This is my paper for my Business Class and professor Spittell's response,
Hue:
It was nice to see you at the lecture. You obviously learned, but you have a few things mixed up. Stop in sometime and I will clear things up for you.
Nice paper. I am grading it an "A".
In the future, please make sure that you use the Wall Street Journal as the source for your paper in those weeks designated WSJ.
JS
Professor of Business and Management
and Executive in Residence
Program in Business and Management
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According to Dr. William A. Longbrake, the economic crisis broke out due to great imbalances in the U.S. and global economies that have been built up for decades. Imbalances are so stunning that they are almost out of control and the traditional policy intervention cannot stop its destruction. These elements of imbalances include, the economic model, the role of human behavior, technological and political developments and policy interventions, the relationship between income, wealth and the saving rate, the distribution of income and wealth, the “Fallacy of Composition” (the paradox that individual maximizing behavior may lessen aggregate welfare) and governance structure.
Economic models are strongly believed to be true in most situations, especially when the markets are efficient and complete. Economic models based on four assumptions; all participants are rational, all have access to all available information, all share the same model for transforming this information into action and the model itself is true. However, in the real market situation, players could take actions based on their instincts, could access to different sources of information leading to various action to same situations. In another words, economic models don’t hold true all the time.
Talking about the government’s role in the big game, the decision to let Lehman Brothers fail is said to be an error triggering the economic crisis. However, as discussed above, the destruction level of the crisis is totally more than the governance policy could handle. Sooner or later, it would happen according to Dr. Longbrake that “because it is now abundantly apparent that we are at the end of a decades-long debt leveraging super cycle.” The causes of the economic depression stem directly from those imbalances built up over decades; consumption and debt leveraging, financial innovation, speculation and bubbles and globalization.
As I read the article Your House: Just a Home by M.P. McQueen on Wall Street Journal issued on September 14, 2009, I got curious about how the housing market got into such a big trouble. Taking Fannie Mae’s story as an example, we can see how the economic models failed and led to destruction. As far as I figure out, the housing market involves four main players: house owner, mortgage banker, Fannie Mae and investor. When the market are efficient, house owner borrows money from mortgage banker when mortgage banker buys “insurance” from Fannie Mae in void of a default; Fannie Mae funds their mortgage investments by issuing debt securities in the domestic and international capital market. This scheme helps mortgage banker have enough fund to give loan to customers at affordable rate. If home owner cannot pay back the owed money to mortgage banker, Fannie Mae will pay for the house’s debt and sell the house’s value to investors.
In the economic depression, the house’s price got significantly lower when house owner still has to pay the same amount of money to banker and they cannot pay for it. Fannie Mae suddenly has to pay for a large number of house debts when the firm itself cannot get enough fund from issuing debt securities to investors (as the price of house goes low, housing investment is no longer attracts investors). Fannie Mae confronted a financial conundrum and almost went bankruptcy. In this situation, the monetary policy was rendered ineffective because foreign purchases of long-term securities kept rates artificially low. Discuss about this, Dr. Longbreak’s report “Great Decisions in a time of Economic crisis” says, “While monetary policy is not an efficient policy instrument for controlling asset prices, it probably can play a role, but that role would be more effective if combined with other governance instruments such as supervisory policy”. Another cause of the housing crash is financial innovation, when everyone believed that home prices would continue to rise and then ignore risk for adverse results. Besides, the housing bubble was fueled by cheap money that makes it easier to access and expand the bubble.
Reference:
1. LongBrake, William A. Great Decisions in a time of economic crisis.
2. M.C. McQueen, Your House: Just a home. Wall Street Journal, September 14, 2009.
3. Fannie Mae Webpage, [http://www.fanniemae.com/about/index.html]
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