The Economy - What's Going On

I've been reading and hearing all sorts of different opinions about the current state of the economy. And since I actually feel like I have somewhat of an understanding about it, I wanted to post so anyone can understand the basics about how it happened and what the bailout is all about.

The Problem

In the beginning, there was the housing market. Between 1997 and 2006, the average American home rose 25% in value. For years, people were making a killing off of the housing market - land was becoming overvalued, especially in prime real estate locations. I'm actually not sure of the cause, but let's just understand that housing is like anything else as a commodity. Prices go up and down with demand. People had a high demand for real estate, and so the prices went up. Is your area building tons of housing? I know ours is.

So these mortgage companies decided to get a piece of the housing action. They gave mortgages to individuals in a high risk category, meaning they would likely not be able to afford their mortgage payments. Usually this is a bad idea, right? Well when the attempted owner could not pay for the house, the company got it. And since real estate was going up so much in value, they would end up turning a profit anyway. Genius, right?

It was quite a profit center, until the real estate market started being more realistically valued. Due to overbuilding during this period of housing boom, we had a housing bust. So now these companies have all these bad mortgages that people can't afford to pay. As a result, these companies declare bankruptcy. Heard of Fannie Mae and Freddie Mac? Both are mortgage companies designed to help people who are having trouble paying their mortgage. Now that there are a whole lot more people who can't afford it, these companies went under, and the government has already helped bail these two companies out by offering low-rate federal loans to them, but it wasn't enough. The biggest company to go under was Lehman Brothers, and this triggered the crisis as we know it today. To read more details (and there are a lot more details) check this Wikipedia article: Subprime Mortgage Crisis

The Bailout

What are the trains of thought with the bailout? Well, if things continue as they are, credit will begin to become more difficult to obtain. Companies would not be able to access credit, and economic progress would slow down drastically. As a result, we could have a stock market crash, and a depression (though not the Great Depression). I've already read stories about established auto dealers not being able to get credit to increase inventory.

The bailout proposes to spend 700 billion dollars toward purchasing these bad mortgages. This supposedly would stabilize the market, and allow people to just start fresh with the market. The problem with this plan is that it may only temporarily stop the flow of things. The biggest problem with the plan is that the 700 billion dollars aren't coming from anywhere - it is all deficit spending. Another problem that most people see with it (and these are mostly business owners talking) is that bailing out these companies doesn't teach any culpability. If you make bad business decisions then you go out of business. But if you make bad business decisions at a high enough level to affect the economy, the government will simply bail you out. Not a good lesson to be teaching young businesspeople.

My Thoughts

I'm not sure what to think really. I think that we are a country with way too much dependence on credit. When you're having financial troubles, you need to start using your debit card, and not a credit card. This is the only way to curb your spending to within your means. We're all trained (especially the younger generation) that soon we'll have more money, so might as well spend some now. We may need a depression to wake us up and teach us that money doesn't grow on trees.

On the other hand, I hate to think that people losing jobs and going destitute is the right way to fix things. Maybe the government will actually put things into place to prevent this from happening again, and the bailout would be a good thing. It's funny though - the Great Depression was caused by people overspending money they didn't have on overvalued stocks, and as soon as stocks became less valued everyone lost everything. Now, people overspent money they didn't have on houses because institutions let them, and as soon as houses became less valued, these individuals and the institutions lost everything. Notice a trend?

I personally think that while it would cause a downturn, lowering the ability to get credit would be a good thing for this country. Learning to rely more on savings will stabilize our economy far more than a bailout would, although the short term would be rocky.

If there's one thing I know, it's that the media is blowing the situation way out of proportion. It will be a while before things get bad, and our economy is still thriving. We still only have 5% unemployment. Things aren't as bad as people think. I hope that the bailout doesn't pass simply because of the media attention it's receiving.