A bedtime storyOnce upon a time, the US economy starts to improve a little, and people decide to take their money and invest in real-estate, "which has always been a very solid investment".
House prices start to rise. Others say, "Hey, house prices are starting to rise nicely, looks like a good investment." They buy another house or two.
Average Joe sees his equity go up, and says, "Hey, sweet, I've got equity now -- I'm selling here and buying a bigger house." Joe cashes in some equity on that house and drops it into a new house.
Mortgage banks see housing prices rising and say, "Wow, that's a terrific investment -- let's loosen the reins a little on these mortgages and sell more."
"Sweet, look at all the money we're making!"
Stockholders in other companies complain -- "Hey, how come they're making huge gains and we're just sitting here? We need to get into that action!"
House prices rise faster and faster, and sanity in the lending practices starts flying out the window. Real-estate never goes down in value, remember?
In late 2007, someone realizes -- "Hey, we've been building and buying houses like crazy, but um... who's going to live in them all?"
Uh, oh. Uh oh. "Maybe we don't want our money in mortgage backed securities right now..."
Others -- "Oh oh, neither do we." ("Um, let's slide out the side door before anyone else notices...")
Everyone else -- Huh? Nobody wants them??! They're dropping in value! Panic! Lots of people can't sell now, and they can't afford all these houses we've lent them money to buy! That means we foreclose, but they're dropping in value fast! What are we going to do with them?! Our books are full of depreciating assets, and we don't have enough cash to cover them!
Bottom line? Every market is driven by "fear and greed" (thanks, Larry) -- greed drove up the prices, and fear is going to rip the bottom out from under us.
We as a nation inflated the values of all our homes, bought a bunch of them, then watched them all deflate in value. The money evaporated.*
So all these huge companies (Bear Sterns, Lehman Brothers, Merrill Lynch, etc.) that borrowed money to fund all this "action" are now gone.
Serves 'em right?"Let 'em crash, serves them right!"
We're agonizing over high CEO pay and golden parachutes, but these are pennies compared to the big picture here. According to Alan Greenspan (so I've heard anyway), at one point in his tenure we were only 4 years from eradicating the national debt. Huh? I thought the national debt was the number with so many digits that people tried to remember what came after "trillion", would be what finally crushed my grandchildren's dreams and drove the nation into poverty...
But no, money was coming fast into the federal government's coffers -- fast. Where was all the money coming from? Prosperous US businesses producing stuff, and all the taxes rolling in from that activity.
A rising tide raises all ships? That rising tide almost saved my grandkids from economic ruin. But if we let our biggest businesses die, the economic engines that supported and drove that kind of growth, our tide goes out -- way out. They are why our economy is the biggest and most stable in the world. If we let the tide go out, the big ships will end up wrecked on the rocks, but so will lots of others. ("Let 'em crash, serves them right...?") And wrecked ships don't magically float again when the tide comes back in.
We can complain about golden parachutes and try to bring the more buoyant ships down to the same level as ours, but who really cares if the water's receding and our own keels are already bouncing off the reefs?
So greed inflates value and "creates" capital; and fear destroys it. Anybody seeing any more fear? Yes -- the tide goes out faster.
What to do? "We need greed back! We need the real economic engines to keep running." Can it really be as simple as throwing in a bunch of money and rescuing those engines and giving the "greedy" cash to be greedy for?
* Well not exactly -- some, like me, happened to sell at a half-decent time and pull out a few tens of thousands of dollars in equity that since would have disappeared had I not grabbed it. Lucky move.
Why didn't anyone see this coming? Brandon Carpenter can attest that *I* saw it coming -- I complained in 2006 that this was "totally ridiculous", and that it was completely unsustainable, and that we were in for a huge mess. Yet nobody at the Fed. listened to me. =)
Hmm... I thought being right about that would have felt more satisfying than it does.
By the way, $700B is about $2300 for every man, woman, and child in America, and is almost what we've spent so far in the Iraq war ($845B).