs, you are supposed to do so with a dose of morality. just because consumers were willing to assume more debt than they should doesn’t mean you should have offered loans to them. this demonstrates severe short-sightedness on the parts of banks. However, in their defense, there have been numerous studies in economics regarding the smoothing of business cycles in the modern economy. While many will argue that the past suggests large fluctuations in recessionary and booming periods, because of the modernization of finance, many doctoral degrees have been awarded for research on the smoothing of the ups and downs in the economy. So you can’t blame the banks entirely for anticipating that the good times were going to continue uninterrupted, but you can blame them for making a business model that lacks morality.
Finally, probably the biggest entity to blame is the american consumer. For years we have lavishly purchased outlandish luxury goods, fueled by the fact that status in american society is represented by what we own. The ultimate american dream engrained into every american is to own a large, new home with a big car and enough money to support a family comfortably. While there is nothing wrong with these ideals, banks began to allow consumers to reach their goals before they could actually afford them. banks simply offered the products, while consumers were the ones who chose to take advantage of them. this shows a fundamental flaw in our society, one that hopefully will be addressed as the severity of this crisis begins to sink into peoples’ minds. but as long as we continue to only blame banks and ignore blaming ourselves, we will only fall back into the same unhealthy spending habits. Germany went through a similar housing bubble burst the crushed their economy in the early 1990′s with the reunification of east and west germany. As a result, they learned their lesson about over-borrowing years ago and now buying a house or a car in Germany requires a substantial downpayment. As a result, on an individual level people’s attitudes towards borrowing changed, but also regulations on banks increased as well. This is the model that perhaps should be adopted by the American financial regulatory system.
You can’t blame businesses for doing what is profitable, although you can blame them for exploiting the dreams of americans who had built a culture based on borrowing money today to buy what we can’t afford until tomorrow. It’s a cycle that feeds on itself – if your neighbor borrows beyond their means to get a new Cadillac Escalade with 22″ rims, by god you are going to go find the bank they got their loan from and over-extend yourself and get a Hummer H2 with 24″ chrome rims. Once our society can get past our phase of excessive consumerism will we be able to begin to solve this problem.
and also not to mention the fact that banks could initiate loans and then have someone else assume the risk for these loans. accountability will be key to preventing this type of ordeal from happening again, and only when banks are held responsible for their own loans will acting in their best interest align with acting in the best interest of the borrower.
If banks were the ones who would suffer the losses on defaulted loans, they wouldn’t have issues loans to people who couldn’t afford them. As it was, AIG was there to insure the loans, thus alleviating the risk that consumers would default from the banks.
Nick,
Great stuff. Your points are all well made and I agree that we are fighting a multi-front war. Fixing any of the problems you mentioned would help prevent another crisis like this one, but I want to respond to which of them would be most important to fix, and which would be feasible.
First off, I think the final point you made in the continuation of your second post is the most crucial. Reinsurance, credit default swaps and other complex financial derivatives can be useful tools if properly understood, but as a result of these in our system, accountability has gone awry. It used to be that a bank would lend only if they felt the customer could be entrusted to pay back the loan. Now, banks can actually STILL turn a profit if the people they lent to default on their loans; they just have to make sure they’ve protected themselves.
Mortgages are being pooled and packaged into instruments that you and I can buy, and a horrible thing happens because of this: the government is hand-cuffed in terms of helping homeowners make payments. Since pooled mortgages and mortgage backed securities are traded on the open market, investors of these have the right to protection as well. Before, when banks didn’t package and send away mortgages, they could renegotiate with customers who were short on cash. In this day and age, banks can’t do this because they no longer own the debt!
The conclusion I’d make is that we should start here. I don’t disagree that the American consumer has been brainwashed to live beyond his or her means, but the consumer is still the voter, and the transformation to a more prudent lifestyle is not near. The government has to take out of play those securities or financial strategies that are narrowly and not clearly understood.
I also don’t disagree that the banks are at fault. However, competition has been fierce, and the banks who weren’t as risky looked bad in comparison to rivals. It’s the government’s job to build a system where incentives lead banks away from this risky behavior. Safety and sensibility have to lead to profitability; if not, the morally rich bankers will go bankrupt.
Good read guys. You guys know a lot more than I do about economics/economic issues. I can’t stand when people talk about the economy and actually have no idea what they’re talking about, so I’m not going to say anything. I will keep reading, however.
I wish this site had email notifications or something without commenting…lol
that’s a very good point dave – it’s not that derivative securities and insurance are to blame, it’s that they have been abused. but, alas, hindsight is always 20/20. although having some foresight would have been worth at least $2 trillion…
so, back to phil’s original question, what are your thoughts on the $900 billion stimulus plan? We’ve already concluded how to prevent this same thing from happening again, but what should we do to get ourselves out of this current mess, and should we even do anything at all or let brutal capitalism allow only the strongest to survive during the toughest of times?
I have to admit that even after preaching about capitalism and all its glories, we can’t simply allow capitalism to correct the market. I somewhat contradicted myself because I first wrote that shareholders should decide which banks should or shouldn’t fail, but then suggested in my second post that shareholders weren’t rewarding the banks with moral integrity. After all, these banks weren’t the ones making a ton of money off of complex financial instruments in the early years of the century.
So what should we do now? I want to be clear that if I really knew the answer to this, I would be a more important person. But…I’ll take a stab at it.
