One week ago, I didn’t fully understand or even care about the $700 billion bailouts Congress was debating. So, when approached for a story about The Levan Center for the Humanities sponsoring a discussion on these bailouts and in 15 minutes I was to cover it, my appeal was mute.
Politics have only remotely interested me, and pressing world topics fell short of my far more important personal drama. And here I was, to report a boring political news story to people who, just like me, didn’t care.
After walking out of the Collins Conference Room that day I felt like I could be, quite possibly, the most ignorant person on the planet. How could so many things within our economy have gone on without me knowing about them?
One week ago, I had an epiphany. I realized I actually should care about whether or not Congress decides to, oh so generously, donate money to these businesses who ventured up the creek then lost their paddles.
If you’re familiar with the topic, the question became should we throw big business a line and tow them out of their own negligent financial responsibilities?
So how did these businesses get themselves in such a pickle that they should need that much money to bail them out? Should we care about this and just how does it affect us? I will explain my newfound knowledge, but not from a seemingly complicated economist’s perspective but from average Joe(ann)’s point of view. Then you can decide for yourself whether you are happy with Congress’s decision to pass this bailout or not.
Economist Michael Harvath explained that when one saves money in the bank, it is getting spent. Not by the saver, but by the banks who lend money out to people who need loans. This is called fractional reserve banking. So if everyone wants their money at the same time and the banks could not possibly pay it all back at once, they are forced to close. Beginning in about 1996, America’s housing market began to rise. The housing market became a bubble, and property values continued to rise over the next seven or eight years.
Banks then began to loan out more money to sub-prime loans (borrowers who are more at risk than regular borrowers). These loans are typically given out to the people who had bad credit in the first place. Harvath explained that of a $12,000 mortgage market, 7 percent are sub-prime loans and 43 percent of these loans default.
Fannie May and Freddie Mac were the government-created businesses that were to help create a securities market for these mortgages. They would buy the loans from the banks, sell them to someone else and typically do it without the warning of the chance of a default.
So, because this vicious cycle kept spinning, insurance product companies made it possible to buy credit default swaps, insurance policies for this default risk. The market for these insurance policies became huge, a $55 trillion market to be exact. But due to a lack of government oversight, companies such as AIG were not able to cover all the loans defaulting.
Harvath explained this situation metaphorically. “Imagine that 80 percent of Rembrandt’s paintings are fake. People would not want to buy because they would be fearful of getting stuck with a forgery. You can’t trust the people who said they were originals, because they’re fake. You don’t really know the worth, and people get scared and no longer want to buy.”
As you may or may not know, our government decided against being a complete free market and letting these businesses crash and burn. They decided to buy the bad paper and run these institutions, hopefully with more regulation and new people.
While you may agree, or disagree, economist Stephen Smith said that this was a good idea for two reasons. One is to establish trust and the other is to stop panic.
Let’s hope this new decision actually has more regulation and that once the businesses get back on their feet, our senators and congressmen learned their lesson and won’t accept payoffs for a free reign again.