CHRONICLE OF A GLOBAL RECESSION
I have heard many times in my life some people telling me that the only way to advance and prosper is leaving behind our past and forgetting our errors. I have never believed in this, as the only way of improving and performing at a higher level on your next try is by analysing and eliminating past errors. It has been 10 years since the global financial crises; which has now fortunately got to an end, started. I was still a young kid to perceive anything of the situation, as at my young age of 6 years I wasn’t even capable of understanding what finance was about. But images are eternal, and those images of people losing their houses, of Lehman Brother’s workers leaving their dream enterprise with just a carton box in their hands. Since then an infinite number of trials, arrests and condemns have passed by, and media has always accused the same people, bankers and brokers, markets and investment funds, retailers and even bank’s receptionists. But there is one that hasn’t been blamed at all, that has been unjustifiably sanctified and has come across as our “saviour” while having caused the most harsh and unbearable crisis in history, of course, this was the government. It all started in the US and ended in the US, but problems and dramatic bankruptcies travelled all over the globe, and once again all was caused by the main regulatory agencies, the central government and obviously the FED. Because deregulation was and has been always a myth, and overregulation always a problem.
Let’s start talking about the FED. IN the year 2006, Bernanke astonishingly inverted the Treasury yield curve, where the FED continuously maintains low term interest rates higher than short term rates, generating an excess of demand for bonds in the short term and debt in the long run. He of course knew that this would cause a recession and a credit financial crisis, but he decided allowing the snowball to get bigger before announcing its existence. Without necessity and in the middle of a real estate market boom, he decided also to impose a 1.7 trillion-dollar quantitative easing (QE) policy, where the FED promised to purchase a determined number of corporate and sovereign debt bonds each month. Once again, we were able to see how Keynesianism is nothing more than a myth, and that its policies only serve to slow economic growth in the short term and cause financial crises in the horizon. Surely, and according to several analyses the financial crisis in the period of 2007-2009 wouldn’t have occurred without the FED’s monetary experiments, or at least it wouldn’t have been so hurtful and destructive, preventing almost all financial and corporate bankruptcies. These two policies caused a mix of economic stagnation and inflation in the short term, starting to shrink the American economy. In our minds remains Regan in the 1980s introducing supply-side policies and allowing free markets to fluctuate leading to one of the greatest epochs of growth in the US.
Other of the greatest problems of the recession was caused by one of the greatest government corporations, concretely, the FEDERAL DEPOSIT INSURANCE CORPORATION, or as it is widely known, the FDIC, which was created in 1934 after the Great Depression of 1930. Its main role was to protect small depositors in commercial banks, even though in the last years previous to the crisis it also placed a premium on “unsound banking” and how not, involved the government in the loss. Over the years, the amount covered by the FDIC to every American citizen with deposits in the US has been in the rise. At first it was of 100,000 dollars, while a family of four people could easily benefit from it and have more than 500,000 dollars insured in just one deposit. The latter Troubled Asset Relief Program (TARP) increased the coverage up to 250,000 dollars and financial pools up to 1,000,000 dollars, providing unlimited coverage for certain deposits of a fraction of society.
The FDIC insurance sound pretty and a matter for partying all night long, but that’s not reality, as important problems were caused by this mechanism. First of all, the FDIC insurance destroyed market discipline and the free fluctuation of market forces, causing depositors to don’t worry about the safety, quality or soundness of their banks; as the State would be there to rescue them. Until there were extreme problems with banks, individuals didn’t go to their branches to get out their deposits and savings, which caused one of the most severe conflicts as most depositors had invested in the highest certificate of deposit, assuming that those rates will make them rich in a couple of years, and without realising that if banks payed the highest certificate of deposit with astronomic rates it was because their risk in markets was terrible, and they required capitalizing as fast as possible.
It is easy to see how the FDIC generated incentives for taking enormous risks, leading to financial institutions failures and bankruptcies. At the time, most of the local banks created were operating with extremely high levels of leverage, proper of big and established banks as Bank of America, Chase or Wells Fargo. But local banks with miniscule structures and just one office decided to take the risk thanks to the FDIC insurance (irony be noticed), which caused millions of people to lose their savings, hundreds of entities to close down and entire towns to sink in unemployment.
While doing the research and analysis for this article I was definitely convinced that free markets didn’t cause the financial crisis, by seeing that in the decades previous to the 2000s the government had developed a “housing policy”, that as always is glorious in the short term, but someone will pay for it in the long run. It all started back in the 1930s with the New Deal, as since then a wide variety of government policies had artificially reduced house prices, encouraging people to buy properties over their possibilities, creating a credit bubble that someday had to explode altogether with loose monetary policies. The Fair Housing Act of 1968 and the Equal Credit Opportunity Act of 1979 were practically designed to prevent racial discrimination in terms of loans, mortgages and credit given by banks. The definite policy was the Community Reinvestment Act of 1977, which was thought to encourage banks to invest locally and reduce Euromarkets influence on mortgages. The new law also pretended to facilitate credit for small businesses. The final and real effect was that banks were forced to make loans to low-income borrowers and many African Americans which didn’t comply with the established credit requirements. This oversupply of mortgages and loans caused that almost 70% of the total loans given under conditions of the Community Reinvestment Act became “Non-Performing Loans” (NPL), which supposed astonishingly high bad debts for financial corporations and banks.
To sum up, the financial recession of this last 10 years should serve to show us how the government underperforms when it exceeds its role. Financial risks were taken through various investment and innovative financial vehicles, and mainly incentivised by the FDIOC deposits’ insurance and the artificially low prices houses had due to government housing policy. Obviously, the FED took the biggest part into the problem to make it even worse by generating greater levels of debt and devaluation through their supposedly inflationary policies of QE and near zero interest rates. The government should always be restricted and limited, because if the beast is given power, the economy will tremble, and we will have to tell the chronicle of another global recession.
“I don't want to transform America. I want to restore to America the economic values of freedom and opportunity and limited government that has made us the powerhouse of the world.” – Mitt Romney