Let me back up a moment and just say I believe the United States is the greatest country in the world. Not so much on paper any more, but in theory. In my heart I know it to be true. I think the American people have the potential to outshine any nation in the world. Granted, our education levels, and even literacy levels are below many developed nations (actually most). The country has become a nation of consumers. We are the world’s largest consumer market. It wasn't always that way, and I firmly believe we have it in us to rise up once again to that level where the world will admire and respect the American "know-how".
Currently, there is debate in the US government regarding a proposed $700+ billion bailout to "fix" the problem caused by the greed I mentioned above. The debate is not only taking place in Washington, but among everyday citizens. People discussing, stating their opinions, and even calling and writing their government representatives to voice their opinion about the proposed bailout. It has sparked people's interest in government once again, at least to a small degree, and that is a wonderful thing.
Talking with people myself and following the news stories, it seems that around 2/3 of the population are not in favor of the proposed bailout. Unfortunately, I do not think the majority of that 2/3 understand the probable ramifications of the government "letting the cards fall where they may." And a good chunk of those who do understand, do not fully perceive just how bad things might get. So I am going to present the doom and gloom for a moment, just so you might grasp the severity of the situation, because apparently Washington is afraid to say all this.
In the not too distant past the housing market hit a huge boom. A good part of this was as a result of low federal interest rates, subprime loans, stated income loans and, to a lesser degree, fraud. Basically, the mortgage and banking industry made a bunch of bad loans. Now that in itself would be fine. They made the loans; they take the heat for the loans when they go bad. All well and good, except the loans were sold on the securities market. It is this last part that is going to make things (has made things) really bad for the economy.
Assuming you are not in the mortgage, banking or financial industry, I will give a very simplified run down on how all that works:
John Doe wants to buy a house, but he has crappy credit.
Jane Smith is a mortgage broker who works for Loans-R-Us mortgage broker firm and offers John Doe the chance of a lifetime to own that dream home, either through a subprime loan at a high interest rate, an ARM (adjustable rate mortgage, that starts with low payments and in five years when the interest rate increases "John can refinance using the equity in the home", only that equity never appeared), an interest only loan (again with the promise of equity to refinance later), or, using a loophole in FHA, John can do a stated income loan (read: fraud in many cases).
John Doe takes the loan with Loans-R-Us, and Jane Smith gets a nice big commission check, as does Loans-R-Us, who sells the loan at a discount to Super-Lenders-R-Us.
Super-Lenders-R-Us then takes the loan and sells it (at a discount) to a securities firm, WallStreet-Money-Inc, and makes a nice chunk of change.
WallStreet-Money-Inc then takes that loan from John Doe and bundles it together with 29 other loans and sells off multiple percentages of this bundled package out to the securities firms. In turn, the securities firms sell out pieces of it to consumers and companies.
With me so far? In a nutshell, the loan got sold off. Now, each of these sales has clauses that state that if John Doe does not make good on his payments then the next level has to buy it back. So when John's loan goes bad, WallStreet-Money-Inc goes back to Super-Lenders-R-Us for the money. Super-Lenders-R-Us goes back to Loans-R-Us and demands the money. Pretty fair right? Well, there is a problem here.
Loans-R-Us does not have the money to pay back all the loans that have defaulted. So they file chapter 7 bankruptcy. That leaves Super-Lenders-R-Us holding the bag. All is still good, right? Nope, they got stuck with so many bad loans that could not be dumped back off on the original brokers that they in turn file for bankruptcy. So WallStreet-Money-Inc gets stuck holding the bag.
If you have been following the news, you now know that the WallStreet-Money-Inc companies could not handle the bag they got stuck holding, so they have gone under (or are in the process there of). So who gets stuck with this proverbial hot-potato? The final investors. Consumers and companies that invested in the securities market.
Many companies have a lot of assets tied up in what they were promised to be high return investments. They have no assets, because that is where their money is. In order to continue to be prosperous (and in some cases even make payroll) these companies borrow against the equity from their securities market accounts. Only those accounts are worthless now, so no one will lend them the money (Can you say "A-I-G"?). And they go belly-up.
