EPTWhile I welcome that sort of discussion, I would greatly appreciate if you first checked the paper for any mechanical errors (I'm not entirely sure of my usage of colons, semi-colons, and hyphens. I think there may be a couple places that I screwed those up), and any sentences that come across as unclear.
It's a little over five pages long in word at 12 pt print in TNR. Thanks to anyone who does this for me, the help I've gotten here in the past has been extremely useful.
And if anyone knows how to put in superscripts in Word 2000, could you tell me how to do it? I want to have a definitions page for certain terms, but I don't know how to go high enough in numbers (I think I have like 6 terms). I want them all at the end of the paper, by the way, I don't know if that will make a difference.
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In autumn of 2008, the American financial system witnessed what is probably the greatest financial crisis since the Great Depression. The meltdown came into public view with the subprime mortgage crisis, which began with the collapse of Bear Sterns—a heavy investor in the subprime market. The crisis really set its roots before then—before President Bush even came into office; the problem began when the tech bubble burst in the late 1990’s. This caused the Fed to sharply drop interest rates, which increased the demand for homes; with that increase in demand, more and more risky investments: the quality of mortgages dropped drastically (NYTimes). It was on September 18, 2008 when Treasury Secretary Henry Paulson released “a three-page, $700 billion proposal that would allow the government to buy toxic assets from the nation’s biggest banks, a move aimed at shoring up balance sheets and restoring confidence within the financial system” (NYTimes). The proposal generated a greater public interest, the nation wanted to know why the they had to “bailout” the “greedy Wall Street fat-cats.” Rather than just throwing blame around, and complaining about the white-collar worker getting bailed out, and the blue-collared worker getting no help, let us assess the situation. What caused all of this? And why is it so important that the banks get immediate assistance?
The growth in the housing sector was largely responsible for the problems the U.S. economy faces today. Three main factors can be attributed to the rise in housing costs. The first was future price expectancy. A change in current prices affects the expectancy of future prices; in this case, the rapidly rising housing prices, coupled with the historical trends of housing (i.e. housing prices never fell too drastically) led people to falsely believe that housing prices would continue to rise, and that investing in a house was a very safe form of investment. The second was an increase in household income. From 1995-2000, household income per capita rose considerably, which increased demand for homes; the increased housing prices, however, rose faster than household income (Origins 11). The impact of increased income is a rather obvious one. When people make more money, they spend more money. Spending money did not create the problem; housing prices increasing faster than income growth created the problem: “People were stretching to buy houses” (Origins 11). The third factor was the decline in nominal interest rates, which began to fall in the early to mid-80s. Similar happenings throughout developed nations tend to agree with the idea that “the decline in mortgage interest rates was a key factor in triggering the run up of housing prices” (Origins 11). Lower interest rates make loans easier to attain. Easily attained loans are good when the people attaining the loans are able to pay the loans. The low interest rates made it easier for people who could not attain a loan at a higher interest rate to attain loans for homes, which created riskier loans.
Had interest rates not gone up, and the housing market not seen a decline, people with risky loans probably would have been okay, and those that defaulted probably would not have hurt the banking system quite as much, as the bank could have turned a profit on the sale of those homes. Interest rates did rise, causing people to default on their mortgages; and the housing market did decline, making it nearly impossible for banks to rid themselves of the homes they now owned. These riskier loans are known as “non-prime loans”, which includes subprime, Alt-A and home equity lending. From 2001 to 2003, 85 percent of loans were to prime borrowers; by 2004, however, that percentage fell to 64, and by 2006 only 52 percent of borrowers were considered “prime” borrowers (Origins 14). The problem with those statistics is rather obvious, and it is quite curious that bankers approved such risky loans at such a staggering rate. Mortgage creators often quickly sold their mortgages to another bank, which created a lack of incentive to ensure the loan would be paid: “The banks buying the mortgages failed to check what they were buying” (Credit 3).