First off, I don’t agree 100% with the $900 Billion stimulus plan. We really need to invest a lot of money into the problem areas of our economy, but that’s not only what this stimulus plans for. Today, I read the Republicans’ list of things that are included in the stimulus, but shouldn’t be. The list included earmarks on a lot of things that may constitute “wasteful government spending”. I’m all for including some infrastructure projects like building schools and fixing highways, but some of the earmarks truly seem unnecessary.
However, I do believe we need to spend big money on two things: helping homeowners make payments and buying bad assets from banks.
Appraising the value of a home is unique in the sense that no other asset would be appraised in the same way. The major difference, of course, is that your home value is affected by the homes around you. If I lived with Phil, and he dropped his computer on the floor, MY computer would arguably be worth the same as it was before he dropped his. Quite clearly, the same example doesn’t apply to home values. Our government needs to do everything it can to keep homeowners in their homes.
The main issue with this is that some homeowners may barely be getting by, and then they see a failed neighbor get bailed out by the government. My suggestion to that is to give future tax breaks to those homeowners who don’t need federal assistance. I have no idea if that’s possible, but letting homes lose value is a mistake that would perpetuate to a far worse outcome than any other mistake would.
My other suggestion, buying bad assets from banks, is the one that clearly deviates from capitalism. I need to learn more, but the bottom line is that banks are far more likely to lend without these bad assets on their balance sheets. Money has been lost, regardless of whether those losses are realized or unrealized. Now we need to make sure our credit markets get moving again so those of us who should qualify for a loan can actually get a loan.
There’s no question that as Americans, we all need to clean up our expectations of what we can and should buy. However, our economy has historically grown because Americans have been able to borrow money and turn it into greater value. Banks must invest in us and we must invest in our businesses. Then, once we start recovering from this crisis, our government must show some fiscal responsibility and start making payments on our debt!
Whoa. I am incredibly pumped about what is going on here. This is exactly why I decided to create this blog—to inspire/host respectful and substantive conversations like this one. Nick and Dave, I think you are both making great points on the financial crisis and bailout. The quality of your arguments is making it difficult for me to pinpoint the ones I agree or disagree with… but I guess that’s the point—there’s no simple right or wrong answers. I think you’ve both touched on the idea that there are two conflicting problems here… On the one hand, we have to figure out how to quickly stimulate the economy in order to stop the crisis. But, on the other hand, we have to reform some things to create a more stable and responsible economic model. The solutions to these two problems often conflict, which makes the situation incredibly complicated. I will agree with Elliott and admit that a lot of the detail-oriented stuff you guys have mentioned is somewhat over my head… but I very much appreciate the level of discourse. I’ll have to do a bit of reading before I can comment on the Community Reinvestment Act and defaulted loans…
I will point out, though, that the media coverage of the economic crisis continues to trouble me. There is a huge lack of substance in the way most of this has been covered, and I haven’t seen many news stories that try to educate the reader about how we really got into such a crisis. Most of the bailout/stimulus coverage has focused on the strategy and politics of the situation and practically ignored the substantive aspects of how we are trying to fix things. For instance, stories will focus on how the stimulus bill affects Obama politically, or on which Democrats and Republicans may or may not be working together. But how many news stories have actually mentioned what is in the new stimulus plan, how it will be paid for, and how it may affect the economy—not many!
In fact, I have learned more from listening to Nick and Dave than I have from most of the economic coverage I’ve seen.
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phil, this has been just as informative to me as it has been to you, so i’m grateful you set it up.
regarding your comments about the media…. I don’t think there could be a worse use of such a great tool. News networks have the power to sway public opinion so much, but instead they simply create hysteria and beat one, usually insignificant detail, to death.
for example. with all the bailouts, the cost has always only focused on the initial cost with no regard to the true economic cost of the plan. if news anchors spent 5 minutes thinking about the implication in the economy of each item in the ’09 stimulus plan, they could give a rough estimate of how much it would help the economy beyond just the initial outlay of cash. They could then figure out the total economic cost of the bailout, which is the only figure american taxpayers should be concerned with. In other words, if you had an investment that you were fairly sure would save you $2,000, wouldn’t you pay $1,000 for that today? But this seems reasonable, and the american wouldn’t keep watching the news if they reported sensible information.
Another example is with GM, Ford, and Chrylser. The worst thing in the world is when the average news-watching american suddenly forms an opinion on how to run a multi-billion dollar hugely complex supply-chain-based manufacturing and development organization. We all seem to be voicing our opinions and bossing Detroit around, but what experience do we have running a car company? We demanded that they start producing hybrid cars and plug-in electric vehicles, but we don’t know the first thing about how to make them, how consumers have been buying them, and whether or not these types of vehicles are part of the long-term future or just interim technology. Also, we demanded that they immediately sell the corporate jets. Great, now that the corporate jet market is down 30%, let’s make them sell those assets, rather than hold on to them until the market goes back up. Also, I would rather the CEO’s spend their time being productive, rather than going through security and waiting in incredible lines and delays in airports. If you divide their multi-million dollar salary by the number of hours they work, you would see that you don’t want them sitting in an airport either. But alas, we think we know how to run a business better than they do, so we boss the around and make them sell their jets and build cars that have low profit margins and (right now because of gas prices) almost no demand.
The problem is that cable news is just like an other company – profit based. Haven’t the banks taught us what a unregulated company will do if their only incentives are profits? I think they would create a mass hysteria outbreak that would collapse our country, as long as viewers increased and people would pay more for ad time.