Thursday, May 7, 2009

Everything I Need To Know About Economics I Learned From Ira Glass

For your general amusement, I am posting the "explanation of bank crisis" I wrote to help Tony with his econ homework. I don't know if I quite got all of it right. Mainly I learned what I know from listening to This American Life and the Planet Money podcasts. I am no economist. So, please bear that in mind.

Before the Clinton Administration, this is how someone would get a mortgage. They would go to the mortgage company with proof of their income, savings, all of the money that had at their disposal. They would have to have a large sum for the down payment on the house and the mortgage, ideally, would cover the rest of the price of the house. The bank/mortgage company would determine how big of a mortgage they could afford to pay back monthly. This would determine the size/price of the house they could buy. If they didn't make enough money to pay enough back each month, they wouldn't get enough money to buy the house.
The Clinton Administration deregulated the mortgate industry which allowed more risky loans. This seemed like a good idea at the time because more money would flow, it would be freer enterprise and so on.
There was a huge boom in the housing market. People were buying houses left and right and the price of houses kept going through the roof. So mortgage companies, in hopes of making more money, kept giving out riskier and riskier loans. More loans means more money in the pockets of the mortgages companies. They started giving out loans to people without making the people prove how much money they have and make. In short, people who did not have the money to pay for their loans could get loans. If they paid their mortgage, Yatzhee. If they couldn't pay their mortgages, we get the mess we're all in.
Let's say I am going to start a bank. I have $10 of my own. Laurie has $100 to deposit in a savings account. This is the capital. Now Gina comes along and wants to buy a house for $100 (a very small house.) I loan her the $100, she will pay me back with interest and anything over and above what is Laurie's money I get to keep. That is how banks make money (in essence. It's a little more complicated than this, but this is the basic idea.) Now, time comes for Gina to pay me back and she says "Oh, sorry, I don't have the money." You see the trouble that puts me in. So I take the house from her and try to sell it to make up Laurie's money.
Problem being, if people all over the place did this, the price of houses would drop dramatically and I would not be able to sell the house for enough to give Laurie her money.
Here's where the government comes in. So, these banks are failing in this manner and the government proposes a bailout. They just had a bailout of some of the largest money lenders in the country and it did not go well. They took the bailout money and did whatever the hell they wanted with it. There was public outrage. It was a debacle. So, this time the government is going to take the tax payer's money, the money that we all pay in taxes, and they are going to buy into the banks. An analogy would be that the first time it was like they gave someone the money to pay their rent and the person spent it on booze or something. The second time, the bank bailout, is more like they are paying someone's rent and, in return, they not only get to move in, but they can kick out the tenant if they want to. The government owns part of the banks now. This keeps the banks afloat but there are ramifications for the future that some people don't like. For example, the banks are not free, independant businesses, they are accountable to the government and the bank owners don't like it because the government can kick them out.
So, anyway, along with this, the banks are not giving out any loans. It has become far too risky. This is a problem because a good portion of American businesses run off of loans. It is how they rent commercial spaces, how they often get their supplies, and so on. Businesses fail. Then other businesses start to fail that held them up. For example, say there are a dozen restaurants in town who need to take out some kind of loan to get something that will keep them in business. Suddenly the banks aren't giving them loans. Add to that the fact that everyone in America is terrified. They've watched their investments lose a huge amount of money. They've watched their retirement funds almost disappear. People don't feel like going out to eat anymore. The restaurants fail. Suddenly produce distributors aren't getting the kind of business they used to get. They aren't making enough money to pay all of their employees so they lay some of them off to try to stay in business. This is why I am here writing this right now and not on a forklift in Durham.
So, there is a group, a branch of the government called the FDIC. That stands for Federal Deposit Insurance Corporation. Suppose a bank is failing, it no longer has the money that people have put into the bank. The FDIC insures the people that they will take care of it should the bank fail. Usually what this means is the FDIC will come into a bank that is failing, very secretly because you don't want the public to know that the bank is failing (if they find out they might all run on the bank, trying to get their money out, and you'll have a huge economic disaster. This is one of the things that happened during the Great Depression.) They will take over the bank, say on a Friday, call another bank to get them to take over this bank, and that is why downtown the old Washington Mutual now has a sign that says Chase. The FDIC is there to insure that banks do not fail and that there is not a run on the banks. It insures people's deposits up to $250,000. This was started in the Great Depression and backs our savings (those of us who still have any savings left after this mess) with the full security of the US Government.


  1. Way to put the cookies on the bottom shelf, Paul Mathers.

  2. Uhh, way to use my computer and sign me out of Blogger, Paul Mathers. To whom it may concern, I wrote the above comment.

  3. What a great way to explain it to Tony. For me - making a long story short - A bunch of very rich people were very greedy, greedy, greedy.

  4. I'm no economist either, but your explanation is pretty right on target. When we sold our last home we had an offer from a young couple who purported to have a 103 percent loan, with the 3 percent to use as they wished. We declined their offer for a couple of which was that we feared they would be in wayyyyy over their heads. I have no doubt that if they had purchased the house, they would now be in foreclosure.