On top of that, consumers (read: average American citizens) invested their retirement plans in what was promised as a guaranteed high rate of return. So those retirement plans: GONE. Other people got hood-winked by investment companies not disclosing the type of investment properly (*cough* F.T. *cough*), and so unwitting consumers are losing their pants as well. Now, if you are not one of those people (and a good majority of American's are not), you are probably saying no big deal, "My money is not in securities." Or even "I don't have a retirement plan like that; I keep everything in the bank." Right? Well as you guessed, there is more to this story.
If you have money invested in stocks or bonds for retirement here's the question you should ask yourself: Do you know whether the companies you have stocks or bonds with have money in the securities market? Your stock might suddenly become worthless because that safe company, which has been doing so well, invested its liquid capital in securities, and now it is going belly up. And because 90% of people involved in stock trades, investments or retirement accounts could not tell you whether a given company is going to run into this problem, the stock market (and entire financial industry) is screwed.
To be safe you pull all your money out (aka "the run on Wall Street"). Well, now that company, which was good and safe, who never invested in any of the bad markets, just had their stock value plummet. Their credit goes down the drain; they lose capital and can not get the Net Terms they once had in order to make their products. So they go belly-up. And it spirals from there.
On top of that, your home value will continue to drop. Before too long, if it has not happened already, your house will be worth less than you paid for it 10 years ago. And less than you will be able to sell it for 10 years from now. You are stuck in a mortgage that is more than the value of the home.
Unemployment rates will rise as many companies go under. The good solid companies will have to tighten their belts, and do massive lay-offs, further increasing unemployment. Consumer spending will drop because people just lost their retirements and possibly their job. To compensate for that, inflation will rise. Meaning you get less for more. Mom and dad, who have been living on their 401K, are flat broke and are coming to live with you. Your sister (whose Birthday was yesterday and you never called), lost her job and is coming to live with you as well. 19% unemployment rates or more. That means one out of every five adult family members (and their kids) will be coming to live with you. And your money is buying less, but you need to support more people.
It does not end there. The global economy depends on the United States; we are the world’s largest consumers. But now we aren't spending. So the global economy starts it spiral. And down, and down, and down it goes. To compensate for this, there will likely be a country or two that decides to go to war, and thus we have World War III. The good news is that war of that level is good for the economy; the bad news is that it is a war and people die (maybe all of us this time).
The scale of this thing has the potential to be huge. If you were not alive during the Great Depression, a historian, or can follow chaos theory, you probably can not comprehend just how bad things could get. It is not a recession. Just because you saw the "DOTCOM Bust" does not mean you understand how horrible things will get. It is similar to the people I hear in my area of Florida saying that a Category 3 hurricane would not be so bad because "we had that no name storm and things were fine." Well that no name storm you "lived through" was like a company laying you off during a booming market, where you can find a job in under a week. The Great Depression was a Category 4 hurricane, and tell it to the Katrina victims that are still recovering years later that it is "no big deal".
This is what the politicians in Washington understand, and why they are thinking about the $700+ billion bailout for the industry. Do you get it now?
That being said, I am still against the bailout. Following the Great Depression, the United States entered a period of unsurpassed innovation and overall greatness. Companies and people had no choice. To survive, people had to suck up a little humility and take what jobs they could. Families moved together, grew closer and became stronger. Companies had to be the best in order to continue on, which meant new ways of thinking, hiring the best people possible, and finally getting off their butts and doing what they had meant to do.
Take Ford Motor Company for example. For years they have wanted to be competitive with Japanese and Korean auto makers. But, with the economy at a decent level, they still had enough car sales to keep Senior Management in a nice lifestyle. Why bother spending the money to make a car that was better than Honda or Toyota at a price that was less? Necessity is the mother of invention, and there has been no necessity. In a depression, there is necessity and Ford (like many companies) will either sink or learn to swim faster than everyone else out there.
Through that necessity, this country could once again be the greatest nation on Earth. And I honestly believe we have the guts, drive and know-how to see it through. Unfortunately, it also means letting the country (and world) hit rock bottom and enter into another Great Depression. Down to go up; seems irrational, but sometimes it takes a little lunacy to make things better.
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