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Sen. Richard Bennett, R-Utah, from the senate banking commitee said this, ""20 years ago the Fed would have let Bear Stearns go bust; today, it is too interlinked to fail." Too interlinked to fail? How did this happen?
I will tell you. The housing bubble started a long time ago. It started to form during the Clinton administration. The fed interest rates were at a very low rate of 1%. For those of you who don't know, the fed interest rate is the interest rate the fed charges banks to hold their money overnight. They also loan money to banks, this was at a comparably low rate. I will try to break this down as easily as possible for you. Since, the banks are getting charged less by the fed, they pass these low rates onto the consumer via auto loans, mortgages, credit cards, etc.
When this happened the banks got this great idea. Now that interest rates are so low, a lot of people can afford to buy houses that they weren't able to a couple a years ago. The banks then got into this war of who could have the lowest rates. Then it got even worse, they expanded their sub-prime lending efforts. Sub-prime loans are loans to people with less than desirable credit. Furthermore, they got into this battle of who could approve the most people. The banks and mortgage companies got very, very agressive. This trend spred into other markets, like auto loans.
This all took place over the course of about 8-10 years. At the same time, in order to hedge inflation, the fed started raising these iterest rates. These sub-prime loans where primarily 3-5 year fixed rate ARMs(adjustable rate mortgages). Gas prices started to climb, which affected costs of everything else. Spending decreased further affecting prices. People became more conservative with their money, because of increasing costs. People became less likely to buy a house, car, luxury, etc.
Now a couple of years into this process, housing sales (sales in general) decreased due to a wide variety of factors. These Adjustable Rate Mortgages also started to loose their fixed status and started re-adjusting. They began to re-adjust to significantly higher rates than what these people were approved for. Soon they would no longer begin to afford their house.
Now Bear Stearns had their hand deeeeep inside the cookie jar. They had a hand in everything. They were one of the most agressive. The wall was weakened when interest rates where so low. The crack started to form when gas prices shot up. The crack continued for years.
Luckily, the wall hasn't cracked all the way through. The Fed bailing out Bear Stearns not only stopped the crack (for now), but it also began to patch the crack. For $19 billion, they saved the collapse of capitalism. Not too bad of a price if you ask me.
Lesson to be learned from all of this. Capitalism without regulation can not function for too long. But who was regulating the stock market, who was regulating the housing market, who was regulating whatever? All sorts of different institutions. You got the SEC, the Fed, etc. However, the Fed is responsible for the health of the total economy. So, their first course of action was to expand the power of the Fed. That's fine, but who is in charge of the Fed? Who does the Fed report to? What kind of oversight is there? Little to non. Thats an issue. All these federal regulating agencies need to be downsized and streamlined. They need to be smart. How they respond to make sure this never happens again, will be key.
The Bottom Line. For now, a major crisis has been adverted. What they will do now to insure this never happens again, is whats important.
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