World Recession: how it happened and who’s to blame?

The collapse of Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) triggered a federal takeover and despite the efforts to shore up the mortgage system, the shoddy underwriting practices of lenders certainly led more to other problems. What did really happen?

The global crisis similar to “Japanese asset price bubble” started in the 90’s when on September 15, 2008 decision by Lehman Brothers Holdings, Inc. to file for bankruptcy, the buyout of Merrill Lynch by Bank of America, and concerns over the American International Group (AIG) ending in that company's bailout by the Federal Reserve System on September 16 causing “extreme instability in global stock markets.” President Bush announced a proposal for the federal government to buy up to US$700 billion of illiquid mortgage backed securities with the intent to increase the liquidity of the secondary mortgage markets and reduce potential losses encountered by financial institutions owning the securities. The mortgage crisis really began in 2005-2006 when the value of real estate increased as a result that their value reach unsustainable levels relative to incomes. Home prices increased than family income. It is what economist called “boom-bust cycle” similar to dot.com bubble in the 90’s.

For easy explanation let us put this way. In the U.S it is easy to buy anything if your credit history is good. You can buy a BMW and take it home within minutes. What was collateralized from the BMW is the income that Uncle Sam will be still earning in the future. Basically US economy is a credit card economy. It is the same situation when buying a house because they have a lax standard. Most of the Americans who bought homes during the period have little review on their credit history (ability to pay). When the value of these homes increased and so was the interest that a borrower would pay. The uncertainty in the US economy were fueled more in March, 2008 when banks refused to lend more to Uncle Sam resulting to credit crunch or severe shortage of money. As a result more loans were defaulted by borrowers. Since banks have problem with liquidity, the cost of borrowing and lending had become higher causing a large numbers of homeowners unable to pay their mortgage plus they may be paying other loans like the BMW that he bought previously. Trouble of US housing market began in 2004 when US interest rates rose from 1% to 5.3%. The domino effect causes the prices of home to fall; suddenly borrowers owe more than what their home is worth for. Another complication is those borrowings were finance by banks. The bank who lent the money to the homeowner while expects to earn future interest from the money that he had invested. He wanted to earn more. So he borrows money from other markets (credit financing companies in the US and abroad) to finance more homeowners who wanted to buy more homes. Most of those loans were granted by troubled financial institution like Fannie Mae and Freddie Mac, Merrill Lynch etc. So the banks borrow from them collateralized also these borrowings from earnings to be derived from the homeowner or mortgage-backed security. Most of these loans are freely pre-payable and at variable rates. Where Fannie Mae and Freddie Mac did got the money to lend to the bank? They sell these debts (simply means utang mo ibenta ko) to insurance managers, pension fund managers, unit trusts, investment trusts and other banking agencies in the whole world or from the instruments called derivatives. Because these lending (or instruments) is not finance by collateral they exacerbate more troubles in the financial system. Why in the world (money market managers & trust institutions) should they invest to Fannie Mae and Freddie Mac? It is pure speculation in the money market business. It is known as hedging in the financial markets. It means you speculate the price of what you earn in the future from this transaction earning the big bucks if it goes on your way. It is simply like playing in a casino and expecting the dice to favor you since the trend shows that your bet would likely earn more in the future. John McCain called it “casino economics”. Warren Buffet describes derivatives once as “financial weapons of mass destruction”. And he seems to be right on his prediction. What complicates more is the style of these financial investors. Or they also used these derivatives to sell to others hoping the price to fall or short selling. The US SEC had banned short selling but it was already too late for the call. We don’t know for sure if the SSS or GSIS reserve for our retirements are also invested in those funds. If it is not invested in stocks normally it is invested in these money market funds. Oil prices are dominantly affected purely by speculation. When oil traders also speculate the price of oil; say the delivery price 90 days from now would be higher by $5. They are also finance by fund managers again from derivatives. Paying the risk involved that will overcome within that 90 day period like supply and demand volatility situation (weather, problem in distribution routes etc .) What causes really our troubles? It is spelled as this way: GREED. It is the excess of capitalism. Socialist economies are not greatly affected like China and Vietnam by the crisis. And so who was winning again while America is whining, the sleeping giant China. Because their growth is not dominantly finance by credit but by earnings from exports. Since China economy depends from their export to US. Small brother should help the Big brother otherwise China will also be greatly affected by the contagious disease by Big Brother and more trouble to the whole world. Countries with big foreign reserves like Saudi Arabia, Kuwait, Libya, Japan and China should loan their money to help. When bank falls ultimately their foreign deposits will not be secured.

As of today there is estimated $900B related to special loans and rescue package of the US housing mess. The US government bailed out commercial property lender Hypo Real Estate to the tune 35 billion Euros ($47.9 billion). To keep the bank customers from running to ATM machines to withdrawal their money, the federal government has also guaranteed the security of all savings. British Prime Minister Gordon Brown announced his country's 50 billion pound bank rescue plan. The plan included the partial nationalization of Britain's eight main banks, 200 billion pounds in short-term loans and 250 billion pounds in inter-bank loan guarantees. The bailout on banks is said to be intended to restore confidence. Where will the U.S get to finance these billions? They have to borrow from the Uncle Sam to finance the mess with no guarantee when Uncle Sam is paid. Because America is already bankrupt from Iraq and its external debt to foreigners is $16.3 TRILLION as of 2006. They import more than export resulting to a high trade deficit. Each American has a debt of $79,000 or a national debt of $ 9.20 TRILLION. The US $ is virtually worthless when you peg it to their gold deposits at Fort Knox. It is like lending or giving money from your left hand to a friend and getting the money from your right pocket. America will simply get the money from future income taxes of Uncle Sam. Uncle Sam will still don’t know if in the future he can recover the money intended for that bail out when those mortgage-backed securities are said now to be worthless when banks had already written off $500B worth of those assets. Very strange but that is how capitalism works hehe… Karl Marx maybe right (tama ba Sir Mon Abad of 85? hehe) when he predicted capitalism will produce internal tensions which will lead into its destruction. .). Most of the big banks in the US and Europe like UBS and Bearn Stearns invested on hedge funds to fund mortgage lending.

The good things: because of stagflation (slower growth) of world largest oil consuming economy the price of oil will fall due to weaken demand. That is only the good thing to happen from the mess. Interest rates will also fall for bank to earn again more money. Those who will gain are those in food industry. Since people will suspend buying unnecessary utilities. They will become prudent in spending. They will spend first on their stomach than other necessities. I expect that there will be a boom to call center industry hehe since there will be more calls to be made for Americans to settle their credit cards debts.

The very bad things: “when the US sneezes, the world catches cold”. Most to be affected in our country will be export dependent industries like electronics, tourism and mining. The worst thing to happen be a depression that would have devastating effect to the whole world similar to 1930’s that cemented World War II.

Who’s to Blame for the Mess: I think it is purely speculative excess of financial institutions. GREED for more profit. Tama nga siguro that money is the root cause of all evils. Tough times indeed but will the US will get out from its mess. Historically yes, the value of US bonds collapsed in 1792. Alexander Hamilton then Secretary of Treasury borrowed money from banks and bought these bonds when prices recovered the US earns more from the investment. The US Savings loan crisis in 80’s the government bailed out some financial institutions and they earn more when the market become stable. Milton Friedman once says “Government intervention can become useful”.

The Lesson: huwag ka aasa sa utang!!!!