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Curing the Financial Meltdown of 2008
Is it possible to get the economy back on track? A complete overview of what happened and the cure.

Housing and credit were two of the biggest players in the country's financial meltdown.

An ancient Chinese curse proclaims: "May you live in interesting times." Most certainly 2008 qualifies as economically interesting. It’s unlikely that anyone predicted last New Year’s Day the problems destined to befall investment banking firms Bear Stearns and Lehman Brothers, prominent mortgage lender Countrywide Financial, IndyMac and Washington Mutual Banks, global financial services titan Merrill Lynch, government-sponsored mortgage guarantee enterprises Fannie Mae and Freddie Mac, and insurance giant American International Group, to mention only the more prominent institutions experiencing distress.

Understanding the Meltdown
Little doubt remains as to how the problems developed. During the prior half-dozen years, as the nation’s home prices rose dramatically, an ever-increasing number of lending institutions granted mortgage loans indifferent to their soundness. The granting of subprime loans to borrowers clearly incapable of honoring the terms became commonplace. Another device that gained favor in the mortgage industry, Alt-A loans, also known as liar loans, permitted the borrower merely to state income rather than submit proof of it. By 2003, most firms involved in mortgage lending participated enthusiastically, with the created loans securitized, a process involving classification, collection into packages, and offered as collateral for third-party acquisition.

Within a short time these questionably-secured promissory notes became the principal assets in many insurance companies and retirement funds. Understandably, housing enthusiasts proclaimed the advent of nirvana as nearly everyone—appraisers, home buyers, county assessors, mortgage loan brokers, investors and speculators, real estate agents, title representatives, investment bank and securities executives, escrow officers, government tax collectors—reveled in the fees, commissions, taxes, bonuses, and appreciation generated, this in keeping with the conclusion reached by noted philosopher Pogo Possum: "We have met the enemy and he is us." With little concern as to the basic underpinnings of the paper being generated, millions of home loans came into being which awaited only mild disruption to kick off troubles, such as a downward turn in housing prices, an increase in unemployment or a recessionary trend in the economy.

The inevitable came to pass in mid-2006 as housing sales slowed and values began to decline. Systematically the house of cards began to fall, as the malaise intensified with each passing month. With the chickens coming home to roost, and an election season in full swing, it seemed only natural that political activity concentrated on searching for the snowflake on which to blame the blizzard. However, the scene suddenly shifted during the third week in September 2008, when the unthinkable happened: Full repayment from the previously sacrosanct money market funds, from which depositors traditionally get back one hundred percent of their money, became uncertain. This possibility, known as "breaking the buck," shocked the financial world back to reality. Within a few days, political combatants began to express mutual agreement that the federal government must act to prevent the nation’s economy from descending into chaos.

In response to President Bush’s September 18 call for bipartisan legislation to confront the problem, Treasury Secretary Henry M. Paulson, Jr., Federal Reserve Chairman Ben Bernanke, and SEC Chairman Christopher Cox met with congressional leaders late into the night. In a White House address the following day, the president stressed the importance of the federal government acquiring nonperforming mortgage loans from banks, predicting a cost "in the hundreds of billions of dollars." In a follow-up briefing, Secretary Paulson informed the media that the government intended to purchase the bad debt with taxpayer money, initially requesting approval of $700 billion. This, he contended, would free financial institutions to make productive loans, thereby aiding individuals and businesses and spurring economic growth.

Not surprisingly, Wall Street welcomed the news of the bailout, as stock market indexes soared, largely reversing the deep declines registered earlier in the week. As expected, following ten days of intense political wrangling, the nation learned on September 28 that passage of the 106-page "Emergency Economic Stabilization Act of 2008" appeared imminent. Although one provision specifically authorized $700 billion as the program’s ceiling, another called for raising the national debt ceiling by $1.3 trillion.

Curing the Economy
Rather than speculate on how effective this bailout will be over the short haul, and who will be the winners and losers in this particular government lottery, I’d prefer to fast-forward through the decade to view the longer-term effect. When added to our government’s current deficit commitment, this expenditure—for which $700 billion is but a token deposit—ensures that our nation remains awash in red ink. It’s my belief that the political hierarchy will resolve this in a traditional manner: by inflating the currency. Inasmuch as the Treasury Department owns and operates the printing presses, the approach of least resistance will be to pay off our obligations with cheaper dollars. As a result, we may anticipate a noticeable increase in cost of living. It’s true, of course, that government will continue to conceal this by systematically issuing deceptive Consumer Price Index (CPI) statistics. In reality, our cost of living increase over the past forty-years has averaged six-and-a-half percent annually, rather than the under three percent regularly reported. Short of mandated suppression with such devices as universal wage, rent, and price controls, as existed during the Roosevelt and Truman administrations in the mid-Twentieth Century, actual cost of living increase will become double digit.

One final thought is in order. The detailed effects of this proposed bailout will be uncertain for some time. Not surprisingly, those legislators signing on scarcely understand what they’re approving, including both president-elect Barack Obama and Senator John McCain, neither with much comprehension of economic matters. As usual, the devil is in the details with the intricacies crafted to benefit the eventual winners. Be assured that massive lobbying is the cornerstone of this unprecedented raid on our treasury.

I’ll conclude with a moral. "If you owe the bank ten thousand dollars and can’t pay, you’re in trouble. If you owe the bank one hundred million dollars and can’t pay, the bank is in trouble. If you and one hundred million others each owe the banks ten thousand dollars and can’t pay, the nation is in trouble."

Al Jacobs has been a professional investor for nearly four decades. He is a nationally syndicated columnist and appears regularly on ProducersWeb.com, DrLaura.com and SheKnows.com. He draws on his extensive expertise in real estate, mortgage, and securities investments to counsel millions on how to invest wisely and spend prudently. He is the author of "Nobody’s Fool: A Skeptic’s Guide to Prosperity." Subscribe to his financial column, "On the Money Trail," at no cost or obligation, by visiting www.onthemoneytrail.com.

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