The Great Ponzi Scheme
The economy collapsed into a great recession because it was fundamentally flawed in the first place. The U.S. housing market, which underpinned the old economy, boomed because the government deregulated banks. The deregulation that began with Reagan widened under George Bush the First. It widened a little more under William Jefferson Clinton, and it broadened even further under George Bush the Second.
As the banking economy became increasingly unregulated, it began to give out loans with almost no collateral. It gave out loans with almost no downpayment. It gave out loans with balloon payments far beyond what the mortgage holder could possibly bear when the time for those balloon payments came due. It gave out loans with adjustable interest rates that would in a few years result in interest far beyond what the mortgage holder could currently support. And all of this worked. For awhile.
Everyone went along because, so long as the housing market was rising … 1) collateral and downpayments didn’t matter because the home would be worth so much more in just a year that the bank would LOVE to foreclose and sell the home for a profit; 2) the homeowners could always meet the balloon payment by selling their houses for a profit in order to make the big payment (so they bought on speculation); 3) sudden upward adjustments of interest at the five-year point could easily be handled by refinancing because the home would have gained so much value that the owner would now have a lot of equity in it, even though he or she had not made much of a downpayment.
All of this only works so long as the market is rising. That is why some people are now calling the housing market a Ponzi Scheme. Like any upside-down pyramid scheme, it only works so long as you can keep expanding it at the top. The pyramid expanded by those very government actions I mentioned above, which allowed more and more people to qualify for homes and those who were already in homes to qualify for larger homes. Every time the market began to slow down, the administration of the time (be it Republican or Democrat) agreed to deregulate banks a little more in order to increase the amount of money people could get for loans and the number who could qualify for loans. That was the only thing that allowed the price of homes to continue to escalate so rapidly. Otherwise, they would have topped out long before they did.
The problem with a Ponzi scheme is that when the growth stops, everyone who got in near the end loses big time for the sake of a few who walk away rich.
The economics as to why this was a Ponzi scheme are simple: if there are no buyers who can afford homes, the housing market will not rise. So, if everyone is already in debt to their eyeballs, the only way to make it possible for them to pay more for their next house (so housing prices can rise) is to increase their income or to decrease the regulations on debt so they can take out more debt even without an increase in income. The government, having very little control over income, eased credit regulations so buyers could expand their debt.
Every economist should have been able to see this was a Ponzi scheme on a giant government-backed scale with inevitable failure built in (yet nearly all economists missed it): Sooner or later, the banks would be as deregulated as they could get. Therefore, there would be no way to expand debt. Therefore, there would be no way to increase housing prices. Therefore, none of the things enumerated above that protected banks and buyers under loose credit rules would apply anymore. All of those factors only worked in a rising market. Nobody thought about what happens when the market stops rising. Buyers would not be able to refinance their homes or sell them for a profit, so they would not be able to meet their balloon payments or adjustable interest rates that were designed to spike upward in three to five years.
So, the logic for forecasting the end of the housing bubble was simple. Collapse was inevitable, but no one wanted to see it. It wasn’t good game for homebuilders or realtors to talk. Stopping it was not in the interest of major capitalists who were becoming fabulously wealthy in this bull market. No government administration wanted to deal with such a crash, so they all readily followed the U.S. government’s biggest trusted economic guru — Alan Greenspan — and opened the floodgates to ever more deregulation. If anyone in government did see what would happen, they worked feverishly to keep it from happening on their watch by loosening credit even more. Only a few lone voices spoke against what was happening, and no one listened. Many are in denial still.
That is also why one could know without a doubt that the actions of The Fed after the Great Recession began would do nothing to bring recovery. All of those actions were more of the same thing — trying desperately to find a way to expand credit again so that the bull housing market would recover. (More on the Fed’s actions for economic correction in my next post.) Only thing is, people had had enough. While they may not have understood the underlying flaws in the economy, they knew they were tired of having all that debt above their heads. Thus, I write at a time when the government’s attempts to free up credit have accomplished absolutely nothing.
A Ponzi scheme only works so long as there are more and more investors. Eventually, there were no more takers, and the whole thing collapsed.
Stories of Ponzi schemes:
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