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1/10/09

Financial Crisis: There is Plenty of Blame to go Around

Ground zero for the United States economy started with both greedy banks and greedy consumers. First, greedy banks would offer loans to uninformed borrowers. These loans would begin with a tiny interest rate but would balloon into a large interest rate that would prevent a borrower from making monthly mortgage payments. However, as in Las Vegas itself was at the helm, greedy consumers would gamble on a home purchase. Greedy consumers would purchase a home that was far above their financial capabilities. Once the home was purchased, these greedy consumers would gamble that they could resell their newly purchased home for a profit before their interest rate ballooned into a payment they could not afford. Everything went great for a couple of years until the price of homes peaked. Once home sales started slowing, greedy consumers could no longer sell their heavily overpriced homes. As such, their interest rate eventually ballooned and because they could not make the monthly mortgage payments, the home fell into foreclosure. People lost their homes and lenders lost their money.

When home foreclosures started skyrocketing, small home lenders were the first victims. Large banks also felt the pressure because of the growing number of defaulting subprime loans. Banks are business savvy and as such, had insurance in the event their loans defaulted.

Insurance companies started getting many claims from many banks. However, the greedy insurance companies had learned how to exploit a loophole that allowed it to essentially insure a loan without having to set aside a matching amount of money in a reserve account. As such, the dollar amount of the bank claims was soon more than the insurance company could pay. Therefore, insurance companies started failing.

Before claims started coming into the insurance companies, some of the largest investment banks in the world had invested substantial amounts of money into funds made up of subprime loan paper. At first, the return on this paper was great, but as the foreclosure rate started rising, these funds became increasingly worthless. As a result, billions of investment dollars were wiped out because investment banks did not accurately assess the risk involved in these investments. Additionally, the fact that these subprime loans were not adequately insured made the risk far outweigh any potential returns.

As such, this snowball effect started to occur because greedy lenders borrowed too much money from greedy banks who were willing to lend to uniformed consumers. As the banks' greed caught up with them, they had to start trying to collect on their insurance policies. However, the greedy insurance companies insured more money than it had on reserve. As such, the insurance companies started to fail. As the insurance companies failed, so did the investment banks that had invested in the now toxic subprime paper and in the failed insurance company.

In response to this growing problem, the government tried to treat symptoms without fixing the underlying problems. First, the government tried to cut interest rates. However, because banks were failing, banks needed to hold onto as much money as possible in order to stay "adequately funded" per the FDIC guidelines. This in turn created the current credit freeze. As such, regardless of how low the interest rates got, banks were still unwilling to lend money. As such, no problem was solved.

Second, the government tried an "economic stimulus" package in which it gave people anywhere between $300 - $1,200. The government encouraged people to use the money to make a mortgage payment. However, being able to make one mortgage payment does not mean that the borrower can now afford the loan. As such, the effect of the "economic stimulus" package was that the inevitable was delayed for a couple of months.

Last, and most recently, the government attempted a $700 billion dollar bailout of the financial sector of the United States economy. No current effects have been realized, but given the state of things, this plan will also have to effect of merely delaying the inevitable "bottoming out" of the United States economy.

The point is, everybody is to blame for this economic disaster, and it is going to take everybody to get the United States out of its current financial state.

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