In order to comprehend what it is that will restore or hold in remission our anemic economy, one needs to look at what has caused it to be ill. The basic premise can be developed by looking at what the United States has been doing to restore a healthy marketplace.
Be it conjecture or reality, the idea of having more financial regulation may be a solution for what has been ailing us. Turn on CNN or read The Wall Street Journal and there is Treasury Secretary Timothy Geithner trying to ameliorate the infection within our economy.
He most recently has been doing it by trying to convince the U.S. Congress to help unclog the banks' funds. He has deemed that through more stringent regulatory management the banking system will begin to have some faith in lending currency again. The government has tried to accelerate loans by allocating billions of dollars to buy toxic assets, and still the banks have been reluctant to ease the flow of money. The banks might still be waiting for more of the money to come into their system and/or it might have been that more regulations need to be put into place.
In order to find the basis for our current economic turmoil, we really have to look back. Everyone realizes that a primary explanation for the bubble's crash came from something that had gone wrong within our free enterprise system.
Kenneth D. Lewis, the chief executive officer and president of the Bank of America, has given his view, "The story of our economic crisis mirrors every great market bubble in history. Clearly, banks were key participants."
Not only have others placed the blame and asked for bank reform, but Bank of America actually has made a claim that they should redeem themselves by making modifications. Lewis continues, "Amid the turmoil, it has become clear that banks need to make changes in the way they run their business, from risk management to expense control to compensation practices. Most banks are making these changes in a good-faith effort to adjust to new economic realities."
Many of the practices had exacerbated the problem, but it appears as if the lack of control purely has done the country in. There are a few particular banking applications that need to be examined. At least some of them might have been problematic. For example, through securitization, financial investment firms buy mortgages, bundle them and then sell them.
With that condition, loans had been made and the banks had eventually dipped into the subprime loan area. Through this the financial system has had a greater acceptance of higher-risk borrowers. Due to this scheme a force had been created. The bubble had become larger and the price of housing had grown by leaps and bounds.
During the early 1990s the Federal Reserve had invited local interested college professors to its Philadelphia branch. At that time I had been teaching business and I had joined the meeting there. It was the first time that I had been introduced to the term "derivatives" and what role they had played in the financial system. I had a hard time on that occasion trying to understand why it wouldn't weaken our economic system because of the many risks that were taken to insure the underlying causes.
In trying to comprehend what the intent had been, I have since then grasped the significance and what role it has played in the market. It is a concept to engender more economic wealth by generating more debt via spreading the risk out. By doing that it would increase the money supply by the amount of the loan.
It has engendered a concept that the underlying odds would be what are saleable. This principle had been expanded into financial instruments like "collateralized debt obligations (CDOs)" and "credit default swaps (CDS's)." The amount of credit swaps had become enormous.
Intermingled with all of the chance-taking have been hedge funds and their related short sales of stocks, which during the boom banks had found to be quite a lucrative way of creating wealth.
Over the tenure of Alan Greenspan's term as the head of the Fed., he had been vigorously challenged by many in regard to the many gambles that had been taken. Over the years, Warren Buffett has labeled exchanges of risk contracts as "financial weapons of mass destruction."
According to many, the Congresses had great concerns about the lack of restrictions. Greenspan had continued to block any efforts to bring regulation of these financial instruments. He had been very convinced that the free market would provide its own regulation.
In observing Greenspan's years, one could see the euphoria that his actions had created. It had stemmed from him being a strong believer in the free market. This author has believed in the freedom, but with certain stipulations.
During his last few years as head of the Federal Reserve Board, I had examined his ideas, and having been involved in the real estate business, I wondered how he had allowed the continuation of the acceleration of subprime and Alt-A loans. One of my inquiries had been why Fannie Mae and Freddie Mac had been allowing some of the loans that they had been packaging. Other risky loans had been bundled and sold as bonds to Wall Street investors.
With all of the speculation that the mortgage packages had created, something or someone had to pay for the perilous loans. These were obligations that had been made to people who did not have such stellar credit. Through this type of financing they had been able to purchase their dream homes at will.
Greenspan had defended our capitalistic idea by indicating that the market should have been able to take care of itself. The thought had been that eventually equilibrium will be reached and things will be fine. The claim of the free marketers follows the basic capitalistic principle of Adam Smith that the market should regulate itself.
The belief had been that competition aids the market and will stabilize prices. Our free enterprise system has been governed by, metaphorically speaking, Adam Smith's idea of the "invisible hand." Smith's notion was to let supply and demand reach their points and businesses would continuously try to maximize profits and thus would begin to raise or lower their prices to reach their businesses' maximum efficiency.
Today, the market has certainly not been operating on its own. A great deal of the profit-making would certainly depend on the financial market's policy and how tightening or loosening credit would increase or lower the money supply.
Greenspan writes that "Fed Chairman William McChesney Martin Jr. once had said that the role of the Fed was to 'Take away the punch bowl just as the party got going.' " In essence, he had meant that the free market could not operate without some type of intervention.
During the time of the Clinton administration, Greenspan had been urged to have the Federal Reserve use more of its regulatory power.
Greenspan had been so powerful and convincing. When he spoke most thought that he had the absolute omnipotent authority for our monetary system.
