The Economy: What’s Going On?

By | March 18, 2008

I’m concerned about the economy. The picture that seems to coming out isn’t a positive one. Here’s my attempt at capturing the situation as best as I can. Essentially, certain governmental policies and actions taken by the Federal Reserve in the past created a situation in which financial institutions had more incentive to make high risk loans. (The thinking is that a solution to a slowing economy is to make more capital/money available for investment/spending, by giving businesses/people easier access to credit.) The current problem came about because people were getting financing beyond what they were worthy of, in order to invest in real estate. This pushed up real estate prices, in turn encouraging more investing in a cyclical process. But this had a limit, and once reached, a lot of people were left with real estate on their hands which was worth significantly less than they owed and agreed to pay on it.

This is eerily similar to what caused The Great Depression. In that case, people could buy stock by only putting down a tenth (I believe) of the value of the stock. I assume the assumption was that they would be able to pay the rest by virtue of the rise of the stock’s value. Of course this encouraged people to buy stock, sending stock prices higher until it became apparent that they weren’t worth nearly as much because the money wasn’t actually there. When people finally realized this, everyone rushed to try and sell their stock, and realizing the problem, then made a run on the banks for fear their money wouldn’t be there if they waited. And since banks never have all of that money themselves (they loan it out), this caused just the disaster that everyone feared.

Again, this is an eerie similarity to what is happening currently. Earlier this week investors made a run on major financial firm Bear Stearn, due to fears that Bear Stearn was in trouble and running out of money. (For perspective, Bear Stearn has been in existence since before The Great Depression.) This indeed caused a crisis, which caused the Fed to step in and take some drastic measures, including extending a $30 billion line of credit to J.P. Morgan Chase in order to buy out Bear Stearn. (In other words, the Fed now owns $30 billion in “I owe yous” on which there is a high amount of uncertainty as to whether or not they will actually be paid.)

As if more evidence was needed that the economy is in trouble, the Fed has been taking these nearly unprecedented measures to try and keep things under control. The question is, is this helping? What I’ve gathered from some experts that I’ve heard, is that they believe the recession, or effects of this current crisis, haven’t really impacted the economy in a big way yet. The measures the Fed has taken have probably helped to delay the problems. But these experts also think that we’re just seeing the beginning of the fall out from the current crisis. In fact, Eric Janszen believes that the finance industry, where all this trouble is coming from, isn’t going to bounce back (and perhaps shouldn’t). Fortunately, he is also offering potential solutions as well (follow link to read article).

Some problems are already being felt. As concerns grow about the future of America’s economy, people begin to look else where to invest. There is real fear that the government will create inflation by consequence of trying to pump more money into the economy. This is causing people to invest in things other than U.S. dollars, whether it be other currencies (have you heard about how much the dollar is falling in value?), gold, oil (thinking about rising gas prices). Another big problem on the horizon: remember how I talked about our huge national debt and deficit spending? Well as the economy weakens and the dollar falls in value, people become less interested in investing in the government bonds. This means that there is a real possibility that the government just plain doesn’t have the money to spend wildly as it has been. (There was a news story here recently about how California is potentially going to lay off a large number of teachers because of lack of funds.)

So why care about economics and policy? Because it does make a difference to us.

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