Stimulus Package Details | Causes of Economic Crisis | Reasons Recession

What In The World Happened?

This analysis was written by the same author of bars in Denver, Colorado.

If you’ve watched your savings and retirement plans evaporate, as tabs for economic stimulus packages, plans, and bills multiply, you might want to know what in the world caused this mess.

There’s plenty of blame to go around. Following are key factors.

Postponed Recession
By many indicators, the American economy was in serious trouble at the beginning of 2000, a time marked by the burst of the dot-com Internet bubble. The economic worries continued into 2001 and became a full-blown crisis on September 11. Rather than experience what might have been a mild setback, we Americans were encouraged to spend, spend, spend. And spend we did, believing we deserved it and feeling we may as well spend tomorrow’s money today.

Too Much Available Credit
What better way to encourage mass spending than to cut interest rates and extend loans to anyone and everyone, and that’s what happened. Spending was supposed to save the American economy after terrorists leveled the Trade Towers. Everyone was happy to borrow, but few thought through the consequences of paying back the money.

Mortgage Madness
For decades, virtually every American homeowner had the same type of mortgage – the good, old-fashioned 30-year, fixed rate home loan. Even in the worst of times (i.e. 1980 and 1981, when the prime interest rate was 21.5%), the 30-year fixed rate mortgage reigned.

In 2004 and 2005, lenders were throwing traditional borrowing ratios out the window and offering 150 different types of mortgage products. Adjustable rate mortgages, interest-only mortgages, 110% mortgages, balloon-payment mortgages, option ARMs, etcetera, etcetera, etcetera.

No documents required, no income required, no telling the truth required. Just show up at the closing and sign on the dotted line, and the loan would be repackaged and combined with others and passed down the voracious Wall Street assembly line, until it was laundered into something that no longer looked like a “toxic asset.”

Greedy Homeowners
The mortgage free-for-all caused American homeowners to get greedy. Instead of taking out home loans at fixed rates of 4%-5%, they opted for even lower temporary rates, overlooking the fact that those rates were likely to adjust upward. They bought houses they couldn’t afford, lied about how much they made, purchased second homes, transferred tens of thousands of dollars in credit card debt onto their home loans, and speculated on skyrocketing markets in Phoenix, Las Vegas, and Miami.

In essence, millions of people all across the country artificially drove up the prices of homes all across the United States. And real estate agents, appraisers, developers, and mortgage brokers went along for the ride, collecting hefty fees and commissions at every juncture of every deal.

Subprime Loans
Adjustable rate mortgages, though, were merely bit actors in the broader scheme of the mortgage meltdown, with subprime loans playing the leading role. Definition of a subprime loan? These were loans given to less-qualified borrowers, at higher interest rates, higher fees, and higher prepayment penalties.

Subprime loans grew from $35 billion in 1993 to $607 billion in 2004. In that same timeframe, subprime loans went from representing .03% of the home refinancing market to 6.5% percent, and from 2.1% of the original home loan market to 10.1%. Amazingly, this didn’t this catch the attention of anyone high up in the U.S. government, not even Alan Greenspan, who was Chairman of the Federal Reserve from 1987 to 2006.

As of March 2009, almost 50% of American homeowners with subprime, adjustable rate mortgages were in foreclosure or behind on their payments.

Derivatives And Too Little Regulation
Under “normal circumstances,” lenders never would have underwritten so many risky loans. Not if they were the ones who had to collect 360 monthly payments from borrowers with no income, no assets, and low credit scores. But the lenders weren’t troubled by such details, not when they could repackage the loans and sell them on the derivatives market, where there was virtually no regulation.

What are derivatives? These are exotic financial instruments that no one seemed to fully understand – Alan Greenspan included – except for a tight circle of Wall Street billionaires. Those in the know took the shady mortgage loans, now commonly known as “toxic assets,” bundled them into pools and sold them over and over again.

