What Caused the Economic Downturn, World Financial Crisis, and Resultant Recession, or Depression?

Why Did the U.S. Economy sink to Into a Deep Recession and the World Financial Crisis followed? Is Worldwide Depression Next?

As a job site, we are very concerned with the economic climate of 2008/2009 and the effect it has on employment in the United States. It seems as though the job market for prospective employees is difficult at best these days. Almost everybody knows somebody who has lost a job. Those who still have jobs are finding it increasingly-difficult to focus fully on their duties due to the stress of thinking they may be the next one to receive a pink slip.

Look around at large shopping centers and business parks in your town, commercial and office space is becoming increasingly vacant. Where are the jobs going? What happened? Why did things change so rapidly? When will our economy once again become vibrant? What can we do to fix things?

FUEL PRICES CLIMB

We all remember March to April 2008 as we began to see gasoline prices climb higher and faster than any of us remember in our lifetimes. By the time summer hit, prices were well over four dollars a gallon throughout most of the nation. How could we see an almost doubling of fuels prices within a few months? We witnessed high anxiety levels and struggling budgets as gas bills doubled; the hardest-hit were the workers who had long commutes to their jobs. Was this a sign of worse things to come?

BEAR STEARNS TAKES A TURN

Alongside the gasoline price increases we were dealing with, we began to hear news of a giant financial investment brokerage having big troubles in regards to a huge number of investments related to the mortgage industry tanking. Bear Stearns, one of the major longstanding giants of Wall Street was in deep trouble. Their managers, investing so heavily in the real estate and mortgage market failed to see that the housing market was actually an 8 trillion dollar bubble about to burst. This was our first smell of something rotten in the investment banking business as Bear Stearns, a company with over 85 years of Wall Street investment banking experience and able to survive the Great Depression and numerous recessions over the years was brought to its knees by taking risks and heavily investing in mortgage backed securities. The Federal Reserve and the U.S. Treasury were forced to help guarantee and broker a deal with J.P. Morgan to purchase the long-time giant investment bank for a mere 10 cents on the dollar. Little did we know this was just the tip of the iceberg?

HIGH PROPERTY VALUES AND CREATIVE FINANCING

We all seemed to know something was wrong in the months and years preceding our energy problems as we began to see housing sales slowly dry-up. Housing prices had reached a point where the average family was no longer able to afford to own a piece of the American dream. All-the-while mortgage companies were pushing homeowners to refinance their current mortgages or take second mortgages with risky and complicated adjustable rate or sub-prime loans – remember the constant barrage of ads on television for quick and easy real estate based loan programs? The prevalently accepted warped perspective became: buy more toys than your neighbors and pay-off all of those credit card bills with the proceeds from your refinance. Those closely watching these dynamics build in our nation were thinking to ourselves – this could not last, something had to give. Well, the bubble was about to burst; the American lifestyle as we knew it was about to change.

WHO IS TO BLAME

It seems most of the blame for this nationwide and worldwide crisis can be found in the real estate/mortgage market and Wall Street investment banking practices encouraging and promoting shady, voracious, profit making schemes. Let’s take a look further at this sad state of affairs.

LAX LOAN STANDARDS

Programs and directives were pushed through several presidential administrations that allowed more Americans into a home of their own. While the original intentions of these loosened standards for housing loans were probably somewhat honorable, greed eventually worked its way in and drove the mortgage market. The scrutiny and critical standards of the past were diminished allowing unscrupulous individuals to take advantage of the more liberal standards for securing mortgages.

UNREALISTIC MORTGAGES AND TANKING VALUES

Just about all of the banks and savings and loan organizations were offering complex subprime and adjustable-rate mortgages, approving many of the loans with limited examination and inspection of the individual’s financial status. Bad mortgages ran amuck and permeated the loan market. The name of the game was to simply get as many individuals into home loans as possible. As interest rates began to rise – as they always do, adjustable and sub-prime loans became increasingly impossible for those marginal borrowers to continue to pay.

Add to the above, the confluence of property values starting to decline as the market was heading for a tremendous adjustment period and many of these homes acquired with dangerous loans became worth less than the actual principle amount owed to the bank.

With property worth much less than the loan amount remaining and the monthly mortgages going through the roof, it quickly became fashionable to simply walk away from the house. When soaring numbers of borrowers were unable to repay or refinance their loans, droves of these mortgage holders simply did not make their payments; the banks were forced to foreclose and thus began their downward spiral.

FLIPPERS AND ADVANTAGEOUS INVESTORS

To add insult to injury, many investors taking advantage of these lax standards, were able to purchase what are called “flippers,” homes purchased using very questionable credit data and normally purchased sight-unseen, entirely with the intent to flip, or sell the house, many times several houses, for a profit. The practice was common to sell, prior to even making the first monthly mortgage payment.

