Plunging economy: What students, parents should know about America’s deepening financial crisis
Over the course of a month, the implosion of Wall Street shocked the world and has prompted many to search for the cause. The discovery of denial, greed and rampant corruption is unsettling.
The great irony is that clues of the collapse have been around all along. So how could the signs be overlooked, and does it foreshadow the fate of America?
A recession is a decline in economic activity (such as a drop in house purchases or a decline of the stock market) for six consecutive months.
“There is an almost-certain 99.9 percent chance we are headed for a recession,” finance professor Dr. Larry Woodward said.
Woodward offers his advice. “The problem isn’t caused by over-regulation or under-regulation, and we don’t need government to regulate more or regulate less; we need a thoughtful government.”
As for whether or not America is headed for another Great Depression, Woodward thinks the only way to follow that path of disaster is if deficit spending continues.
How does all this affect college students? Dr. Paul Stock, finance, accounting, and economics chairperson, said, “This crisis might affect college graduates looking for a job in the financial sector. If there is a recession, businesses will be looking to cut costs, and the first place they will cut are the number of employees. Unemployment will go up.”
Stock believes that the crisis will impact students’ parents more than the students themselves.
He said that parents who are retired “might lose some money in their retirement accounts, and those who are looking to retire in the next three to five years might have to wait. Unfortunately, if there is a recession, there is a good chance many of them will be laid off.”
The origins of the financial crisis can be traced back to an act passed by Congress in 1977 called the Community Reinvestment Act. It has essentially forced businesses to sustain a minimum percentage of low-income mortgages every year or risk being fined.
These mortgages eventually became the highest amount of loans in any income category. Lenders misled many potential homeowners into higher loans. Just about anyone, regardless of the ability to afford them, was able to take out a home loan.
The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) received preferential treatment from Congress in 1991, giving them an advantage over competitors in that they were not subject to many of the taxes and standards other companies were.
This allowed Fannie and Freddie to use their reputable appearance to sell risky low-income mortgages to gullible investors as low-risk investments. The Federal Reserve’s takeover of Fannie and Freddie (and other investment banks) brought to light the long-held allegations of their bribery to members of Congress who would fight to keep their tax immunity status.
In 2005 people suddenly realized how easy it was for anyone to take out a loan to build a new house.
Home prices began to rise nationwide, and banks were selling loans with variable interest rates.
Most people didn’t pay attention to the fine print of their mortgage enough to realize that a variable interest rate is a loan that starts off very cheap, but every two to three years their interest rate will rise substantially.
Many people were taking out 30-year variable interest rate mortgages. This led to a massive housing boom that lasted for two years.
Across the country, homes were being built and financed by mortgages that many homeowners couldn’t afford.
As a result, homes weren’t worth as much as buyers had paid for them. Many homeowners couldn’t sell their houses because potential buyers could not afford them anymore. This made the value of their mortgages substantially decrease for investors.
After the housing bubble popped, investment banks realized just how much their riskiness had cost them. Last month, the Federal Reserve took over Fannie and Freddie. Soon many investment banks like AIG, Merrill Lynch, and Lehman Brothers went bankrupt.
Investors were shocked, and many of their investments were gone forever.
Some people, like Richard Fuld, former CEO of Lehman Brothers, were luckier. He knew his company would collapse and still decided to keep almost $500 million, plus additional payouts.
Last month, Treasury Secretary Henry Paulson proposed a $700 billion bailout for these investment firms using taxpayer money. Congress rejected the bill because Paulson would have near-complete control of the money.
This month, however, Congress passed an $800 billion bailout bill that contained grants and subsidies many congressmen have been trying to pass. Some grants included funding for small wooden arrows and subsidies for wool.
This bailout made it possible for AIG to use taxpayer money to take executives on an expensive and lavish retreat.
Today, the world’s financial markets are in a crisis. The stock market is appearing to crash in slow motion.
The Dow Jones fell below 8,000 Oct. 10, which was its lowest level in five years. Many people are pulling out of the stock market.
In the meantime, UMHB finance chair, Stock, offers the advice that students and parents should live within their means.
He said students should also monitor their credit rating and try to improve it between now and the time they plan on taking out a mortgage.