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03 November 2008

Global Crisis - U.S. Bailout Plan

There is no denying that the United States, and now the World, is in a financial crisis of historic proportions. Are the days of economic superpower status are quickly fading away.

Let's quickly review what has happened in the past 8 years to get us to this point. The Federal Reserve Chairman Alan Greenspan lowered interest rates (Fed Funds) to 1% signaling an era of easing money.

So what did we do with it? It got funneled to the housing market. Americans started realizing the Amercian dream and buying houses at a blazing rate of speed. This drove up the prices of housing, but no worry's, low interest rates and banks flush with cash to lend made it easy for borrowers of moderate means to afford housing once believed to be out of reach.

Banks even lowered their lending standards making it possible for people with no down payment, little assets and small incomes to qualify for large loans with tiny interest only payments. In some cases, banks didn't even check to see if a borrower had an income. In many cases borrowers could only afford a mortgage half the size they were approved for.

Borrowers were getting adjustable rate mortgages (ARM's) that allowed them to pay interest only for the first 5 years. That made that half a million dollar home very affordable. And since housing prices were going up 20% a year there was nothing to worry about.

Fast forward 5 years. Guess what happens now. The adjustable rate resets. That means that the interest rate is going up to the current market rate. Well now, isn't it interesting that the new Federal Reserve Chairman Ben Benanke has increased Fed Funds rates to over 5% from 1%. Mortgage rates have increase as well. The new principle and interest payment these borrowers are now faced with is going to go up. Yikes, they could barely afford the low interest only payments.

What happens next sets off the worst financial disaster since the Great Depression. Borrowers can't afford to pay and they default...in record numbers.

As more and more borrowers defaulted, banks, brokerage houses and mortgage brokers were forced to write down the declining value of their assets. This was over a half a trillion dollars and may still be going up. Almost all of the banks and brokerage houses in America lost 80-90% of their value. The stock market sold off and lost 40% of its value before stablizing, but who knows, that sell off may not be over.

In steps the mighty government. The Federal Reserve has been putting off a financial credit re-alignment for 8 years. There is no putting it off anymore. Several unprecendented money supply expansions have happened in the past eight years, but none can possibly top the expansion that occurred in September of 2008. It is estimated that the country's bailout will exceed 1.5 trillion dollars. And in the end that probably won't be enough. In fact, the only thing that will ultimately work is to let the markets re-balance themselves...except, there might be one thing that could work. Hyperinflation! That is what the Federal Reserve and the Treasury department have brought to the plate. They've expanded the money supply more than at any time in history and are willing to hyperinflate the economy to drive it out of its credit squeeze.

First, lets get the banks loaning money again to all those people that couldn't afford to pay it back before the crisis hit, then we'll deal with the hyperinflation by raising interest rates through the roof, causing even more people with ARM's to default on their loans because their payments have gone up again. Yeah, that sounds like the solution.

The Fed has lowered the Fed Funds rate to 1% again. At least banks can loan themselves money at very favorable rates, even though they have yet to do so. Us poor consumers are paying a higher interest rate today then they were one month ago, before the stock market collapse. How is that going to get consumers borrowing again? Isn't it the consumer that needs to borrow to get the economy going again?


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