Nouriel Roubini was one of the few people who very accurately predicted our current economic meltdown. Recently he wrote that the cause of the meltdown was “the bursting of a huge leveraged-up credit bubble”. He goes on to say in this recent article that he believes the economy will get worse before it gets better. The question we should be asking ourselves is why? We know that the nation’s banks made terrible decisions about granting credit, not only for houses, but also for credit cards, auto loans, furniture loans – you name it. If you could walk and breathe you could get credit to buy almost anything. In retrospect the result of all of this is obvious: a lot of people who couldn’t possibly pay back their loans didn’t pay back their loans. For a long time the banks new that they shouldn’t give loans to non-creditworthy people, so why did they change their minds? The banks had found a way out of their potential liability – they sold the loans. A whole industry of derivatives and credit default swaps emerged. Loan obligations were sliced and diced and sold and resold and insured and eventually very few people in the banking industry actually had the ability to understand the true value of the new derivatives they had created.
There was one other really bad problem with these loans – they had exhorbitant interest rates. Even people with good credit would have had a hard time making the required payments. As Roubini said, it was a bubble, and it has burst with devastating results. The Secretary of the Treasury raced to solve the problem of our collapsing banking system (they had loaned out their money and it wasn’t being paid back) by creating the TARP fund, a $700 billion government fund that was a way to funnel money to banks. About half of that money has been doled out, but the economy is still on the ropes. Why? Because the banks have their money back, and they have no desire to loan money in this economy! Who would? So we sort of have an economy of self-fulfilling prophecies where the banks are afraid to loan money to businesses because they don’t thinks the businesses will be able to pay them back and businesses are failing because they can’t borrow any money and the banks are saying, “See, we knew they would fail!”
Our banking system has gone through many incarnations since the U.S. began. The current system of a U.S. Treasury and a Federal Reserve that works with private banks is a cobbled together operation that has certain weaknesses, like a propensity to creating credit bubbles and to creating what we have now: a credit vacuum. It is time we took another look at the structure of our banking system, particularly with regard to creating a new type of bank, a Federal Direct Loan bank that would issue loans directly to consumers at low interest rates. This bank would compete with the private banks and keep them honest. It would also be a lender even in the most difficult times, ensuring that individuals and businesses could obtain credit and therefore ensuring that the economy would continue to function even when the wealthy private bankers have decided that they don’t want to play.
Something tells me that this would not be a popular idea on Wall Street, but I’m guessing it might fare better on Main Street.
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