QUOTE (jarrettvaughan @ Sep 23 2008, 05:45 AM) I think that it is very ironic that the American system is based on free capitalism which has limited government control, legislature and intervention. There is a strong belief that if the market is left alone, it will run fine. Due to this basic ideology, the economy has destroyed it self and is now looking for Government assistance. Of course, this goes againts the core values of the system.
Does this prove that an economy that has limited control, legislation does not work?
Government-sponsored enterprises Fannie Mae and Freddie Mac were able to obtain a monopoly position in the mortgage market, especially the mortgage-backed securities market, because of the advantages bestowed upon them by the federal government.
Laws passed by Congress such as the Community Reinvestment Act required banks to make loans to previously underserved segments of their communities, thus forcing banks to lend to people who normally would be rejected as bad credit risks.
These governmental measures, combined with the Federal Reserve`s loose monetary policy, led to an unsustainable housing boom. The key measure by which the Fed caused this boom was through the manipulation of interest rates, and the open market operations that accompany this lowering.
The boom came about from an increase in the supply of money and not from demand from consumers, the result is malinvestment, a misallocation of resources into sectors in which there is insufficient demand.
n this case, this manifested itself in overbuilding in real estate. When builders realize they have overbuilt and have too many houses to sell, too many apartments to rent, or too much commercial real estate to lease, they seek to recoup as much of their money as possible, even if it means lowering prices drastically.
This lowering of prices brings the economy back into balance, equalizing supply and demand. This economic adjustment means, however that there are some winners -- in this case, those who can again find affordable housing without the need for creative mortgage products, and some losers -- builders and other sectors connected to real estate that suffer setbacks.
The U.S. government doesn`t like this, however, and undertakes measures to keep prices artificially inflated. This was why the Great Depression was as long and drawn out.
The government`s actions encourage moral hazard of the worst sort. Now that the precedent has been set, the likelihood of financial institutions to engage in riskier investment schemes is increased, because they now know that an investment position so overextended as to threaten the stability of the financial system will result in a government bailout and purchase of worthless, illiquid assets.
Read more here:
http://tinyurl.com/42y7qy