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The current Wall Street collapse has its roots in the technology-stock bubble of the late 1990s, when the price of the stocks of Internet startups skyrocketed, then collapsed in 2000 and 2001, resulting in the loss of $7 trillion worth of assets and the recession of 2001-2002.
The Fed's loose money policies under Alan Greenspan encouraged the technology bubble. When it collapsed into a recession, Greenspan, to try to counter a long recession, cut the prime rate to a 45-year low of one percent in June 2003 and kept it there for over a year. This had the effect of encouraging another bubble - in real estate.
As early as 2002, progressive economists such as Dean Baker of the Center for Economic Policy Research were warning about the real estate bubble and the predictable severity of its impending collapse. However, as late as 2005, then-Council of Economic Adviser Chairman and now Federal Reserve Board Chairman Ben Bernanke attributed the rise in U.S. housing prices to "strong economic fundamentals" instead of speculative activity. Is it any wonder that he was caught completely off guard when the subprime mortgage crisis broke in the summer of 2007?
And how did it grow?
According to investor and philanthropist George Soros: "Mortgage institutions encouraged mortgage holders to refinance their mortgages and withdraw their excess equity. They lowered their lending standards and introduced new products, such as adjustable mortgages (ARMs), 'interest-only' mortgages, and promotional teaser rates." All this encouraged speculation in residential housing units. House prices started to rise in double-digit rates. This served to reinforce speculation, and the rise in house prices made the owners feel rich; the result was a consumption boom that has sustained the economy in recent years."
The subprime mortgage crisis wasn't a case of supply outrunning real demand. The "demand" was largely fabricated by speculative mania on the part of developers and financiers that wanted to make great profits from their access to foreign money that has flooded the United States in the last decade. Big-ticket mortgages were aggressively sold to millions who could not normally afford them by offering low "teaser" interest rates that would later be readjusted to jack up payments from the new homeowners.
But how could subprime mortgages going sour turn into such a big problem?
Because these assets were then "securitized" with other assets into complex derivative products called "collateralized debt obligations" (CDOs). The mortgage originators worked with different layers of middlemen who understated risk so as to offload them as quickly as possible to other banks and institutional investors. These institutions in turn offloaded these securities onto other banks and foreign financial institutions.
When the interest rates were raised on the subprime loans, adjustable mortgage, and other housing loans, the game was up. There are about six million subprime mortgages outstanding, 40% of which will likely go into default in the next two years, Soros estimates.
And five million more defaults from adjustable rate mortgages and other "flexible loans" will occur over the next several years. These securities, the value of which run into the trillions of dollars, have already been injected, like virus, into the global financial system.
But how could Wall Street titans collapse like a house of cards?
For Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, and Bear Stearns, the losses represented by these toxic securities simply overwhelmed their reserves and brought them down. And more are likely to fall once their books - since lots of these holdings are recorded "off the balance sheet" - are corrected to reflect their actual holdings.
And many others will join them as other speculative operations such as credit cards and different varieties of risk insurance seize up. The American International Group (AIG) was felled by its massive exposure in the unregulated area of credit default swaps, derivatives that make it possible for investors to bet on the possibility that companies will default on repaying loans. According to Soros, such bets on credit defaults now make up a $45 trillion market that is entirely unregulated. It amounts to more than five times the total of the U.S. government bond market. The huge size of the assets that could go bad if AIG collapsed made Washington change its mind and intervene after it let Lehman Brothers collapse.
What's going to happen now?
There will be more bankruptcies and government takeovers. Wall Street's collapse will deepen and prolong the U.S. recession. This recession will translate into an Asian recession. After all, China's main foreign market is the United States, and China in turn imports raw materials and intermediate goods that it uses for its U.S. exports from Japan, Korea, and Southeast Asia. Globalization has made "decoupling" impossible. The United States, China, and East Asia in general are like three prisoners bound together in a chain-gang.
Many on Wall Street and the rest of us are still digesting the momentous events of the last 10 days. Between one and three trillion dollars worth of financial assets have evaporated. Wall Street has been effectively nationalized. The Federal Reserve and the Treasury Department are making all the major strategic decisions in the financial sector and, with the rescue of the American International Group (AIG), the U.S. government now runs the world's biggest insurance company. At $700 billion, the biggest bailout since the Great Depression is being desperately cobbled together to save the global financial system.