When questioned about derivatives and credit default swaps, the former Fed chair says, "The majority of lawyers, in my experience, seek to regulate; that is, to contain certain activities with little weight given to the benefits of such activities. The question is: what do you lose? For the diminution of system risk, you can stop the system dead and eliminate speculative losses. But you will also get significantly reduced economic activity and ultimately lower standard of living."
He continues, "I've been extraordinarily distressed by how badly the most sophisticated people handled risk management. But the question is: If protecting their own resources they can't do it, who's going to do it better?'
In evaluating his aforementioned comments and thinking about the aftermath of his admonition, I'd like to bring up a very major consideration. At first free marketers, like myself, would believe and be fooled by Greenspan's theory of complete nonintervention. The market could probably take care of itself and that is, if all things were equal. Each owner would look out for his own interest.
The complication is that those who deal in risk most often hire others to do it for them. Stockholders of large corporations have executives who take the chances for them and are given bonuses. Many of them, as we have since found out, are rewarded even if they allow and are the causes of a calamity.
This leads to the concept of moral hazard. That owner who takes the financial risk has a different motivation when it comes to the probability from their employee, who is insulated from the perils of it. The hired decisionmaker is most often concerned about immediate gains and will not truly think about the overall health of the company.
The contention is that Greenspan should have been more observant and should have stipulated certain restrictions throughout the banking structure. A lack of carefulness, by the feds, had just perpetuated throughout the financial system.
Throughout the financial system were stated income loans. It was a period of time when loan processors received extra pressures to approve loans that were not viable ones. Faulty appraisals were done primarily so that the appraised value would hit the sale price on the contract, not to mention what the looseness of banking system had caused within the stock market. It is no wonder there is a deluge of toxic assets.
In so many words, greed needs to be controlled. The Federal Reserve should administrate regulations for appropriate wrongdoing and create efficiency. The free markets need to address parameters. That is, the Federal Reserve should have given more credence to restraining freedom of consequence, dishonesty and efficiency.
Before a Joint Economic Committee of Congress, Marten Eakes, the CEO of the Center for Responsible Lending, made the following statement: "If you have high losses, it means, as a lender, you're doing something wrong, not that the borrowers are wrong."
He goes on to explain that he spent eight years trying to stop the abusive lending, "which have cost millions of families already their homes and wealth that they have spent a lifetime building up in those homes."
Later in his testimony, Eakes made a valued statement that brings forth contentions addressing the importance and the absence of the Federal Reserve's regulatory policies within a free enterprise system. He declares, "A market for homeowners is like a soccer game. You do not want to have rules and referees who run around and impinge on the players. But if you do not have boundary rules that say this is what is an ethical marketplace on the boundaries, you will end up with the kind of catastrophic foreclosures that we have had."
He alludes to the statement that Greenspan had made about being surprised in regard to the profound economic meltdown, "You know, for people to say that this is a surprise to them is mind-boggling to me, because I feel like I have been talking about this, and hearings have been recognizing the problem since 1994 when the Home Ownership and Equity Protection Act was first passed.
"In that bill, Congress designated that the Federal Reserve was to be the entity to pass these boundary rules to make sure that unfair and deceptive practices did not creep into the mortgage marketplace. And the Federal Reserve to date has simply not done its job."
In a recent interview in The Wall Street Journal, Geithner claims, "The United States of America got itself in the position where enormous damage has been done as a consequence of a long period of excess risk taking without meaningful supervision.
"And the consequence of that is tragic because they're basically fundamentally unfair; because people who were careful and responsible, conservative in their decisions, are suffering a lot from the consequences of mistakes they were not a part of."
To determine what has caused our severe downfall, one has to evaluate the system that caused it. The most powerful force and the catalyst for our economy's wellbeing lies within the Federal Reserve. If one looks back at what I have just written, one can see that the whole problem was founded on manipulation, a lack of proper forecasting, greed and short-term gain without heeding the long-term horror of inordinate risk taking.
The spreading disease could have all been cured with the proper use of regulatory powers.
Trying to do a diagnosis, be it recession or depression, the ailment lies not in the stars but strictly should be blamed on the unabridged free rein that was given by the Federal Reserve and the lack of proper calculations by Greenspan.
In conclusion, it is more than finding the source of the problem. The prevention of such an inordinate catastrophic economic burst from ever happening again might be inhibited through the use of certain measures.
During the G-20 summit, leaders of the world agreed that there needs to be a coordination of regulation of the global hedge funds and the private equity funds that as of today have not had any rules. The leaders also deem that banks should be required to have reserves to set aside for decelerations of the economy.
Regulation needs to be coordinated with the other powers of the world. The United States doesn't want an imbalance so that investors will invest more in those countries that have less regulations.
To have the free enterprise system continue to thrive, as it has before, it cannot have too much meddling by the government or banking system, but needs some form of economic engineering. And yet there cannot be too much government or banking system sanctioned interference.
But we cannot allow again the euphoria created by the Federal Reserve chairman to create an economy without the proper adaption to the moral hazard that creeps into the explosion. The unbridled form of insatiable greed caused by an "anything goes" attitude did not allow the free market to reach its equilibrium.
Therefore, the free enterprise system throughout the world fell on its face. The epidemic began when Greenspan spoke, and the economic world followed.
Sponsored by Century 21 Alliance
No comments on this item
Only paid subscribers can comment
Please log in to comment by clicking here.