For the flippers, under-qualified home purchasers, savvy mortgage brokers and banks, the game ran rampant, empowered by a never-ending upward journey of property values, far too easy mortgage qualifying standards, teaser mortgages and liar loans, all combining in a unique recipe for disaster.

We should have seen this thing developing and put the brakes on it long before it was able to get to the point of entirely destroying the U.S. and worldwide economies – but we didn’t.

What’s amazing is how quickly everything turned in the housing market. At one moment everybody and his brother were in the home loan writing and refinancing business making tons of money on loan fees while it seemed property values would never end their upward momentum, and the next moment the entire world is collapsing as a result of the real estate market.

MORTGAGE BACKED SECURITIES

Then we have the issue of seemingly-wise Wall Street managers and investment banks from huge, credible companies, creating new vehicles of investment with specific focus around this failing mortgage market. These very same risky mortgages that became so prevalent over this period were broken-up into small pieces then bundled and sold around the world to a myriad of mutual funds, hedge funds, retirement funds, banks, and private investors; these were called mortgaged backed securities. Investors found themselves in a state of frenzy anticipating a high rate of return on their money with these security vehicles; they basically ignored the risks of the questionable assets and began investing heavily. The prevalent justification must have been the fact that these loans were backed by solid real estate assets that historically always increased in value and the mortgage backed securities were chopped and diced to such an extent that the risk was spread-out quite thoroughly to avoid a total collapse.

INDYMAC BANK

In the midst of our struggles to keep gasoline in our tanks during the summer of 2008, we continued to see economic struggles in the housing market were very real and about to hit main street American. On Jul 12, 2008 the federal government took control of Pasadena-based IndyMac Bank. This bank was heavily invested in the bemoaned and devalued real estate industry. Once worth $32-billion, the second largest bank failure ever in history, it seemed impossible such an institution could fail overnight. But this was only the beginning as many more banks invested in the mortgage/real estate industry were about to follow. Some of the very largest banks were and continue to be very close to bankruptcy, the only saving grace being the U.S. government, backed by taxpayers working in the background keeping them afloat with rescue money or assisting in brokering buyout deals with other large institutions. Some troubled banks in the news include such banking giants as Washington Mutual, Wells Fargo and Bank of America.

LEHMAN BROTHERS

Just when we thought things could not get worse, really big economic troubles seemed to be brewing when Lehman Brothers, a financial services and investment banking firm with a rich history of over a hundred and fifty years, claimed bankruptcy on September 16, 2008. This was an unthinkable occurrence. This company had massive exposure in housing and mortgage industry investment instruments called derivatives.

AMERICAN INTERNATIONAL GROUP (AIG)

Then there is the big insurance company AIG who plunged into the market of credit default swaps. These are the financial instruments you hear about that are essentially contracts similar to insurance policies, protecting investors against failure in certain assets, including subprime mortgages. As of this writing in March 2009, AIG stock is down from over $45 per share a year ago to less than one dollar per share. Now, the American taxpayer has been forced to bail-out this too big to fail company due to devastatingly unacceptable worldwide financial collapse of many industries around the world without the insurance they provide. Amazing how a lack of oversight and regulations in the mortgage business had such a far-reaching devastation. It seems the hundreds of billions of bailout money given to AIG is never enough and with its managers taking huge million dollar bonuses with the taxpayers money, the tension continues to build.

CREDIT TIGHT

With so many bad, toxic assets causing so many banks to fail and become marginal, credit markets are drying-up. With this lack of capital, businesses and individuals alike are finding the good old days of easy credit fading away quickly. We have basically become a debtor society run entirely on credit. Combine with these factors with a gross oversight by federal regulators for many years, it all resulted in what became a “perfect storm” of monstrous proportions responsible for an unprecedented recession and possible depression.

HOW TO FIX THINGS

If you study previous economic downturns, recessions and the great depression, you’ll find some patterns. Above all, we need to learn from our mistakes and curtail greed and corruption.

In that we are a debtor nation, we cannot do anything other than free-up the credit markets once again to get our nation moving again.

In our opinion, and as funny as it sounds, we actually need to repeat the process that got us into this mess in the first place. We need to do just what the Obama administration is doing, making borrowing so cheap and mortgage interest rates so low so that everyone, first-time homeowners and business owners alike, can refinance with steady, solid, low fixed-rate loans, not unstable and adjustable loans. If we do that, we can prevent a depression and a return of the American economy.

Joseph Nino Rudolph