Inside the Economic Rescue Plan: One Giant Bailout ...
Inside the Economic Rescue Plan: One Giant Bailout ... was generated during the massive bubble ... too much worthless money (in the form of debt) will make the economic ...
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Radical rescue: Hundreds of billions for government bailout
Many just don't support the bailout in its current form. ... The transaction did not include about ... he would not support the bailout. Again, he is for it to rescue the greedy ...
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Thinking the bailout through - Paul Krugman - Op-Ed Columnist - New ...
... be far richer as a result of this rescue ... Today’s economic distress and whatever form it may take in the future ... the dragon has been cut off, and the current federal bailout ...
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Meltdown and Bailout: Why Our Economic System Is on the Verge of ...
Meltdown and Bailout: Why Our Economic System Is on the Verge of Collapse ... is to buy these failing banks at their current market ... IT that there are problems with the dog-eat-dog form ...
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TheStar.com | World | Bush pleads for economic bailout
... 700 billion economic bailout package – now referred to as a "a rescue ... risks "economic catastrophe, potentially." McCain said he did not believe the current ... this bubble will ...
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Senate backs reworked bailout plan
Look at the bailout, and its pretty clear that outside of Wall St. nobody will ... of savings will initiate their 'risk diversification' plans taking the form of ... And all of this in the midst of the economic crises!!! Posted 01/10/08 at 12:14 ...
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Source: Globe and Mail
NewsDateTime: 1 hour ago
House ready to try again after Senate approves bailout
... version of the bailout measure to start loans flowing and stave off a potential national economic disaster. But critics on the right and left assailed the rescue ... in any Economic Bailout http://www ... Did you see how much of the bailout we are sending ...
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Source: Rocky Mountain News
NewsDateTime: 1 hour ago
Main Street's view of the Bailout
Why are we not turning to the economic ... The proposed $700 bailout proposed by U.S. Treasury Secretary Henry Paulson, in its current form, will do ... We did not drink the Cool Aid when everyone was inflating the bubble because we knew we could not ...
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Source: BusinessWeek
NewsDateTime: 9/29/2008
Taxpayers Shouldn’t Fund Wall Street’s Bailout
There’s also the problem of the bailout’s sum. The current crisis is caused by rapidly ... we can do. Please call your representatives and tell them no bailout in any form. ... no effort to explain what exactly the scenario would be if the bailout did ...
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Source: BusinessWeek
NewsDateTime: 9/30/2008
Analysis: Congress repeats 1930s errors with bailout vote
In the 1930s, the US Congress did more than its fair share in helping to ... They also barred any form of regulation of the industry as president ... So now they need a rescue package for the bailout package?? You couldn't make it up.
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Source: Times Online
NewsDateTime: 9/30/2008
"An economic 9/11," warned Terry Connelly, dean of Golden Gate University's Ageno School of Business, of the potential fallout. As the package went down, panicked investors caused the Dow Jones industrials to nosedive nearly 780 points in their largest one-day point drop ever. Markets across Asia fell sharply Tuesday in the wake of the Wall Street downdraft. Lawmakers defeated the legislation by a 228-205 vote, although Democratic and Republicans leaders and Treasury Secretary Henry Paulson all pledged to keep working for a package acceptable to all sides. Vowed Mr. Bush: "This is not the end of the legislative process." In the meantime, the economic wreckage that the administration and Congress have warned about - rising unemployment, shrinking nest eggs and prolonged recession - might not happen immediately, but that doesn't mean it won't happen at all. "This is like the advice you get from the doctor who says you should quit smoking," said Robert Brusca, chief economist at Fact and Opinion Economics in New York. "You know he's right. But if you don't, you're not going to die tomorrow and you're not going to die next week. But at some time, it's probably going to get you." For now, Treasury was expected to work with other government agencies, including the Federal Reserve and the Federal Deposit Insurance Corp., to deal with problems on a case-by-case basis. "Our tool kit is substantial but insufficient" without a bailout, Paulson warned. There are some steps the Federal Reserve can take to cushion damage from the worst credit crisis