“Behold, the LORD maketh the earth empty, and maketh it waste, and turneth it upside down, and scattereth abroad the inhabitants thereof. And it shall be, as with the people, so with the priest; as with the servant, so with his master; as with the maid, so with her mistress; as with the buyer, so with the seller; as with the lender, so with the borrower; as with the taker of usury, so with the giver of usury to him.” Isa 24:1-2
This is how the BC Jews tried to reason their way through hard times. They ultimately figured that they must have done something to make God mad at them. They looked for scape goats, but ultimately realized that it was likely that they were all to blame because they were all interconnected.
We find ourselves in a similar situation today with our economy.
What happened as best anyone can figure is that financial institutions lost confidence in the financial system as the value of mortgage-backed securities was questioned.
I’ve already posted some things on why mortgage-backed securities failed, but here’s the best summary I can come up with. It was a huge pool of global cash chasing the percieved safety of the American mortgage market. Irresistible demand combined with a philosophy of deregulation resulted in a supply of increasingly risky loans that were passed off as high quality investments.
The important question is what we do to move forward. In order to talk about the solution, we first have to dig a little deeper into the problem.
We are no longer an independent economy. Our economy is intimately linked to every other world economy through a shared global financial system of interdependent hierarchical lending institutions. All of these institutions to one degree or another hold mortgage-backed assets. When the value of those assets began to erode, the most highly leveraged and least regulated of those institutions, the investment banks, quickly collapsed because they didn’t have other assets to cover the loses they were experiencing in their mortgage portfolio.
By this time every financial institution that held mortgages in one form or another began internal audits to determine what those assets were really worth. As they discovered the extent to which they had been overstating their net worth, they realized that they were overextended. They also realized that if they had to, they probably could not raise enough cash from selling those assets to pay off all of their outstanding loans. Their natural reaction was to retain more cash to make up for the loss in their asset value. The way they did this is was as their outstanding loans were repaid, they initiated fewer new loans. The way they did that is tightened up their new loan requirements which resulted in fewer qualified loans. One of the loans that quickly fell out of favor were those to other banks. That’s because every bank assumed that every other bank shared the same problem they did.
It quickly got to the point where all banks were holding on to virtually all of their funds. This is not a viable long-term position because banks depend on loans for their income. It is an entirely understandable short-term position, however, because the survival instinct is much stronger than the profit motive.
And so the problem.
Unlike in days past when we could barter for goods and services, our economy runs on the principle of deliver today and I’ll pay you tomorrow. In other words, borrowing against future earnings. So the reason why the plumber can leave you a bill rather than insist on a cash payment is because he is able to take that bill to the bank who, for a small fee, will loan him $ .80 for every the dollar of your bill. The bank is willing to do that because the plumber can show a history that you and your neighbors do all pay your bills. The plumber can then pay his bills even though you might take a month to pay yours.
So when the banks stopped lending because they didn’t have enough value in their pool of assets to support their outstanding portfolio of loans, the plumber could no longer leave a bill and started asking for cash. The builder had to shut down his project because he couldn’t get the loan against the future value of that project which would allow him to pay the plumber in cash. The truck dealership had to cancel the sale of a new truck to the builder because the builder couldn’t get the bank to finance the purchase and didn’t have the cash to buy the truck. The truck manufacturer had to close a plant because they weren’t selling enough trucks. The factory worker couldn’t get his faucet fixed because he didn’t have the cash to pay the plumber.
Basically you get the idea. Legal commerce pretty much grinds to a halt and the only people who have cash are drug dealers and illegal immigrants, and only because they don’t use the banking system.
The next interesting thing that happened is that the US Treasury proposed a vague $700B bailout plan where the US would buy assets from banks, only to see the British trump it with a direct investment of government funds into their banks. The rest of the world had to follow suit because if they didn’t, money would quickly move into British banks and out of the banks of the countries who didn’t provide similar guarantees to their banks.
So what is happening now is that each of the major industrial nations is guaranteeing that their banks now have sufficient cash to cover any loses they may experience from the mortgages they hold as assets. The hope is that this will prove sufficient to cause banks to loosen their lending rules and begin to put some of their money at risk again in the market.
Next post will speculate on what this means for the future.
In the meantime for those so inclinded, here’s little bit of scripture to think about in scary times.
“Fear not, little flock; for it is your Father’s good pleasure to give you the kingdom.” Luke 12:32
this comment is meant for a different post, but i was unable to comment on that one.
you wrote:
“So when you begin to unravel this conservative fantasy, it leaves a lot exposed. The conservative/libertarian ethos is that an individual should be completely accountable for their own actions. They are solely responsible for their own success or failure. So by extension, if government just left everyone alone, defended the borders, and kept the peace – the marketplace would sort everything else out by rewarding the just and punishing the unjust.
What this crisis (and really the last eight years) has proven is that this philosophy no longer works in a globally connected economy. We are interconnected and co-dependent. Our attempt to go it alone, in one great last grasp for conservative greatness, has left us battered and weak. ”
It amazes me how many people believe that we have operated under a libertarian/free-market/capitalist system for the last 8 years because that’s what Bush says. these same people are usually correct to call Bush for his lies, but when it comes to this claim, he is taken for his word. ridiculous.
since 1913 this country has operated under a central bank. that and the income tax are two planks of the communist manifesto. our government has overreached its constitutional bounds by remarkable lengths. this economic crisis is a direct result of government intervention: the antithesis of the libertarian, laissez faire philosophy. we don’t have a free market. and because people fail to recognize our system for what it really is, we are going to be taken further in the wrong direction. we are headed down a dangerous path of socialism which, at its heart, is essentially totalitarianism.
furthermore, i just read a superb article about a similar topic and i though you might find it of interest:
http://www.lewrockwell.com/orig9/dilsaver1.html
JL,
Interesting link. Not sure that I agree with all that is contained there, but I certainly agree that those who oppose abortion have been cynically manipulated for the past couple of decades.
I am not a libertarian, but I do appreciate the intellectual purity of the idea.
Jeff