Transparency and Perfect Information
The present financial crisis has many causes, and there is no one issue that is 100 percent responsible. In fact, one could argue that if only one of the following things had occurred, we would be nowhere near the position that we find ourselves in today. However, in the Jenga tower that is the economy, we took out too many pieces: global changes, the Reagan era, the real estate issues, and the problems with the banking system. Now we are stuck with a formerly, beautiful, gilded tower that is now a pile of ruble. Without transparency and perfect information, this was bound to happen eventually.
We made many mistakes in the United States, but the enormous changes around the world definitely hurt our economic status. The United States has funded multiple wars and been involved in some major nuclear scares. The Korean War, Vietnam War, Cold War, Cuban Missile Crisis, and Berlin Blockade all demanded huge amounts of resources, greatly increased national debt, and created varying amounts of social unrest which can decrease consumption and general trust in the government. These events, combined with China’s rapid rise under Deng Xiaoping and India’s halt of inward-focused economics greatly affected the American, and for that matter, the Global economy. The pressure to make the numbers fit provided by China and India’s continued rise to prominence definitely influenced the publicly owed companies. Also the massive amounts of debt accrued through funding the Iraq and Afghanistan Wars have been draining the economy since they began. The changes and events in the world over the past thirty or so years have all contributed to our current situation and now we are experiencing the consequences.
The Reagan era ushered in many changes, especially in the financial sector. Reagan strongly believed in supply-side economics, and that the private sector should set the nation’s economic course. He, aided by the Federal Reserve, squashed inflation, and used the principles of supply-side economics in their entirety. Reagan also is largely responsible for the deregulation of the private sector. It is important to note that all of these actions could have been hugely successful in the short and long run if transparency and perfect information had been plentiful. However, in the incredibly competitive atmosphere of business, these two critical necessities were ignored and Reganomics ended up contributing to the current recession.
The banking system and the real estate issues are similar, and both stem from an excess of freedom, power and deregulation in finance. In addition to deregulation, the problems with the banking system came about through over-confident bankers who failed to plan for the big global changes as mentioned above, and calculated for known risks incorrectly. Banks have also grown far too large. Once the figurative walls between savings banks, insurance companies, investment banks, and brokerages were torn down, banks simply encompassed too much. The bankers got lazy and started grouping large amounts of assets together and setting up very imaginative ways to keep track of everything. This leads into the essential problem with real estate: innovative mortgages. Innovation is great when it is well researched and tested. However, sub-prime, alt-A, and option ARM mortgages were very poorly thought out. These are a few examples of ways banks helped people buy houses, when they had the income of someone who should be renting an apartment. Obviously, when it came time to pay up these people could not. They defaulted and the banks were stuck with all sorts of liabilities. Eventually, this bubble of very naïve thinking with no regard for long term success burst, and now we are seeing the result.
All of these factors combined lead to where we are today. Interest rates and inflation are extremely low. The unemployment rate is high and still rising. Household debt has risen from sixty percent in 1997 to 100 percent by 2007, and national debt is now 350 percent of the GDP as opposed to 160 in 1980. Investment has taken a sharp downturn and consumption is decreasing. The United States economy is in trouble, but it can all be fixed eventually. The key piece next time around must be transparency and perfect information to prevent another, similar recession.
We made many mistakes in the United States, but the enormous changes around the world definitely hurt our economic status. The United States has funded multiple wars and been involved in some major nuclear scares. The Korean War, Vietnam War, Cold War, Cuban Missile Crisis, and Berlin Blockade all demanded huge amounts of resources, greatly increased national debt, and created varying amounts of social unrest which can decrease consumption and general trust in the government. These events, combined with China’s rapid rise under Deng Xiaoping and India’s halt of inward-focused economics greatly affected the American, and for that matter, the Global economy. The pressure to make the numbers fit provided by China and India’s continued rise to prominence definitely influenced the publicly owed companies. Also the massive amounts of debt accrued through funding the Iraq and Afghanistan Wars have been draining the economy since they began. The changes and events in the world over the past thirty or so years have all contributed to our current situation and now we are experiencing the consequences.
The Reagan era ushered in many changes, especially in the financial sector. Reagan strongly believed in supply-side economics, and that the private sector should set the nation’s economic course. He, aided by the Federal Reserve, squashed inflation, and used the principles of supply-side economics in their entirety. Reagan also is largely responsible for the deregulation of the private sector. It is important to note that all of these actions could have been hugely successful in the short and long run if transparency and perfect information had been plentiful. However, in the incredibly competitive atmosphere of business, these two critical necessities were ignored and Reganomics ended up contributing to the current recession.
The banking system and the real estate issues are similar, and both stem from an excess of freedom, power and deregulation in finance. In addition to deregulation, the problems with the banking system came about through over-confident bankers who failed to plan for the big global changes as mentioned above, and calculated for known risks incorrectly. Banks have also grown far too large. Once the figurative walls between savings banks, insurance companies, investment banks, and brokerages were torn down, banks simply encompassed too much. The bankers got lazy and started grouping large amounts of assets together and setting up very imaginative ways to keep track of everything. This leads into the essential problem with real estate: innovative mortgages. Innovation is great when it is well researched and tested. However, sub-prime, alt-A, and option ARM mortgages were very poorly thought out. These are a few examples of ways banks helped people buy houses, when they had the income of someone who should be renting an apartment. Obviously, when it came time to pay up these people could not. They defaulted and the banks were stuck with all sorts of liabilities. Eventually, this bubble of very naïve thinking with no regard for long term success burst, and now we are seeing the result.
All of these factors combined lead to where we are today. Interest rates and inflation are extremely low. The unemployment rate is high and still rising. Household debt has risen from sixty percent in 1997 to 100 percent by 2007, and national debt is now 350 percent of the GDP as opposed to 160 in 1980. Investment has taken a sharp downturn and consumption is decreasing. The United States economy is in trouble, but it can all be fixed eventually. The key piece next time around must be transparency and perfect information to prevent another, similar recession.
posted by Stuart at
4:41 PM
1 Comments:
Stu, I think you've pegged a lot of big causes here (and a missed a handful, too). This is about 75-80% of the story of how we arrived here. It's only about 75-80% because it reads like a Reagan-esque playbook in describing the situation. You're missing some of the long-term failures of the present situation and you're overlooking the role of developing nations in putting upward pressure on commodity prices, flooding the US with their savings which made making these loans more attractive. You're on the right track here, but there's still work to do. Hopefully, some of your classmates will look at my comments before they post their pieces to help them out.
By
Rob Wedge, at 9:40 AM
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