Bank failures, nationalization of once private companies, government bailouts that will most certainly exceed $1 trillion…how did this happen? And what is the best solution? As this crisis continues to unfold, Americans are growing increasingly angry as they realize that they will ultimately be responsible for picking up the tab of the excesses of Wall Street. Whose fault is it? You can trace the seeds of this crisis back to the ‘easy money’ policies which began under Federal Reserve Chairman Alan Greenspan and continued under Fed Chairman Ben Bernanke. When there is an abundance of cash available in the marketplace, interest rates drop based on excessive supply. Financial institutions are in the business of lending and their job is to put cash to work as efficiently and safely as possible.
During the first wave of easy money during President Bush’s first term of office, many homeowners replaced their higher rate mortgages with new mortgages at rates we hadn’t seen in thirty years. Eventually financial institutions’ most credit worthy customers had refinanced and these institutions still had plenty of access to cheap money. Make no mistake, publicly traded companies are fiercely competitive and unfortunately, the executives often make management decisions which are focused on quarter-by-quarter results. Not only has that long been the nature of Wall Street, but too often executive bonus compensation is tied to quarterly or yearly results. So if you are a CEO with tons of cash and your competitors are making a fortune lending to subprime credit customers, you are under a lot of pressure to do likewise. All of this was happening during a period of decades of advancing real estate values. Financial industry executives had to have known there were risks but were easily blinded by their own greed and overly optimistic view of the world.
Consumers, too, played a vital role in creating the credit crisis as hundreds of thousands of people clamored to buy homes that they could not afford with little or no money down. In fairness, financial institutions made a compelling sales pitch… “Realize the American Dream of home ownership”… in an era when home values are growing 5-10% or more per year. In the end, the government, Wall Street executives and consumers all had a hand in creating the worst financial crisis since the Great Depression. Yes, there’s plenty of blame to go around. The question now is, “What’s the best solution?” Federal Reserve Chairman Bernanke and Treasury Secretary Paulson believe the only choice is a massive federal government bailout. Others believe that the free market system should be allowed to do what it does best, punish the weak and inefficient. Arguably, Bernanke and Paulson are the two smartest people on Capital Hill by a factor of ten and their views should be carefully considered. At this point, relying on the free market system is highly likely to cause disruptions that no one is prepared for including a cascading of financial institution failures that could easily domino over to other industry groups. Credit markets could dry up completely leaving companies without cash to meet payroll. My experience is that many workers are about one to two paychecks away from being completely out of cash. Best choice? Hold your nose and embrace the bailout.