U.S. Financial Crisis: What Got us Here, and the Only True Way Out

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In the last century, the US financial system has been converted from an asset backed system to a fiat currency with no real backing and our economy has increasingly been built on debt. We now see the results of this kind of distorted system.

The root cause of this financial meltdown stems from several decades of economic growth fueled by borrowed spending. People are buying more expensive homes, cars and toys on loans that they can never pay off. Businesses are expanding with debt that exceed their current sustainability and are given to them based in-part on future projections. Yes, investors and speculators have abused the system and made it worse. Yes, sub-prime lending and special investment vehicles, derivatives and mortgage backed securities added fuel to the fire. Those things only made it worse and brought this trouble on faster, but they are not by themselves the root cause. An economy reliant on over extended debt is the problem.

The $700 Billion bailout now being pushed through by the government may help prevent an immediate economic collapse, but ultimately it will help the rich stay rich and do little for the long-term stability of our economy. It’s an expensive two-edged sword that is trying to avert panic and the subsequent meltdown that would lead to full collapse. It’s a short term fix, and will probably do its job as a band-aid, but will not heal us long-term. To carry it out, we will increase the printed money supply and thus liquidity, leading to further tax burdens and higher inflation with a weaker dollar. It will further erode the base of our economy over the long haul and do nothing to help change the pattern of growing debt on all levels. Thus the house of cards remains little more than a delicate illusion.

Banks and high risk investors earn big money in good times, and can lose big money in bad times. So let them lose it. That’s the nature of capitalism, it’s a method of pruning. They are partly to blame for this mess. Government should not bail them out in the way they are proposing to do. By purchasing bad loans and letting the companies continue in this way, they are not allowed to suffer their own consequences. Furthermore, it does nothing to help the people struggling to pay off their debt – folks that shouldn’t have gotten the loans in the first place. Indeed banks should have turned many of them down, but the people asking for the money should have been better stewards with their finances. Property speculators certainly shouldn’t be bailed out because we all know that investment requires risk and they didn’t seem to mind making huge profits while times were good. Any investor that can’t recognize a bubble that’s ready to burst shouldn’t be investing in that market.

I don’t mind the ban on short selling, it’s probably the most stabilizing short-term move to prevent a sell-off panic and meltdown. Right now the market is too fragile to let market makers induce further manipulation through short selling. Really, the idea of short selling should be removed from the markets as a whole. However, I understand they are in place to help find fair price in a market that is manipulated and regulated by government. In a world where money is actually backed by something solid and business transactions are handled in the way commerce was intended, then short selling is of no use. Unfortunately, those days are centuries removed and so is the stability of those times.

So what’s a better plan?

The short answer is to offer limited financial aid and the induction of emergency finance terms for much of this expensive debt. A halt to market manipulation by temporarily banning short selling was one good thing out of all this. But in addition, an interest rate freeze on sub-prime loans and certain ARM’s should be instituted. This will help prevent further default. In fact, a voluntary rate reduction by the banks would help their liquidity by permitting many defaulted or nearly defaulting lenders to maintain payments. The lost income on the reduced rates would be peanuts compared to the losses they would suffer otherwise. Extended loan terms for individual home owners would help keep monthly payments manageable, while still keeping them on the line for the money they owe. They probably bought too much house to begin with, and it’s perfectly fair for them to face those consequences, especially when saving them comes at the expense of the rest of us. This is where some of the financial aid would come into play. Allow troubled homeowners who are in default or facing default to apply for additional government assistance. Yes, this is a partial bailout, but it’s helping the ones who truly need the help, and it would come at a far less cost than $700 Billion. Such assistance would have strict qualification requirements and again, would be used to help worst case scenarios.

Don’t bother pumping any money to aid Money Market funds. They are not in true jeopardy unless there is a run on funds, which won’t happen if we can stabilize the market. If there is a run on funds or on banks, there isn’t enough to cover the withdrawals anyway – so why spend billions to continue offering a fake perception that can’t be upheld?

For the banks themselves, don’t buy off their bad debt. Additional cash would be injected into the ones that are sustainable through the loan restructuring and home owner financial aid (see above). More banks are bound to fail – let them go. Let the stronger banks pick them up as bargains and let a lesson be learned.

As for speculative investors, deal makers and company heads who utilize these tools of bad debt, let them suffer the most. Speculative property owners could get the same locked rates and new loan terms to help them out – but I would not allow them to get any financial aid and certainly no handouts. They took the risks and enjoyed large rewards. They kept pushing when they shouldn’t have, and here’s where the road has lead.

These rather simplistic ideas don’t sound like much for such a large crisis – and they aren’t. The point here is we need to suffer an economic correction, and it’s ok to do so! We’ve been fiscally misbehaving for decades, so it’s time for some punishment.

The above proposals will help us some in the short-term to stave off a full collapse. From there, we need a financial overhaul. We need to close-up government legislation that has lead to an increase in sub-prime lending. Its original intentions were to help lower-income people realize the dream of home ownership. No one can argue against the concept of increasing home ownership – but the fiscal practicality just doesn’t exist. This is why such socialistic approaches, as wonderful as they may sound, simply don’t work and will destroy us financially.

We need to remove complicated investment vehicles and financial schemes that wall-street hustlers utilize to manipulate markets and over leverage financial institutions. Much of these, by the way, were not dreamed up by “greedy capitalists” but rather from overly complex government institutions and their cohorts, such as the Federal Reserve and World Bank.

Stop leveraging so heavily. Banks and investors have lead the way in this area and it comes down to once again excessively using debt. It was a major contributor to quickly inflated home prices as speculators continued to drive up prices through leveraged purchases.

Another thing to consider is a re-evaluation of the global market. It’s assumed by everyone that opening the US to global trade has been good for our economy. However, with more jobs being outsourced, and low-cost products being imported from developing nations, our ability to compete and to profit is greatly reduced. Not to mention the quality control issues we have faced (products from China, for example). The perceived gains from open trade have diluted internal economics and will continue to weaken the dollar.

This business of a full-fledged bailout through buy-out is absurd and may prevent an economic collapse now, but it won’t help built long-term strength in a disastrous financial system. The flaw is that the bailout is designed to allow institutions to be able to continue to lend so that consumers and businesses can continue to borrow in order to spend and conduct business. That use of debt to spend and grow is what ultimately has lead to this mess, and will one day lead to an irreversible collapse if it is not brought into check. The plans being put forth do nothing to bring it into check and are only extending the inevitable.

Ironically, this whole bailout is being funded by debt, shifting it from financial institutions to the taxpayer. The only advantage to the shift to government is that they can get away with not paying it down – at least for now. So the bottom line is while this proposed bail out may be hailed in the short-term, it will only further delay the inevitable if we continue to build our economy on the back of debt.

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