The diagnosis of this issue takes us through several turns, but the crux of the matter, unfortunately, lies in the lap of our political leaders, who have tried for decades to pander to specific blocks of voters in order to gain more political power. It could be argued that these political maneuverings are extremely similar to the Machiavellian politics that have been looked down upon for centuries as unethical and immoral. It’s an unfortunate aspect of our Republic; an aspect which nearly all of us have been silent about as it has rolled through our nation from the top down.

There are several long-running macroeconomic relations involving “interest rates, equity, prices and exchange rates suggested by arbitrage in financial and goods markets” (Dees, 2008) that have an impact on any economic situation found throughout major economic setups.

As if an imploding housing bubble and energy price super spike weren't damaging enough, our ailing financial system decided to slide into full cardiac arrest. And while the White House, Congress, and the Federal Reserve have all shifted to an extreme level of apparent earnestness to try to deal with the exploding credit crisis, even the perfect mix of fiscal and monetary policies seems unlikely to now prevent the worst recession in a generation. As JP Morgan Chase summed things up in a note to its clients, "The fat lady sings." The whole financial fiasco has moved far beyond liquidity problems on Wall Street. It has certainly started to affect the average citizen on a day-by-day basis.

The prospect of a downward spiral of house prices depresses the value of mortgage-backed securities, and, therefore, the capital and liquidity of financial institutions. “Experts say that an additional 10% to 15% decline in house prices is needed to get back to the pre-bubble level. That decline would double the number of homes with negative equity, raising the total to 40% of all homes with mortgages. The mortgages of five million homeowners would then exceed the value of their homes by 30% or more, which could prompt millions of defaults” (Feldstein, 2008). This is the cold, hard reality of the matter which we should all come to recognize, respect, and fear accordingly.

This is one of the biggest reasons that our economy has slipped into such a large, downward spiral. Many don’t fully understand how much of our economy is tied to the housing market, as millions of people call on their personal home equity to provide liquidity for their many needs. When home values are plummeting, it’s not just the real estate brokers who suffer, but rather, the entire nation. Suddenly, an emotional depression (rather than an economic depression) starts to nest inside the minds of young Americans as they finish college, get married, start a family, or look for their first real job as a trained or educated worker. This is important because the economy is merely a reaction or reflection of the mass emotion held by the people. When negative emotions are allowed to control spending habits, consumerism officially begins to dwindle.

As mentioned in previous articles, nearly 70 percent of the U.S. economy is made up of consumer spending. Yes, Americans have never been known for their ability to save money, but we have been known as a people who have a knack for creating money and money opportunities. If the pipeline of consumerism dries up, then much of what we call the “strong and vibrant U.S. economy” tends to follow.

Economists and politicians have eagerly proposed policies aimed at stopping the decline in housing prices. “The government can't and shouldn't be trying to stop price declines” (Glaeser, 2008), according to Edward Glaeser of Harvard and Joseph Gyourko of Wharton. This artificial floor that Glaeser suggests the government is trying to secure could be one of the reasons for such a massive decline in the housing market. On one hand, we have an economy that is supposed to be strengthened by the fact that there is little fiscal manipulation to interfere with the free markets. On the other hand, some would argue that without a little bit of Keynesian economic manipulation, people would lose jobs, homes, and money.

The unsettling trend that is beginning to emerge from American politics is that there is always something “they” can or should do to stop the negative things that happen inside a free market. Somehow, the idea that everyone deserves something has manifested itself and taken root in the offices of Washington, DC leaders. The truth of the matter is that business cycles are in existence for a reason, slowdowns and expansions occur because of innovation and failure, and learning and wisdom take hold out of the reaction to natural events. When governments begin to water down the natural events of a free market, they unfortunately begin to increase the likelihood that unnatural events will take place, unnatural events which none of us have ever seen before, and are therefore unprepared to deal with.

“If we think the housing bust is bad then we should probably prepare for worse to come. Business Week says national home prices could plummet an additional 25% over the next two or three years” (Coy, 2008). An additional decline of 25 percent would be devastating to home equity lenders and even more devastating to people who have borrowed against their home equity. Houses that were selling for $400k just two years ago are already being sold for fifty-cents on the dollar, but as mentioned by Coy, an additional 25 percent decline could be on the horizon.
This greatly affects people who are in homes right now, but it’s not a bad situation for people who are currently looking to buy their first home. With the bad comes some good, and this is one of the few good things about a housing market that is fading away into the background. It’s certainly a buyer’s market right now, but unfortunately, this has a devastating impact on the gigantic industry built on selling real estate.

Calling this year’s turmoil on Wall Street “the worst financial crisis since the ’30s” and “the most dramatic event in a lifetime,” Harvard’s often reserved economic experts did not mince words in describing the ongoing financial crisis that has seen the disappearance of three of the nation’s five major independent investment banks and the government rescue of one of the world’s largest insurers. Professor of economics Kenneth S. Rogoff echoed the sentiments he expressed at an April panel discussion at Harvard, in which he said that the ongoing economic crisis “looks like a really bad one.”

How did all of this begin, and where did it come from? Could we have avoided this fiasco? Answers to these questions will be attempted, but first, it is important to classify and understand our current situation in more detail.
On October 13, 2008, the chief executives of nine large American banks were called to a meeting at the Treasury Department. At the meeting, Secretary Henry Paulson offered them $125 billion from the federal government in exchange for shares of preferred stock. The chief executives accepted his terms. “In some accounts of the meeting, Secretary Paulson is described as playing the role of the Godfather, making the banks an offer they could not refuse. But in one important respect, he was more Santa Claus than Vito Corleone: the agreement allowed the banks to continue paying dividends to common shareholders” (Scharfstein, 2008).

Would it have been more beneficial to the U.S. economy if these banks were allowed to live and die according to the demand of the free market? I think that if this is the question we are asking, we are way off base. It’s not a matter of benefit, nor is it a matter of what is right versus what is wrong. Instead, it’s a matter of what we are prepared to deal with in terms of ramifications. It’s a matter of what we are capable of achieving if things don’t go according to plan!

Chrysler was an excellent example of how businesses can repay their obligations to the tax-payer, but the mere fact that the automobile industry is right back where it found itself so few years ago is a telltale sign that we’ll never be able to do enough. We will never be able to stop the negative things that happen in a free market. It is the opinion of this writer that the efforts expended to avoid the negative things of a free market are supporting the poor precedent that was unfortunately set so many years ago. Political innovation and problem solving has taken a back-seat to political precedence.

In future installments, I will be analyzing some specific incidents in recent history, in an effort to help all of us make more sense of what is going on and what we can do about it. Looking at the situation in this way will help us know what to expect. As a wise man once said, “Those who are unable to learn from the mistakes of history are destined to repeat them.”