Just about every night, I talk to my younger brother before I go to bed. His brain operates a little differently than mine. He’s good with numbers and deciphering information and taking tests and solving word problems. While me and my sister and my other brother stood up to be recognized as summa cum laude’s at our graduation ceremonies, he stood up at his because he really was one.

Most nights, we discuss world news and I make him tell me versions of everything in simplified terms. He’s kind of like a walking CliffsNotes, so I thought it would be perfect to begin having him contribute, to Minus Five, his insights on the economy.

Today’s lesson begins now:

When MF asked me to “in layman’s terms, explain what is going on in our economy that is not in a recession,” my first impulse was to start with Monday, September 17, 2008. But that would be jumping the gun. Yes, the Dow lost 500 points that day (504, actually). As I’m writing this (Wednesday, September 17, 2008), the Dow has just lost another 449 points. It’s the lowest the Dow has closed in over three years. It’s the most dramatic loss in eighty years. That’s important to take in, but it’s really the last chapter in the book.

The economy has very natural cycles of growth and stagnation. Important people with advanced degrees and really thick glasses watch the economy every day and somehow manage to take the numbers that mean nothing to anyone else and turn them into words like “bull market” or “booming economy” or “the most god-awful recession that nobody wants to call a recession except for Warren Buffett” (I wrote the last one). In any case, Americans did very well for ourselves during the Reagan years, and had a very natural stagnation/recession during H. W. Bush (which wasn’t handled well, so it turned into a recession followed by another recession). During the Clinton years, the economy saw the most solid piece of growth ever. And then in about 1998, the economy started to stall out after the e-commerce bust (but mostly because it was a very natural time for stagnation after a large, unprecedented growth period). Think of the cycle like this: when kids go through growth spurts, they eat a lot more, they have more energy, they’re more anxious, and generally just exploding in both size and cost. Then their bodies relax a bit and they eat a bit less and tend to calm down for a while before the next growth spurt. The economy does much the same thing. And in 1998, it was time for a bit of a rest. It has less to do with which political party is running which branch of the government, and more to do with financial/political leaders paying attention to the cycle and providing aid when needed—otherwise known as feeding your child. Both major political parties are equally capable of taking care of the economy, despite exceptions to the rule (always remember: we elected Eisenhower and Clinton, and we elected Bush and Carter–both parties have their bad players).

Then we elected a president who has a very “hands off” approach to the market. The theory is heavily weighted with the principles of capitalism (which is good, of course), but it didn’t work out very well. First, they deregulated a lot of different markets. The most obvious one, of course, is the housing market. So, people who otherwise would be denied a home loan were suddenly qualifying for hundreds of thousands of dollars (at a variable interest rate, of course). As the interest rates went up, the people found that it was no longer possible to pay for the house and eat at the same time. Those who got hungry enough (or who had children to feed as well) opted for food rather than shelter. They lost their homes, and likely their credit rating in the process. It wasn’t due to “irresponsibility” as McCain would claim, but rather buying into a bad deal in a deregulated market.

So, now a lot of people are homeless (or renting, or living in less expensive homes) with bad credit. There are foreclosures piling up. There are builders who don’t want to build any new houses because they know they won’t be able to find anyone to live in the house and they’ll wind up with the expense which will bankrupt their business. Ordinarily, this would be the end of the story and it wouldn’t be such a big deal, except that there are these things called “Mortgage-Backed Securities.”

Here’s what you do: get a bunch of people and/or banks and/or investment companies and you all pool your money together. Then you lend the money to people looking to buy a house. The people to whom you loaned money pay back into the pool every month (ideally). They’ll pay back the principal loan amount, plus interest, so you make money if you had money in the pool. Historically, it’s a great investment, and very rarely winds up collapsing major financial institutions, let alone several major financial institutions within a few months of each other.

What happened? Well, the loan officers, who were supposed to be making sure the people getting the loan were qualified, didn’t do their job. They didn’t have to. Nobody was looking at them. There were no regulations; just money to be made. The people in charge of the interest rates got a little trigger-happy. There was money to be made. More interest means more money. More money in the pool means the people who bought Mortgage-Backed Securities get more return on their investment. More people getting more return on their investment means more people throwing more money in the pool and more money for the investment companies who take a piece of every investment going in and every investment coming out. It means more of everything for everyone because the housing market was deregulated. Hurray!

