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Why is it so Hard to Fix an Economy

By Paul Sullivan,
Georgetown University

When your car or motorbike has problems you take it to the mechanic or the car dealership to have it fixed. In a few hours the car comes back fixed and you drive away.
When an economy is damaged like the U.S. economy was in 2007-2008 it takes a long time to figure out what is broken or on the way to being broken, and what to do about all of these problems.
The short and bitter story of the breaking of the American economy is one of blind greed, ignorance, and poor management smashing the lives of millions.
The blind greed was from many quarters. The people involved included those who bought houses they really should not have bought and took on mortgages that they really could not have paid. Many regular people bought many houses to ride the upward swing in housing prices. There surely was an upward swing on housing prices. Prices were going up faster than at any other time in the history of the country. Many people made piles of money. Millions were tossed into bankruptcy. A lot of people were buying homes from mortgage brokers and others who did not request full disclosure of their income, other assets, or even their credit ratings. The mortgage brokers and many banks, but not all, were all part of the schemes to make a lot of money quickly on the housing boom.
Much of the money for the massive loans needed to pump up the housing sector came from the shadow banking sector. Normal banks are regulated in how much risk they can take and how much reserves and capital they need as backup for bad times. Regular banks cannot have too many risky loans being held by law. Shadow banks are not so regulated.
How was this massive amount of money produced to create and drive the housing boom that was a major cause of the gigantic bust in the economy? There were many routes. Some regular banks wanted to get their risky and even other loans off their books. They sold them to middle men and others. These and other loans were sliced and diced into securitized instruments. The real risks of the packaged loan groups were often lost in the securitizations. So there were bad loans in with good to great loans, yet the whole package was sold as a good to great loan security on Wall Street and elsewhere. The shadow banks that bought the loans, packaged them and then sold the packages were making buckets of money every day on this.
The shadow banks also developed derivatives on the loan packages. These were essentially bets that the loans would do well or poorly. You buy short if you think they will do poorly, for example. Either way, if you bought the right derivative at the right time you got richer. Insurance on the derivatives and the sliced and diced mortgage backed securities were also sold. The shadow banks got rich by selling these financial instruments. Everyone seemed happy and getting better off. More and more people, many without the incomes to support their mortgages, got into homes. Wall Street and the shadow banks were getting rich beyond all reasons. And these events should have been the tip offs that something real bad was about to happen.
Many turned away from these risks, or scoffed at those who pointed them out, because, to quote a famous former head of a gigantic shadow bank, they “were making too much money”. Greed can blind. The economic crisis in America was born from greed.
At the heights of the buying and selling of these financial instruments there were literally tens of trillions of dollars moving about the world built on the values of houses in the U.S. alone. One of the main problems was that the U.S. regulators did not have a handle on what might happen. Many in the shadow banks really did not understand what they were buying and selling. Many new home owners did not have a clue what was about to happen. (Similar things were happening in Ireland, Spain, the U.K, and many other countries that wanted to be part of the housing boom. China may be falling into a similar situation soon with its housing market weakness and its growing shadow banking system.)
In the U.S. it all went tumbling down. The bubble burst. The Ph.Ds. on Wall Street and elsewhere with their super complex financial computer models lost touch with what was going on. These financial computer models were understood by very few people, including some of the very people in government and in the big shadow banks who should have known what massive risks they were taking. These computer models also seemed to not be set up to deal with such huge losses so quickly.
Millions lost their jobs. Millions have given up looking for jobs. Families have been ruined. Lives have been put on hold. Trillions disappeared in what seemed a blink of an eye. Major banks collapsed. Stock markets tumbled.
The debt of the US grew as the government tried to bail out the banks, cut some taxes and otherwise tried get the economy moving. The debt also grew due to the loss of tax and other revenues because people were unemployed; companies were in collapse, and many other economic weaknesses. The Federal Reserve Bank shoved their target interest rates as low as possible to try to push money into the system and unfreeze the credit markets.
The government trying to fix an economy from tax changes and government spending chances is fiscal policy. This is done mostly by the Congress and The White House. The Federal Reserve Bank trying to change the interest rates via changing the money supply in the economy is monetary policy. The Federal Reserve Bank is supposed to be independent of The White House and Congress.
Both fiscal and monetary policies are now constrained due to the earlier moves of the U.S. and other governments. Attempts at Quantitative Easing, QE, seem to lightly repair the scratches. QE is when the Federal Reserve Bank can no longer use targeting interest rates to get the economy moving, but targets the purchase of certain assets. In this case the Bank is buying mortgage backed securities to reduce mortgage rates. We will have to see how QE3 works.
Government spending and tax cuts seemed to have slowed down the job losses compared to what might have been without such more, and may have repaired a few of the innards of the economy. However, may people and businesses seem to be still afraid of what the economy might do next. U.S. businesses are sitting on $1 trillion or more in cash and not investing it or hiring people. The government seems incapable of signing a budget or dealing with the debt problems.
The country is facing a potentially devastating fiscal cliff in January with a massive increase in taxes and significant budget cuts. This potential economy cliff adds a greater sense of risk to decisions needed to be made now. It also has slowed further investment and hiring.
Economies like the one in the U.S. are very complex. They involve hundreds of millions of people making tens of billions of decisions each day. This economy also involves a dysfunctional Congress and somewhat indecisive business sector. The U.S. economy is also tied to a mostly fragile world economy. Nearly $300 billion has left the stock markets of the U.S. due to a lack of trust and a sense of risk in them.
So it will take a lot more than bringing the economy into the economic mechanics shop and a few more hours.
The U.S. economy may not be back on track for many years. Fixing this broken economy is far from easy.
However, we have been through worse.
What is one solution very few are talking about? We now have the technologies and the right prices to get trillions of barrels of oil and tens of trillions of cubic meters of natural gas out of the ground that we could not get at previously.
As with Mongolia, our underground wealth may help move the country forward to a better future. I will write about that next week.

Short URL: http://ubpost.mongolnews.mn/?p=1309

Posted by on Oct 3 2012. Filed under Opinion. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry

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