Priorities for Fixing the Financial Crisis

In an article written by Jeffrey D. Sachs (Director of the Earth Institute at Columbia University), he describes what led to the financial crisis we currently are in, citing banks that leant Trillions of Dollars for home purchases and consumer loans to people ill equipped to pay them back. One thing he fails to mention is how many of these consumer loans were piggybacked onto the equity in home mortgages due to the skyrocketing home prices. He has it right that the easy lending practices and speculators drove prices increasingly higher till it peaked and crashed. The Government however, played a big role in the housing crises as well. In the 90’s, under increasing pressure from the Clinton administration, Fannie Mae the largest underwriter of home mortgages was pressured to expand mortgages to low or moderate income people. This was the start of the housing crisis.

He then lists the four cascading threats to the economy. First, the sharp decline in consumer spending for housing, cars and other durables, is creating a direct effect of the sharp decline in lending. Second, many homeowners will default on their mortgages and other loans as mortgage values fall. Third, the banking sector will cut back severely on its lending as it has to continue writing off bad debt. Fourth, the retrenchment of lending threatens even the shortest-term loans which banks and other institutions lend to each other for working capital.

He then lists the gravest risks to economy in severity. The fourth threat, being the worst, if short term commercial paper collapses, it would be difficult for solvent companies to attract working capital. The third threat is the impairment of bank capital. As banks write off their bad loans it could cause a severe recession, not a depression. The second threat, the financial distress of the consumer, will cause many to lose their homes and file for bankruptcy. Consumers as a group will become net savers again after years of heavy borrowing. That trend will not be bad in the long run but will in the short term. The first threat is the cutback in sales of homes. The inventory now is large, housing demand is off and consumer spending on durable goods is way down.

Mr. Sach’s cure essentially is the Government. But hasn’t congress already allocated 700 billion to the Troubled Assets Relief Program (TARP)? The new administration is talking another Trillion dollars. Lets face it the government has no business owning business. We all know out of all this stimulus money, billions will be earmarked to pet projects. If they would spend it on real infrastructure projects like roads, bridges, or schools, it could create millions of jobs. But that would mean subbing the projects to Contractors and also cutting the red tape so these projects get done before we are out of the recession.