And then what happened? The interest rates went too high. People stopped paying their mortgages altogether. People declared bankruptcy so the mortgage companies couldn’t go after them for the loss. No mortgage payment means less money in the pool. One or two lost mortgages won’t matter much. But when you have tens of thousands of foreclosures and bad mortgage debt, it drains the pool pretty quickly. All the individual investors who had money in the pool lost their money. And all the investment companies and all the banks that had money in the pool lost their money. All the boys and girls who were getting rich so quickly and so easily in a deregulated market suddenly found they had lost their jobs.

That’s how “138-year-old pillar of financial stability” Lehman Brothers can suddenly be worth only $1.75 billion (that’s what British bank Barclay’s paid for a piece of their bankrupt shell today). That’s how “international insurance giant” AIG (which covers people, property, and investments in 130 countries worldwide) suddenly needs $85 billion from the Federal Reserve Bank to stay afloat while they sell off their assets (and don’t panic about that—it’s only a loan that they will pay off as they find people to buy their subsidiary companies). That’s why Merrill Lynch agreed to a buyout by Bank of America.

You see, regulations are somewhat of a “Catch-22.” On the one hand, they slow down the process of making money by making people follow certain rules. On the other hand, they prevent people from making bad decisions like the ones described above, and thus crippling the American economy and, in turn, the worldwide economy. When there are too many rules, nobody wants to play the game. When there are too few rules, too many people are playing the game (and a lot of them suck at the game and a lot more of them cheat). It all boils down to the people at the top not looking ahead, not listening to those who have been playing the game for a long time (who know what rules should be in place), and generally not caring about it at all.

So, we’re in a recession. I would agree with McCain that the fundamentals of the economy are strong, in that we’re still alive and we all have the desire to not die. That’s essentially what you need to rebuild: a desire to do so. It’s going to take a while, but I’m sure things will begin to pick up shortly. Usually, after the first 100 days of a new president, things begin to pick up (regardless of which party gets elected). In the case of this election, I would say, as far as the economy is concerned it doesn’t matter who gets elected, with one qualification: as long as whoever gets in office reinstates the regulations that helped the economy grow in a controlled manner, we’ll be fine. If the system is allowed to run itself with little to no intervention, we will continue to spiral downward. The economy will come back to life regardless, but it will come back much faster if someone gets in office that can inspire people to get up and get going. The workers at the bottom of the chain need jobs. The people at the top of the chain need to feel secure that if they invest in a business, they’re not going to lose their shirts. The people in the middle need to know that someone somewhere gives a damn about them at all.

The good part of this whole catastrophe is that people are starting to figure out that the rules, while inconvenient at times, are there for a reason.

UPDATE: As of Friday’s close, the Dow had pretty much gained back everything that it lost earlier in the week. If you weren’t already aware, you cannot use the stock market as any indication of economic security. The market is all based on fear and rumor. Generally, the market will grow with the economy overall, but the day-to-day state of the market is so volatile, it’s not a clear indicator of how the economy is truly functioning.

Also, you probably shouldn’t expect the politicians to do anything about any of this until after January 20, 2009. It’s an election year, so they don’t want to do anything that might cause a panic amongst their constituents this close to Election Day. Historically, this is when Congress gets even less done than usual. Plus, nobody (Democrats or Republicans) wants to attribute any “fixing” to Bush. They’d rather just attach the “fail” to him and let the next president take credit for fixing it.

As far as viable solutions, my suggestion was to reinstate the regulations they tossed out in the first place. Obama and Biden seem to agree (at least, that’s the message I get from their speeches…no action has yet been taken, despite the fact that they are both currently senators and could reasonably be expected to do something). Palin wants to reinstate the regulations in order to “get the government out of the marketplace,” which doesn’t really make sense, given that regulations come from the government and the government hasn’t been in the marketplace at all for almost a decade now. McCain wants to set up a 9/11-style commission to investigate and find the source of the corruption, which doesn’t really make sense, given that there is no corruption. There were no rules to break, so nobody really broke any rules. Election speeches are fun.

Love,

Michael

This entry was posted on Tuesday, September 23rd, 2008 at 9:56 am and is filed under Uncategorized.
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