The decline in lending standards can most certainly be blamed for many of the problems in the housing sector. Still, some people blame the Fed for keeping interest rates too low for too long, or they blame foreign investors for “flooding the U.S. market with liquidity seeking high returns.” While that did play a role in what happened, an “aggressive tightening of monetary policy” would have increased the risk of significantly slower economy-wide development. And taking away the funds from foreign investors would have solved the problem, but “given the integration of U.S. companies with the rest of the world, it would be infeasible.” The decline in mortgage-lending standards could and should have been stopped. Appropriate incentives must be created within the current lending model, or a “better and more integrated force of regulators” must be created to “compensate for the misaligned incentives (Credit 4). The system needs to be changed; the nation cannot continue to operate in the same manner and expect that its problems will be solved. Change will make things harder for some people, but it is necessary to the economic prosperity of the nation as a whole to no longer undertake such risky behavior. Truly, people must live within their means, and stop taking out loans that they either have no intention of ever paying, or are simply incapable of paying.
All of the behavior above was a recipe for disaster, but the banks compounded the possible problems by creating non-transparent derivatives on mortgage-backed securities (Credit 5). Derivatives are bets made on a wide variety of things, using mostly borrowed money. Derivatives are high risk, and carry a very large monetary value; the US commercial banks alone had 182.1 trillion dollars worth of derivatives, and the global total was 596 trillion dollars. The way banks handle derivatives is similar to someone gambling on a roulette table that puts some money on both black and red, so that they never lose a lot of what they bet, but they never win a lot either. There is a major difference between the two, though; banks were not betting against the house the way one would at a roulette table, they were essentially betting against the equivalent of the other players at the table (Citigroup). That actually works very well, if everyone pays when they lose, but when a player does not pay their bets, a domino effect occurs. The failure to pay by one bank carried the possibility of destroying the entire system, which is exactly what happened when Lehman Brothers failed.
At this point it is nearly unimaginable that banks would make even bigger mistakes than what had been made, but they did. Banks were betting with far more money than they ever had; the 596 trillion dollars worth of derivatives were ten times the GDP of the entire planet. Secondly, there was no oversight on the derivative market. Banks were making bets with other banks without knowing how stable they were. Why banks were allowed to engage in such risky behavior is mind-boggling, and the fact that they did engage in such risky behavior is enough to make someone think, “let them fail.”
As with almost every other situation in life, things are not as simple as they seem. Banks perform some of the most vital operations of our economy. On the most basic levels, banks give loans to people to buy a home, or a car, or whatever it is an individual needs a loan for. On a larger scale, banks provide loans to start businesses, and to fund growth in already established businesses. Generally speaking, smaller commercial banks make these loans, and if that’s all it took was small banks to make loans, then the collapse of larger investment banks probably would not carry such a large impact, but that’s not how the banking system works. Banks almost never actually have the cash to make loans, so they borrow from other, larger banks. And those banks borrow from even larger banks, and so on until the largest banks. Then the rights to those loans get sold to other investors (foreign or domestic), and so on. The process is incredibly long, and complicated, and would take an entirely separate paper to describe. The point is, if banks do not make loans to each other, then we begin to face the problems we currently face; because banks do not only stop lending between themselves, they also stop lending to businesses. When businesses can no longer receive loans, they begin to cut jobs. When people lose their jobs they cannot spend as much money, which affects other areas of the economy, and eventually creates even more job losses.. If the lack of liquidity lasts long enough, it causes a recession, and recessions are generally painful things to go through. So the so-called “bailout” was vital to the banking industry because the banking industry creates opportunities for other industries to flourish.
None of that is to say that the “bailout” should not be questioned. Certainly taxpayers have a right to know how their money is being spent, and studies have shown that politics has already played a very large role in the voting process for the proposed bailouts (Fisman). The people should question everything done by the government to be sure that the action taken is in the best interest of the public, and people should take no exception with this “bailout,” but the fundamental motivation of the “bailout” need not be second-guessed. Whether or not the 700 billion gets applied in the proper way is something that needs to be scrutinized, because if it gets applied improperly, no good will come of it.
Making sure banks are properly funded, and functioning is not giving to the rich to make the poor poorer. Adding funds to banks helps to ensure that a vital function in our economy stays functioning, because without them, the whole system faces collapse. This is not a case of making sure the “greedy Wall Street fat-cats” keep their pockets lined with money.
