Friday, January 15, 2010

The Financial Crisis: More than One to Blame.

The Crisis Commission started its yearlong investigation on what caused the financial collapse in the fall of 2008 and major Bank CEO’s were the first to sit in the hot seat. Members of the commission quizzed these men vigorously for several hours on the issue of leveraged grouped mortgage securities and insurance on those grouped debts. However; it seemed the commission focused little on how the crises happened and more about taxpayer vengeance on these banks. The attention on bank bonuses proved the commission is a political stunt to demonstrate to citizens of the United States action is be being taken against TARP recipients. Politicians have incentives to act in ways that are not conductive to the financial health of the country, can America find a singular cause to the crash, or do the leaders of the country need a scapegoat?

The answer is there is no one entity that caused the crash. I state that opinion not because I have a conservative agenda or enjoy the merits of unhindered capitalism but because a market as diverse as the United States’, does not fall from bad banks, evil government, or uneducated homebuyers. It took all three. In addition, we (US citizens) are not collectively responsible for what happened in 2008 and early 2009. Many were responsible with finances and refused to buy into the Adjustable Rate Mortgages (ARMS) and finance a high luxury lifestyle on borrowed money. The problem the economy has now is what role should the government take in the recovering economy?

There are many suggested answers what the government should do; conservatives want federal money rolled back, liberals want banks to pay for the crisis, the Federal Reserve wants to protect home prices, and people want more jobs. The common belief among all of these groups is the federal government can solve the many economic issues in the United States. In reality, the federal government has very little ability to handle these issues, for several reasons.

First, the federal government cannot remove the financial aid it has given over the last year. The reason is the elected officials (including conservatives) will lose in the fall elections if they cut any programs. Incentives for government officials to spend are higher than the incentive to do the correct economic action of slowly removing aid and focusing on its job of regulation. Second, adding new taxes targeting big banks will not raise money to stem government debt. The finger pointing by the White House and congress is a political stunt to try to appease angry citizens due to bank bonuses. The problem with this approach is the reason banks have the money to pay the big bonuses is directly related to the government allowing banks to barrow money for free from the treasury and then investing that money in foreign currencies.

Which brings us to a third reason the government cannot help the economy. The Federal Reserve is keeping rates at near 0% supposedly protects home prices and job creation. However, it is hard for small banks and businesses to make any money at a 0% policy, hurts responsible savers, and fixed income citizens. Big banks are making big money off 0% but the small businesses, which create most of the jobs, are having a hard time with their investments and cannot hire new employees. Lastly, people that want jobs cannot look to Washington for help because Washington cannot create 10 million jobs itself.
There is a silenced majority, of financially responsible citizens in the United States, frustrated by federal government policies. The source of this frustration stems from the fact these citizens did not barrow more then they could afford, saved their money when houses were expensive, and built balanced portfolios that survived the crash. As home prices fell, these people started to buy the now affordable houses but then the federal government dropped interest rates so low, it has held up home prices. In addition, because rates are zero, the responsible savers are no longer making money on saved assets. The question they ask is why irresponsible barrowers getting mortgage breaks for making loans they could not afford?

The government has pinned its hopes for economic success on the citizens that have spent all their borrowed money in the past. The reasons for this decision are many but are based on political calculation rather than economic success. Low rates mean three things. First, the market never fully corrected and new asset bubbles are forming quickly. Second, savers that would have become buyers, creating economic growth and new jobs, are sitting on the sidelines trying to survive in a market dominated by 0% rates. Lastly, the people at the bottom will now suffer longer because of lack of jobs, expensive homes, and rising government costs. More of the middle, will start to slip into the bottom and the gap between super rich, and the rest of us, will continue to grow. Can we point at finger at banks to make all our problems go away? No, there are far more people to blame.