The New & Improved Deal

“If the people of the nation understood our banking and monetary system, I believe there would be a revolution before tomorrow morning.” (Henry Ford)

First, the US economy is highly based on consumer spending. One way to increase consumer spending is to make easy credit, i.e. credit cards and other vehicles. At some point, consumers must stop buying, and start repaying credit cards (beyond interest). With credit you buy now, and pay later. Most people just imagine that later never comes. When this happens, consumers buy fewer goods causing a small recession.

However, this isn’t allowed to happen. The Federal Reserve is pressured by congress and the stock market to lowers interest rates, which in turn lowers all interest rates. This makes it easier for everyone to get credit and increases demand for goods and services.

As a side effect, it also increases the supply of money in circulation. In this short term, this also increases the demand for consumer goods and homes. However, soon the market realizes the demand is inflationary, and then the price of everything goes up. As consumer prices rise, budgets get tighter and it is harder to pay bills. People begin defaulting on their credit payments, including mortgages.

Further low interest rates are a message that credit is easy to get and both borrowers and lender make riskier decisions than they would have. This creates malinvestment.

The finance industry has been profiting from the credit boom. For example, they profited in the short run by pushing loans on risky people. But as people default on the loans, it takes the very same banks under.

And banks were also taking on lots of debt in the credit-induced mania. Carlyle capital had a $21.7 billion mortgage portfolio that was supported by just $670 million of net assets.

Now these mortgage backed portfolios have some net worth, basically the money you get when people pay on their mortgage. And they were pretty safe; most people don't like to lose their homes. But there are problems. Easy credit was driving up demand for homes, and encouraging real-estate speculation. This inflated the prices of homes. A person who bought a property at market peak may have a 500k loan on a 300k home. This includes people who took out equity lines of credit against the imaginary equity in the appreciation of their homes.

At some point there was a market correction. Once the market had its correction most people weren't willing to be "upside down" on a home loan, especially speculators. They just mail back the keys to the bank, called "jingle mail"

Now as this started happening en mass, the value of the mortgage backed securities plummet. Billions and Billions of dollars in "wealth" were artificial, and vanished leaving banks holding the bag. Increases in wealth to to increased standard of living, now we have decreasing standard of living, like USSR.

Now there are calls to save the banks. I feel bad for the banks that having problems, because the Fed enabled their activities. It was like giving whiskey and car keys to teenagers. But we can’t just ignore the laws of economics, any more than we can ignore the law of gravity. Instead of letting the bubble pop, the Federal Reserve is attempting to keep the value of the mortgage securities high.

They do this by “buying” the securities and giving cash loans to the banks with the worthless securities as collateral. If they don’t do this, the entire market for securities may collapse. But someone is on the hook if the securities collapse, the American taxpayers. We are “eating” the bad debt. Or in other cases, otherwise healthy banks are doing the same thing. BoA bought Countrywide and Bear Sterns was eaten by JP Morgan Chase.

Is the fed “injection of liquity” going to create more inflation, creating more defaults?
Again people say Captialism failed. The Fed created the first Great Depression and it did it again.

And what happens now? Is the Federal Reserve held accountable for creating another bubble? No. Incompetence is rewarded in government. Federal Reserve is granted more power, even though it created the problem. It was only responsible for protecting banks through the use of loans, but now oversees entire financial industry.

It is up to the taxpayer, who by and large wasn't profiting in the financial speculation to catch the falling knife.