It's Not Your Toilet!

There is a fundamental problem with the way that most of the world is explaining the current economic crisis. You see, most people (including the President) are using the plumbing analogy. You'll often hear the words "clogged", or "flowing". Like "we just need to get the credit markets "flowing" again." The problem with this analogy is that credit is NOT your toilet! Credit (or debt depending on what side your on) is a contract between two parties. It's not some one-sided system that can "flow" again once the bad parts are gone. Toxic assets are made because one of the parties defaulted on payment. Understanding the reasons for the crisis are essential to finding a solution. The reasons are likely too numerous to mention. But the larger problems are easily explainable. The first and biggest problem is that most Americans are incredibly selfish, image-driven, and indulgent. That said, if there's no way to indulge those appetites they don't get anyone in trouble. That's where the Community Reinvestment Act comes in. Most people will probably call me racist for even mentioning the CRA. but the sad truth in our country is that around 30% of our minorities live below the poverty line. Regardless of race, it is not prudent to lend to anyone below the poverty line. It's not prudent to lend to anyone that doesn't have the ability to repay the loan, whether it be because they don't earn enough or because they are over-leveraged. But that's exactly what the CRA (a Jimmy Carter project that was expanded in '99 under Clinton) does. It forces lenders to take in account the color of peoples' skin and forces them to loosen their standards in order to even be able to lend to more minorities. That loosening of standards soon became the industry norm. The subprime loans to minorities were seen as discrimination, so now the rich could also get subprime loans. This is, in large part, how so many Americans got over-leveraged. By getting a subprime or interest only loan they got way more house than they could honestly afford and so, as soon as something goes wrong in their life they can no longer afford it. The securitization of debt and credit default swaps are getting all the publicity, but without defaults, neither of these would have been a problem. Certainly financial companies used both of these instruments to over-leverage themselves, but in the end the fault lies with those Americans that took on more debt than they could reasonably afford. This fundamental problem will also be the problem going forward. As mortgage defaults rise (and they are rising, according to Equifax) the so-called "toxic assets" of large banks will increase. The problem with the plumbing analogy is that, when the "toxic assets" are unclogged and the credit markets "flow" again, who will contract the debt? Those that need the money will likely not have the proper credit rating, and those that haven't needed it in the past will likely not need it in the future. The bigger problem is that our trillions of dollars (both borrowed and printed) have not cleared "toxic assets" off the books and more are certainly on the way as these mortgage defaults increase. So, not only will there not be anyone to borrow money from the banks when/if the toxic assets get cleared but there are more toxic assets on the way that may take more money than we can print to get rid of.