The fifth largest US investment bank and securities trading and brokerage firm, Bear Stearns, recently collapsed. And the United States government used a bail out to have JP Morgan buy Bear Stearns. This has some people saying that America has been conned with a huge Ponzi securitization scam; the bubble has burst and it looks like the government will have to keep using tax-payer dollars to save the big guys at the expense of the rest of us.
But how did this happen? Philosophers’ Playground wrote a helpful explanation which I will reiterate here:
After the internet bubble burst and after 9/11, the economy was shaky, so the Fed lowered interest rates to spur growth.
Because interest rates were lowered, people could buy larger, more expensive houses.
As a result, the housing market kept doing well, so people kept investing in it and lenders kept giving out riskier and risker loans (expecting prices to continue going up).
But then rising oil prices caused inflation, so interest rates were raised to slow inflation.
When interest rates were raised, the people who had bought bigger houses based on low interest rates couldn’t make their payments. (They had adjustable rate mortgages.) In addition to increased monthly payments from increased interest rates, people’s ability to make their mortgage payments were hindered by the rising prices of day-to-day expenses as a result of the inflation caused by rising oil prices.
As a result, houses flooded the market, and less people could afford to buy houses. The increase in supply and decrease in demand caused the bubble to burst.
Bear Stearns had invested heavily in housing loans through re-using (and re-re-using, etc.) profits from loans before actually receiving the profits. When the real estate bubble burst, the investors pulled out and what effectively ensued was a run on the bank.
Since pretty much all of the big financial institutions have invested in a similar “house of cards” fashion, the government bailed them out by getting J.P. Morgan to buy Bear Stearns at a deep discount and assume the bad debt. That is an attempt to keep confidence in the system because–like with a run on the bank–the system is based on confidence. The value of the system is only there if most people believe in it.
Unfortunately, when people lose their confidence in an economic system that only has value because of their confidence, it will collapse and hurt the people. When this nation-wide ponzi scam of an economy collapses, I fear what horrible effect it will have on the working people. I worry that many people will fall into poverty, and many people’s lives–both poor and not–will take a drastic turn for the worse. But what would be the solution? Do we keep investing in a massive ponzi scam to delay its collapse?
How do you think the bloated economic system affects poverty? Post your thoughts on the subject in this thread at the World Hunger and Poverty Forums.