Wednesday, October 8, 2008

Financial Crisis

Below is the most succinct capture of what's wrong & why:
(I will say that I didn't write it, but I may actually stay OUT of trouble if I don't note the author...)

[regarding the current economic crisis:]
Almost all of these problems (and much of the current chaos) are, at their root, the result of political failure.

Our government attempted to stimulate more home ownership than the market would have created on its own. It is our own government that encouraged the over-development of homes, particularly homes for first-time buyers financed with subprime mortgages.
The government created this crisis by lowering the cost of funds to banks to such a low level that lenders (and borrowers) were encouraged to build, even when many borrowers could not afford the monthly payment.

To make matters worse, other borrowers began building with the intent to resell. They believed home values would only go up, allowing them to make a quick profit. This caused housing prices to rise to unsustainable levels in many parts of the country. But when the market became glutted with much more construction than it needed (or that homeowners could afford), we ended up with poor quality mortgages and excess homes throughout the country.
The government kept this false economy moving for a number of years through its indirect support and regulation of Fannie Mae and Freddie Mac, which purchased many of those "toxic" mortgages.

Taxpayers are now on the hook for at least $200 billion which may or may not be recoverable in the future, and the dominoes are still falling. Add in the $150 billion economic stimulus package that ended this summer and proposals such as the $700 billion bailout, and the cost of this failure could exceed one trillion dollars! That’s close to 7 percent of our nation’s economy.
The real cost of this failure is that billions of dollars of capital were funneled into housing instead of more productive assets.

As investors grew cautious of the deterioration in asset quality, three large financial institutions, Bear Stearns, Lehman Brothers and AIG, failed. Three others, Merrill Lynch, Washington Mutual and Wachovia, are being merged out of existence with other more solvent institutions. These failures have caused fear and panic in the financial system.
Capital has literally stopped flowing between savers and borrowers, and even between banks. Credit is largely based on trust, and this trust has been severely compromised. Without equity and debt capital flowing to entrepreneurs and credit-worthy companies or consumers, the economy could slow dramatically.

We have watched the financial markets closely for several months. Without hesitation, I can confirm that the system really has seized up. Reports of this are not exaggerated. Given this crisis, the government is stepping in to support the system in hopes that capital will start flowing again, giving entrepreneurs the capital to invest and allowing loans to be made to support them.
A market economy functions best when governments do not attempt to influence outcomes with a political agenda. It is regrettable that our government is stepping in again to do just that. These bailouts, buyouts and “supports” are poor policy that will cause more long-term harm than good. Why? Because each government intervention leads to new problems, prompting calls for even more government intervention.

Very soon, we will be faced with higher taxes to pay for any bailout, even more regulation and a weaker currency. The value of the dollar will be driven down by our ever-increasing debt. Interest rates will rise, too, making it all the more difficult to be competitive in a world economy.
In the short run, government intervention might help restart these markets, but whether it will or not simply isn't clear because we have rarely faced market disruptions this severe.
In the long run, however, these steps are likely to cost us far more than any benefits we might gain in the short run. If we learn anything from crises such as this, it should be that government intervention - no matter how well-intended - tends to cause more harm than good.
This crisis also underscores the importance of personal responsibility, including living within our means. What we are witnessing is not a failure of markets, but a failure of certain individuals, corporations and our own government. Many core principles - especially Integrity and Humility - have been alarmingly absent.

[We do] not support government interference in the market; however, the fact that our monetary system is a government system is undeniable. Thus, the government determines the health of the financial system. Consequently, some form of action to restore confidence in financial markets is necessary, but only so long as the government does not continue overreaching, attaching political and policy agendas to its actions, and picking the winners and losers. The proposed bailout package that was voted down by the U.S. House of Representatives on Monday violated all of these tenets.

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