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U.S. Credit and Banking Crisis

As much as the Administration has been trying to avoid using the word ‘recession’ to describe the state of our national economic crisis with euphemisms such as “a downturn,” “a slowdown,” and even “a period of uncertainty,” the majority of Americans who still believe in the Dream and who took financial risks to see big gains back in 2006 and before are not blind, deaf or dumb.

A major symptom of recession showed itself back in late 2006 in the housing industry when the number of foreclosures in the United States suddenly rose, leading to liquidity issues in the global banking system. California, the Southwest, the Midwest, Florida and other coastal markets experienced a huge housing boom in 2001 and on, but now these areas are the hardest hit by the inability of borrowers to make the payments as set down by the sub-prime and other adjustable rate mortgages (ARM) they agreed to. Loan incentives and the promise of a long-term rise in housing prices persuaded borrowers to take on mortgages, even if it required living beyond their means. They quite reasonably assumed that they would be able to refinance under more favorable terms at some later date. Unfortunately, things didn’t go as expected. The housing bubble burst in 2006 as housing prices began to decline. As a result, refinancing has become increasingly difficult, and defaults and foreclosures have grown in number as ARM interest has been reset at higher rates. The hopes of the Clinton administration’s 1994 National Home Ownership Strategy have been dashed. 2007 saw nearly 1.3 million U.S. residential properties going into foreclosure. This figure overshadows the gain of 69% home ownership back in 2004 which was an astounding increase over the stick-in-the-mud plateau of 64% from the 1970s through the 1990s.


Things have gone from bad to worse. Losses domestically and internationally have amounted to a total of about US$435 billion. Major financial institutions obviously have been hit below the belt by the risk of payment default for a variety of reasons. One of the main reasons is due to a form of financial engineering known as securitization. Securitization is the pooling and repackaging of financial assets into securities that are ultimately meant to be sold to investors. Many lenders were willing to agree to this type of structured finance process. As a result, mortgage payments and their related credit and default risk were passed on to third party investors in the form of mortgage backed securities (MBS) and collateralized debt obligations (CDO). The whole incestuous mess came full circle as corporate, individual and institutional investors were then subsequently hit as housing prices fell, payments were defaulted on, and mortgages reverted back to the institutions that granted them in the first place. Not only have stock markets domestically been drastically affected, but stock markets globally have also declined significantly.


To compensate for such widespread dispersion of credit risk and to stave off further economic damage, lenders have since placed restrictions on lending activity. New loans are offered at even higher interest rates. The impact of this crisis goes far beyond the woes of financial institutions alone. Economic growth suffered downward pressure, and the effects of this downward pressure will continue to be felt for a number of years because the economy is driven by investments. If interest rates for loans are higher, this in general makes loans less accessible to people. Democracy and capitalism might be uneasy bedfellows, but in the very least, choices and possibilities for ventures were made available. It takes money to make money, and many a small business when given a chance has blossomed and flourished to carry on the great tradition of American ingenuity and get up & go. Choice will be severely limited without loans that make more financial sense. As a result, commercial investment will continue to be dictated by the robber barons who built cities on rock and roll. The Bush administration’s too little too late efforts to cut interest rates and allocate federal monetary reserves to bring about economic stimulus are mere attempts at true reform. They are the equivalent of political and economic hand waving.