A chronological re-ordering of the events and arguments of THE BUBBLE
PART 1: THE CAUSES
The Federal Reserve and Interest Rates
- Low interest rates from the Federal Reserve enticed people to borrow savings that did not exist. Both the government and the artificially lowered interest rate diverted resources into housing, creating a bubble that would inevitably burst.
- Increased home prices encouraged home owners to borrow money based on their real estate price and accumulate more debt.
- When the market responded by forcing interest rates back up, these bubble projects failed. People realized they could not afford this lifestyle.
- Fannie Mae and Freddie Mac were Government Sponsored Enterprises that subsidize and guarantee home mortgages. Their liabilities were implicitly guaranteed by the government, who nationalized them in September of 2008.
- Banks frequently underwrote bad mortgages and sold them on secondary markets created by Fannie Mae and Freddie Mac.
- Commercial bank deposits are guaranteed by the FDIC, a highly leveraged government program that allows banks to take more risks.
- The Greenspan Put was the widespread belief in the market that Alan Greenspan would intervene to bail out the financial sector whenever threatened. This was based on his reaction to the Savings & Loan Crisis, the bailout of the Mexican Peso in the 90’s, the bailout of LTCM, the liquidity approaching Y2k, and his actions forcing the interest rate down to 1% for a full year after September 11th. This was later replaced with the even larger Bernanke Put.
Government Home Ownership Policies
- The mortgage income tax deduction artificially stimulated the real estate market and led to larger home purchases.
- The Basel regulations allowed banks to be more leveraged if they held mortgage loans and even more leveraged if they held mortgage backed securities.
- Presidents Clinton, Bush, and Obama have all attempted to decrease the down payment needed to buy homes.
- Includes both subprime loans (low credit score) and alt-a loans. (low down payment, adjustable rate, no doc)
- By 2008, half of all mortgages were nontraditional mortgages.
- Fannie Mae and Freddie Mac owned more nontraditional mortgages than the entire private sector.
- The Department of Housing & urban Development required Fannie and Freddie to allocate 50% of mortgages to individuals that were at or below the median income in their communities.
- The Community Reinvestment Act required mortgage lenders to fulfill a quota for low and moderate income home buyers in certain communities. Although it was expanded in the 1990’s, the role in the housing bubble was minor.
PART 2: PAST CRISES
Panic of 1920
- The Depression of 1920 was worse than the first year of the Great Depression. Production fell 21%, GDP dropped 24% and unemployment went from 4% to 11.7%.
- The Federal Government cut spending in half from 1920 to 1922 and did not enact a stimulus policy.
- The Depression ended in the summer of 1921 and unemployment dropped to 6.7% in 1922 and 2.4% in 1923.
The Great Depression
- Nominal GDP was down 46% during the Great Depression.
- Both Herbert Hoover and Franklin Delano Roosevelt increased government spending while implementing wage and price controls, along with tariffs.
- The Great Depression lasted a decade and the economy did not recover until World War II was over.
Inflation In The 1970s
- America rapidly increased the money supply and abandoned the gold standard in 1971.
- The economy suffered a downturn and prices increased dramatically. The cost of oil alone went from $3 to $30 a barrel.
- To fight inflation, Federal Reserve chairman Paul Volcker allowed interest rates to rise, by slowing down money creation. This lowered price inflation from 13.5% at its peak to 3.2% in 1983.
- The high unemployment and high inflation of the 1970s was predicted by the Austrians, while the Keynesian school of economics believed that combination to be impossible.
PART 3: Response To The Current Crisis
Interest Rate Cuts
- The Federal Reserve has consistently lowered interest rates throughout the crisis.
- They have now pushed interest rates down to zero.
- Bear Stearns creditors were bailed out on March 14th, 2008, despite their investment bank being leveraged 35.5:1.
- Fannie Mae and Freddie Mac were taken over by the government in September of 2008. This confirmed that their debt was guaranteed by the government. Treasury Secretary Paulson claimed in July 2008 that the companies were adequately capitalized despite only having $83 billion for $5 trillion in obligations.
- Although Lehman Brothers was allowed to fail, the rest of the financial sector was bailed out by the Federal Reserve, the Treasury department, and Congress.
- When Congress did not bail out the auto companies, President Bush did.
- In February of 2008, following uncertainty in the Subprime mortgage market, George W. Bush signed a stimulus bill for over $152 billion dollars, attempting to get people to spend again.
- To support the housing market, George W. Bush signed the economic recovery act of 2008 which added $800 billion to the national debt.
- Following the bankruptcy of Washington Mutual and the bailout of AIG, George W. Bush signed the Trouble Asset Recovery Program which authorized the Treasury to buy up to $700 billion in bad assets.
- Due to the slow moving economy, newly elected President Obama continued George W. Bush’s spending spree by signing a $862 billion dollar stimulus bill.
PART 4: What America is Facing
- Student loan debt’s version of Fannie Mae is called Sallie Mae.
- Student loans have spiked over a trillion dollars, more than all the car loans in the country combined.
- Graduates are finding they cannot pay back their loans with or without a job.
Coming Price Inflation
- Prices will dramatically rise due to the money created in response to the housing crash.
- Increased prices will lower the standard of living in the country.
- The devalued dollar resulting from inflation will wipe out savings for millions of Americans, particularly in the lower and middle classes.
National Debt Bubble
- The national debt approaching $16 trillion dollars is not sustainable.
- Foreign countries will stop buying Treasury bonds and interest rates will rise.
- Rising interest rates and deficits as far as the eye can see will lead to interest payments consuming the entire budget.
- America will be forced to cut spending.
Unfunded Liabilities Bubble
- The unfunded liabilities from Social Security and Medicare are as high as $119 Trillion Dollars.
- With the already high national debt, the federal government cannot absorb these added costs.
- Both Social Security and Medicare will be forced into bankruptcy. Defense will have to be cut.