Monday, September 29, 2008


Okay, let me get this straight: Large and established financial institutions have been suffering, some going bankrupt because:
  • They have been lending money, too cheaply
  • to risky borrowers
  • for overpriced purchases
  • that they couldn't afford
  • (like houses priced at 10-20 times their annual earnings).
Got that. And... many of these borrowers are now defaulting on those loans. Of course. This really isn't a surprise.

So, the financial institutions are now losing money on those bad loans. Okay, got that.

So, they'll have less money to freely lend, to risky borrowers, for overpriced purchases, that they can't afford. Individuals and businesses will have to pay a higher rate in the future to borrow money, forcing them to be more cautious in considering the necessity of borrowing money for a purchase, and forcing lenders to be more cautious in determining the ability of the borrower to repay the loan. Okay, got that.

So... um, I'm a bit lost as to why this is a crisis. When did we as a nation move away from the principle that we should buy things that we can afford? Housing prices have risen steeply in large part because borrowing was so cheap, leading borrowers to believe that they could afford to pay such high prices, because everyone else was doing it.

Now, how does this affect the proverbial "Main Street" so bantied about? First off, there is the FDIC (Federal Deposit Insurance Corporation) which insures individual deposits up to $100,000 per account for standard checking, savings, money market and CD accounts.*

Then, there is the SIPC (Securities Investor Protection Corporation), which protects individual investor's securities holdings against the failure of financial institutions, with certain limitations.**

So, a bank or brokerage failing will not likely cause you to lose any money directly. Of course, if you own shares in a company that goes bankrupt, well then, you've just lost some money. But then, the issue is diversification of risk. Or, if you were a borrower with an adjustable rate mortgage for an overpriced house, you may still be at risk of losing that asset. Fortunately, politicians have moved in to redress this issue, and are seeking the facility for borrowers and lenders to renegotiate such loans to keep the borrowers in their homes, and maintain the viability of the mortgage to be repaid.

So, the government is stepping in, to prop up the financial institutions (that have been reckless in lending too cheaply to risky investors for overpriced purchases which in many cases they could ill afford and didn't need), so that consumer confidence in these institutions will be preserved (despite the fact that our confidence is shaken because of their own recklessness), and so that they can go on lending money "affordably" so that business (like Boston Market and Starbucks) can borrow for growth and expansion, and keep the economy rolling along.

Somehow, I'm just not convinced that a slowdown is not what is needed (or, in fact, that such an artificial propping up of a failed sector in the economy will actually prevent it). In Wall St. terminology, we'd call it a "correction." And, if we're all in it together, we'll all pull through it just fine. We always do. That's one great thing about America that has not yet been destroyed by eight years of failed policies. We're industrious folk. Let the big, old institutions fall of their own making. Smaller, lither companies will grow from the rubble. New ideas will emerge that will pick up the slack.

It's amazing to me that those most vociferous in their supposed support for "free market" economics seem so quickly to run away from it when their most cherished institutions begin to falter. I say, let them falter. We'll be okay.

*What Is Insured? You are probably familiar with the traditional types of bank accounts - checking, savings, trust, certificates of deposit (CDs), and IRA retirement accounts - that are insured by the FDIC. Banks also may offer what is called a money market deposit account, which earns interest at a rate set by the bank and usually limits the customer to a certain number of transactions within a stated time period. All of these types of accounts generally are insured by the FDIC up to the legal limit of $100,000 and sometimes even more for special kinds of accounts or ownership categories. For more information on deposit insurance see FDIC brochure "Your Insured Deposits."

**Investments protected by SIPC. The cash and securities – such as stocks and bonds – held by a customer at a financially troubled brokerage firm are protected by SIPC. Among the investments that are ineligible for SIPC protection are commodity futures contracts and currency, as well investment contracts (such as limited partnerships) that are not registered with the U.S. Securities and Exchange Commission under the Securities Act of 1933.


Anonymous said...

There's also the issue that if businesses can't borrow money, then they can't pay their bills, then they need to reduce costs, and labor is usually the first thing to go. So, you are right, a downturn is what is needed to "correct" the market, but as the market is correcting, it will mean hard times for many US workers who will be laid off as the business figures out how to operate in the "new", more conservative, economy.

ArticulateDad said...

Well, I've got a little bit of experience as a small business. In fact, I've worked almost entirely for myself or under contract for most of my life.

When I had a landscaping business in the early 1990s (that paid for my undergraduate studies), it started with a $60 used lawnmower in the back of a 1982 Honda Prelude, and ended (when I went to graduate school) with 6 part-time employees, a brand new Ford F-150, and some $10k worth of gardening equipment and supplies. I took the truck under lease, and bought a $3500 walk-behind mower with credit, that was paid off in under a year. Otherwise, I spent the money I had already made.

The point is: businesses should not routinely need to borrow money to make payroll or pay their bills. Now, there are some needs, like building inventory for a retail business, which require a large outlay of cash, which a small business often lacks. But, if they have a proven track record, they ought to either qualify for a loan (here is a place where government intervention makes sense) or credit from their suppliers. Tightening of access in this arena makes it harder to start or run a small business, but not impossible. Frankly, too many businesses fail in the first two years anyhow. Maybe this would simply cull out the weakest before they start.

But the bailout of lenders by buying up bad debts from the past (rather than simply insuring future access to credit) doesn't make any sense. If the government really has $700 billion to spend, that'd make a handsome reserve for providing credit to small businesses. Think about it. This far FAR exceeds government set asides, grants and contracts for small businesses. If that's really the motivation behind present actions, then why not attack that issue head-on. It'd be like direct student loans. They just simply make sense. They bypass costly and ineffective handouts to intermediaries, and they have strong potential to actually make the government money while doing a good service to society.

Why prop up confidence in the irresponsible folks who got us into this mess in the first place? Are they really worthy of our trust that they'll suddenly have sense about how to properly manage loans? I don't think so. It's time for some fresh ideas, and some new blood. It's time for change.

And one of the first places to change, is the assumption that a healthy economy is based on consumer spending. It's simplistic, and wrong. Spending does not create wealth. Wealth is created by innovation and production. Why is Wal-Mart the largest retailer in the world? Because society has valued consumer spending, and we've put a priority on price, regardless of the impact on quality (or quality of life).