Great Depression Round 2?

I urge all of you to listen to the latest This American Life entitled "Another Frightening Show About the Economy." You can download it for free from ITunes under the podcast section and you will be enlightened.

I imagine a lot of people are like I was before I heard this show. When it comes to our current economic crisis, I had a very remedial understanding of what was going on. I knew that big mortgage companies and banks took out loans and now can't pay them back. This meant on a very basic level that the average person was having higher interest rates and more trouble with getting a loan. The government proposed a bailout plan that would put $700 billion dollars into the market, but the potential of this seemed to only pad the crash rather than rescue the market.

Now I understand on a much deeper level what is going on. Ira Glass interviewed all these different people and had them describe the situation in layman's terms, using examples that related this situation to the life of an individual. I.e., certain loans are like credit cards, certain companies (mutual funds) are like savings accounts. For all the details, listen up. It is amazingly interesting and scary.

Anyway, the thing that struck me the most is this whole Credit Default Swap business. I had never heard of this stuff before, but in the most basic, metaphorical explanation based on what I just learned, here goes:

So say Dave and I buy fire insurance for our apartment. A couple of my friends also buy fire insurance on my apartment. They don't live here but they are paying a fee to purchase insurance on my house and will get a payout if my house catches on fire. They do this because their house is brand new but my house is old and more susceptible to fire. More and more people buy fire insurance on my house, from a local company who is reaping in the benefits of all these fees and policies, thinking that the house is actually very stable and nothing will happen to it. Well one day, an electrical fire starts and burns everything down. There are no regulations on these transactions so Dave and I can claim we lost x amount of money. Because all of these negotiations are private, we don't know much about the company or anyone else, and vice versa. So, we claim x amount of money, and so do the other 100 people who bought fire insurance on my apartment.

Let's back up. The insurance company had 1 billion dollars when they opened up. They sold all these policies and earned more money, but they don't actually have enough to pay out all the claims on my apartment fire. But they were smart! In order to make these deals safer, they did the same thing but in reverse. They bought insurance from another company on many houses they knew were likely to catch on fire. When those houses catch, my insurance company will get the money. So then if my apartment catches on fire, they have the money from the other fires and can just pay out all the policies they sold. Except my apartment caught on fire first.

This translates to bonds. Say McDonalds buys a share of Freddie Mac via bonds through the stock market. McDonalds goes to an agency that sells insurance for bonds (let's call this agency Basil Inc), meaning if Freddie Mac goes bankrupt and can't pay out their stocks, Basil Inc. will pay McDonalds all the money they invested in Freddie Mac, minus a share and some additional fees. Well, then Basil Inc. sells the same insurance policy on the stocks that McDonalds owns to fifty different companies. They are making a lot of money and Freddie Mac is a safe, reliable business so the risk of them going under is very slim.

Freddie Mac is giving out loans to people with money that doesn't actually belong to Freddie Mac but rather to other companies they have taken out their own loans from. Those companies have taken out loans from other companies, so in a given day, Freddie Mac owes Company A and Company A owes Company B and Company B owes Company C and Company C owes Freddie Mac whatever amount of money. When one of them goes bankrupt, the whole circle falls through. Well, Freddie Mac made some pretty dumb choices and gave out a lot of loans that people couldn't pay back. So now Freddie Mac owes Company A money that Freddie Mac doesn't have. In theory, Freddie Mac would get the money from Company C. But Company C doesn't have the money because they're getting it from Freddie Mac, essentially. Dave calls this circle jerking.

So anyway, the above paragraph happens. Freddie Mac goes bankrupt and shit goes crazy. The circle jerk is no longer working. Now, all the people who bought insurance on the bond of Freddie Mac that McDonalds owns are going to Basil Inc. and saying, this stock fell and I have an insurance policy through you that states you owe me money. Basil Inc. doesn't have the money because the insurance policies they have bought on other people's stocks haven't paid out yet. People are pissed. And fucked.

So the government steps in. This whole insurance buying and selling process has been completely unregulated, because of Republicans along with Democrats. Congress voted not to regulate this but now, the government has to do something. So the government has two choices: 1, the government gives Freddie Mac some money and in addition, takes over some of the loans they've defaulted on, or 2, the government gives Freddie Mac some money and in return owns part of the company. Companies want option 1, obviously, and tax payers want option 2, obviously. The Paulsen Plan, the original bailout proposal, followed option 1. But just this weekend, the Bush administration shockingly switched via some weird clause in the bill and are now employing option 2. Crazy.

Then they realize in order to make a difference, $700 billion isn't enough. Because of how fucked everything and everyone is in this business, no one is selling, buying, trading or giving out loans. Everything is frozen. For people like us, this means interest rates on loans and credit cards are higher and it's harder to get a loan, but it hasn't trickled down to us in a dramatic way yet. For small businesses, this means if they want to open a new factory, they have to actually have a good chunk of the money in order to get a loan for the rest, rather than just taking out a loan for all of it. It also means credit checks will be run more vigourously. This is a good thing in a lot of ways and bad in some ways because there were be more and more people who can't live in our society because they don't make enough money and they can't use a credit card anymore. The government wants to avoid this but knows that the current system isn't working and has to change. They are beginning to nationalize some of the banks, but to much resistance from people who view this as too much government control. Looking from their perspective, if the people in the government are just as corrupt, greedy and power-hungry then them having control of the banks is terrible. Socialism then dictatorship! These people want to run their own businesses. But, they did a pretty goddamn terrible job at it and the government is overriding some of their wishes.

So now the government is buying stocks in banks and taking a "nonvoter role" in them, according to New York Times. This is a compromise between the tax payers, who don't want their money spent on saving these billionaires who made poor business decisions but want the government to intervene somehow, and the billionaires who know the business and the market and worry that the government will fuck up worse.

My opinion? The government should buy some stocks in the banks and take partial ownership but realize that huge reformations and regulations must be discussed and enforced in order to build the market back up in a whole different way, particularly when speaking about Credit Default Swaps. This means there will be a crash that will effect us all, but that's inevitable. I'm pro the government regulating banks and trading and health care, but only when doing it in conjunction with the private business owners. First off, those people are important and powerful and have a more knowledgeable opinion on the market because they run it, versus a government expert who doesn't actually work in it. Secondly, everyone has to work together to solve the short-term problems and build up a reformed system, or else anything in the future will always be unstable and subject to a coup. Lastly, I don't want the government or the private corporations to be all powerful. Balance! There should be serious discussions about this, including officials from other countries, as the circle jerk is international.

But hey, I'm just a nonviolent hippie.

Which reminds me... oooooooooooomm to His High Holiness the Dalai Lama. He's currently in the hospital! That poor man has seen so much shit in his life, I wonder if he wants to die or live. But that's beside the point; I don't think his condition is life-threatening. Anyway, om.