Letter to President Obama (re: nationalization)

President Obama,
I am writing you today to profess my opinion on the current economic crisis and specifically the nationalization of the United State’s banking sector. I am not addressing you as a liberal or a conservative, but as an economist; a non-biased economic analysis is what your administration needs. Currently, we are looming in an economic threshold, and your decisions in this matter can either make or break our nation and your administration. The economy is the most important, and unfortunately the most complicated issue affecting America today; I will try to simplify the topic as much as possible. The nationalization of banks may cause many unintended and unpredictable consequences. However, if done in the right way, nationalization has the potential to save our economy from this crisis and give the American people back what they have lost.
When addressing the financial crisis, we first must decipher what our current economic standpoint is today. According to the CPS (Current Population Survey), “the unemployment rate rose from 7.6 to 8.1 percent” in February 2009. This is the highest unemployment rate in over 25 years. Currently our national debt is over eleven trillion dollars. GDP (Gross Domestic Product) dropped over 6 percent in the fourth quarter of 2008 according to the Bureau of Economic Analysis (BEA). All of these statistics lead to one conclusion: recession.
The United States is currently in a recession, the second recession of the decade. The first was in the year 2000, after the “bubble burst” from the technological revolution in the late 1990s. In 2000, stocks began to decline, the housing market fell, and in 2001 the terrorist attacks of September 11th put the nail in the coffin US economy. Fortunately, the United States monetary policy quickly and effectively pulled us out of the 2001 recession. Unbeknownst to anyone in 2001, the policies used to save us from the recession would set us up for the economic disaster we are in today.
Monetary policy successfully pulled us out of a recession in 2001. The Federal Reserve predictably lowered interest rates (standard monetary policy). The lower interest rates led to better mortgage rates for homeowners in the US. The US homeowners realized this and many jumped to refinance their homes. As the demand for new mortgages rose, the increase in demand subsequently raised the prices of houses (and essentially the overall price level). As housing prices rose more houses were built and the economy was effectively stimulated. The monetary policy worked and the future for the US economy quickly looked reassuring, perhaps too quickly.
The new interest rates set forth by the 2001 recession allowed too many people to refinance their homes. Although housing prices rose, the mortgages were wrongfully issued to “subprime borrowers, defined as those with lesser ability to repay the loan based on various criteria” (Subprime Mortgage Crisis). Many of these “subprime” mortgages defaulted, and the issuers (banks) were at a loss. When these homeowners failed to repay their loans, foreclosures occurred. Along with the foreclosures, a multitude of new houses were built and still remained up for sale. According to an article in the New York Times by Jeremy W. Peters, “The number of existing homes still on the market, meanwhile, grew to a record of 3.725 million units.” This created a slew of empty homes in America and by July 2006, “Selling a new home [was] getting harder and harder” (New York Times). A bubble was created; a bubble much like the bubble created in the 1990s from the technological revolution, and that bubble was about to pop.
The excess supply of houses in the market created a surplus in the housing market. The surplus caused the supply curve to shift downward, increasing the quantity of houses available at any given price. Simply, the extra houses on the market caused the value of each house to go down, and housing prices fell drastically. As the prices of houses fell, the construction of houses declined due to the decrease in demand. As the construction of houses dropped the demand for construction supplies dropped (cement, steel, equipment). As the demand for consumer goods crashed, jobs were lost. When jobs were lost, disposable income decreased. As disposable income decreased, the market demand curve shifted downward, this essentially halted the US economy. The housing bubble burst for the mortgage industry and the banks who issued the subprime mortgages would soon pay the consequences.
When the bubble burst, the lenders immediately felt the effects of issuing risky mortgages. In March 2007, “At least 25 subprime lenders, which issue mortgages to borrowers with poor credit histories, have exited the business, declared bankruptcy, announced significant losses, or put themselves up for sale”(Business Week). The demise of twenty five corporate banks does not come without costs. A multiplier effect ripples throughout the economy when such a disaster happens. Just like the housing industry, the banking industry was now cutting wages, jobs, and capital. The downward spiral of the economy grew exponentially as the number of failing banks grew, but this is only the beginning.
Investment banks, which specialized in trading securities backed by mortgages, felt the ripple effect of the mortgage crisis. It was quickly assumed that “the subprime meltdown will result in earnings reductions for Bear Stearns (BSC), Lehman Brothers (LEH), Goldman Sachs (GS), Merrill Lynch (MER), and Morgan Stanley (MS) “(Business Week). Bear Stearns, one of the first and largest investment banks impacted by the mortgage crisis, was probably hit the hardest: “The Bear Stearns funds once had over $20 billion of assets, but lost billions of dollars from bad bets on securities backed by subprime mortgages” (Reuters). The inevitable collapse of Bear Stearns was apparent, and the collapse of such a large bank could have immeasurable effects on the economy. The collapse of Bear Stearns could simply not be permitted and The Federal Reserve “agreed on March 14 to give emergency funding to New York-based Bear Stearns” (Bloomberg). This move by the federal government was a drastic, necessary provision taken to prevent economic turmoil in the United States. The collapse of Bear Stearns and other investment banks effectively brought the subprime mortgage industry in the United States to an end.
The governmental bailout of a privatized company is a significant turning point in “free market” economics. Although the nationalization of Bear Stearns was absolutely necessary, it changed the future of the banking industry in our nation. Banks, knowing the government may bail them out in the case of a catastrophe, may have incentives to take on more risk in the future. Moreover, the bailouts go against every free market ideal which our economy is based on. Although the free market is ideal, realistically, our economy is regulated in a multitude of ways throughout every sector. The banking sector is now one more aspect of our economy to experience necessary government intervention.
Although the publicizing of banks goes against the free market ideal, the unintended benefits may be surprising. When the government “bailed out” these companies, essentially what they did was buy stock in the companies. NPR newsgroup reporting on the bailout emphasized “preferred shares will carry a 5 percent annual dividend that increases to 9 percent after five years.” The taxpayers will earn return on the shares the government bought to bailout these banks. The rate of return is also subsequently increasing in five years, creating incentives for the publicized banks to become privatized once again. The return could be used to lower taxes, revive the housing market, or even to regulate the banking system in which it is earned.
With privatized banks, the ultimate goal is to earn profit, even if earning profit justifies taking on risky banking procedures. In 1999, The Gramm-Leach-Bliley Financial Services Modernization Act was passed by the Clinton Administration. The act essentially put an “end [to] regulations that prevented the merger of banks, stock brokerage companies, and insurance companies” (EPIC). The act repealed a section of the Glass-Steagall Act of 1933, a regulatory act to prevent speculation. The Financial Services Modernization Act deregulated the banking industry and allowed risky operations like subprime mortgage trading to happen in the first place. The government had no power over the operations and transactions of securities in privatized banks. Nationalization gives the government back the ability to control the banking industry and prevent precarious financial transactions.
President Obama, in the past nine years the American people have been involved in a seemingly endless economic struggle. Nationalization is a safe solution to prevent an economic catastrophe, but the free market ideal should not be forgotten. Nationalization will provide economic security through government regulation and financial protection. With the help of your administration and my analysis we can successfully recover from this recession and achieve economic prosperity once again.