At the height of the insanity, investment bankers couldn’t get their hands on enough “paper” to sell to unsuspecting investors around the world. In October 2008, Iceland (yes, the country, with 330,000 inhabitants) went bankrupt as a result of its foray into the global derivatives market.

On a daily basis throughout 2008 and into 2009, pension funds and investment funds, throughout America and across the world, reeled from losses incurred from their dalliances with derivatives.

The most frightening aspect of all? Because of the rebundling of mortgage loans, today, no one has a clue which assets in a portfolio are worthless and which have value, which borrowers will pay on time and which will default, which makes it impossible to make an accurate evaluation of assets.

That’s why credit markets tightened as everything began to unravel at the beginning of 2008. By the fall of 2008, credit was almost frozen, as details of the full extent of the debacle became apparent.

Worldwide Economic Erosion
There’s no boundary left on the planet that hasn’t been crossed by global economic transactions, and in September 2008, the U.S. economic crisis triggered a global economic crisis and visa versa. Every powerhouse in the world is now experiencing trouble – from Britain and the rest of Europe, to China and Japan, and Brazil and Australia. All of the world’s twenty leading economies are experiencing tough times.

Downward Economic Spiral
What’s happening now? Right this minute? Right here in the United States? All Americans, from the poorest to the richest, are learning to live within their means, something we haven’t had to do in more than a generation of free-wheeling consumerism. No more credit cards to rack up. No more home equity lines of credit to tap to pay off the credit cards. No more annual double-digit home price appreciation to allow us to secure another home equity line. No more hefty stock market gains to make a comfortable retirement seem attainable.

Contagion of Fear
On an individual level, we’re now being forced to live without borrowing, which means far less spending. Maybe even a little savings. Which means stores will close and jobs will be lost. Which means the economy drops further, which scares us more. So we spend less. Meaning more contraction of the economy, and more job losses. Which begets more fear and leads to further belt-tightening. No one’s going to convince us to spend our way out of this mess this time.

This isn’t the same as the recession in 2001. We’re not afraid of dying this time. We’re afraid of living – very long lives, with very little money. Just try to pry that money out of our wallets and bank accounts. We’re avoiding temptation at every turn, staying out of malls, cutting back on luxuries, watching every penny. And thus, the downward economic spiral continues.

At the same time as Americans are arising to rude awakenings, every business in America, from the most successful conglomerate to the newest solopreneur, is learning to live with less risk and less leverage. Less credit, less room to gamble, less opportunity for growth. Which leads to less spending. Less job retention. Less job growth. Less, less, less. The recession, which is in all likelihood is really a depression, continues.

Lack of Confidence And Abundance Of Uncertainty
As of February 2009, almost $3 trillion in liquid funds were being held by individual Americans and institutional investors. Everyone’s waiting. Waiting to see what will happen next, reluctant to make any move, for fear it’s the wrong move. Politicians and economists and policymakers refer to this as a crisis of confidence, but essentially it’s self-defense.

Stimulus Packages To The Rescue
Our elected and appointed government officials – the same ilk who missed the signs of the economic freefall in the first place – have decided that the only way to stop this nasty cycle is to pump money into the economy in the form of massive stimulus packages. Stimulus packages so huge that the numbers lose all meaning. Stimulus packages that erase the idea of a free economy and corrode capitalism.

Will the economic stimulus packages work? No one can answer this question with any certainty.

But most are in agreement that something had to be done in 2008 and 2009. With any luck – and it’s frightening that trillions of dollars in allotments might boil down to luck – the stimulus packages will work well enough to actually stimulate the economy back to stability…maybe even prosperity.

There’s just one question that begs to be answered: Is the massive government borrowing that’s required to pay for the assorted stimulus packages (funds that will come primarily from the Chinese) going to lead to a massive U.S. economic catastrophe?

In other words, is the U.S. Government racking up credit card debt that it intends to pay off with a home equity line, collateralized by a house it expects to appreciate in double-digits?

Let’s hope not.

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