since the Great Depression. The Fed, which has been providing billions in short-term loans to help banks overcome credit stresses, could keep expanding those loans in an effort to spur financial institutions to lend more freely again. And, it could keep working with other central banks to inject billions into troubled financial markets overseas. Undoubtedly, both businesses and consumers will run for cover. They will clam up. The snowball hitting the economy will pick up speed and gather mass. Ken Mayland economist, ClearView EconomicsAlso, the Fed could make it easier for banks and investment firms to draw emergency loans from the central bank by expanding the type of collateral they pledge to back those loans. And, if the credit crisis were to turn even worse, the Fed also has the power in extreme circumstances to expand emergency lending to other types of companies and even to individuals if they are unable to secure adequate credit from other banking institutions. The Fed also could do an about-face and start cutting its key interest rate again. The Fed in June halted an aggressive rate-cutting campaign and has kept its key rate since at 2 percent. While some Fed officials doubt that another rate reduction would do much to boost confidence and persuade banks to begin lending again, Brian Bethune, economist at Global Insight, insists a deep cut would pack a powerful punch. It would lower the prime lending rate, now at 5 percent, that serves as a benchmark for credit card rates and many other types of loans. Peter Morici, an economics professor at the University of Maryland, suggests Americans should be conservative with their money and focus on paying down debts. However, Morici told CBS' The Early Show that without some sort of government intervention, "everyone's personal finances are going to be worse. This has to be solved." If Congress doesn't act, analysts, who were scrambling to downgrade their economic forecasts, believe the U.S. economy could shrink even further. The unemployment rate - now at a five-year high of 6.1 percent - is expected to hit 7 or 7.5 percent by late 2009, which would be the highest since after the 1990-91 recession. Some economists say the jobless rate could rise even more. "Undoubtedly, both businesses and consumers will run for cover. They will clam up," said economist Ken Mayland, president of ClearView Economics. "The snowball hitting the economy will pick up speed and gather mass." More banks could fail, too. In the second quarter that ended in June, the Federal Deposit Insurance Corp. estimated 117 banks and thrifts were in trouble, the most since 2003. The threat of more banks failing in the U.S. and abroad forced the government to act swiftly. The tanking stock market and falling home values - the single-biggest assets for most Americans - have taken big bites out of people's wealth and their retirement accounts even as high energy and food prices are shrinking paychecks. Consumers are major shapers of the U.S. economy. If they retrench, the country will go into a tailspin. The bailout plan was intended to revive jittery and fragile banks on Wall Street and Main Street by buying billions upon billions of their worst mortgage-related assets so that lending, the oxygen of the American economy, would flow freely again. "People are going to go home and look at their 401(k)'s and not be very happy, and these are not just people from New York, but Iowa and everywhere else. This bill is meant for everyone - not just Wall Street but Main Street," said longtime New York Stock Exchange floor trader Theodore Weisberg. For some perspective on the value of $700 billion, consider this: According to the Wall Street Journal, half the money FDR spent on his New Deal program to lift the country out of the Depression and banking crisis was for public works projects. For $250 billion in today's dollars, the nation got 8,000 parks, 40,000 public buildings and 72,000 schools. On a more mundane level, $700 billion could pay the wages of 22 million average Americans for a year. (According to the Labor Department, the average nonsupervisory, non-agricultural wage was $612 a week in August.) The government could pay off the $550 billion in outstanding student loan debt in the United States, and then some. That's from both government and private lenders. Seven hundred billion dollars is five times what the federal government has devoted to Gulf Coast recovery in emergency funds and tax credits since Hurricane Katrina.
The number of Americans continuing to collect uninsurance claims increased by 48,000 to 3,591,000 for the week ended Sept. 20, the most recent week available. The 4-week moving average jumped 46,750 to 3,528,500 from the preceding week. Economists from Briefing.com expect September job losses to spike to 105,000 and for the unemployment rate to remain steady at 6.1% when the government's monthly report is released Friday. The economy already has lost 605,000 jobs this year
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