A year ago, there were rumors about the mortgage rate. The Federal Reserve heard about it, but ignored the issue. Two month later, Alan Greenspan noticed the housing bubble, but still did nothing. As a result, today, many U.S. corporations, which were once the icons of this great country’s economy, are at the edge of bankruptcy. For the first time in U.S. history, a one trillion dollar bailout plan was designed and legislated in congress. From the increase of oil price to the decline of stock market, people all over the country have been affected by this economic crisis. Compare with previous economic disaster like the Dot-Com boom, what is happening now is very complicated and mysterious. The disaster are caused by many different factors, and in this paper, two major factors will be shown.
The first factor is misunderstanding of the fundamental idea between risk and yield. There are many investment choices such as: CDs, stocks, government bonds, corporate bonds, and mutual funds, but the percentage of return varies by its level of uncertainty. For example, the yields for treasure bonds are about 4%, while the yield for the corporate bonds are about 9%; however, the chance for you to lose all your money in corporate bond are much greater than government bond.
So what happens to banks is, let’s say, a person deposited a hundred dollar in a local bank for 3% interest rate. The bank has to keep five dollar because the Federal Reserve requires it, but they borrowed your other ninety-five dollar for other investment like real estate or corporate bonds or stocks. When the economy situation is solid and stable then the bank is running smoothly. But if the market falls, even just a little bit, the bank can be in big trouble because they invested by borrowing your money. And that is exactly what happened with Lehman Brothers. The largest bankruptcy in world history, $663 billion in asset, and at the end $611 billion (97%) is borrowed money.
The second major factor is the increase failure of risk management for both banks and the government. It is the basic of investment states: under any circumstances, an investment institution [banks] should have a plan that can survive the worst possible situation. However, many corporations concentrated on the market and forgot about this important concept; consequently, in the past 6-month, Freddy Mac, Fannie Mae, and AIG have lost about $1 trillion dollar that is about 7% of country’s GDP.
On the other side, government also did many things wrong. A year and half ago when the country’s housing market was creating new records everyday, and people started to use retirement or education saving for real-estate investment, the government did not do anything with the interest rate. The reason why is because during the time the engine for U.S. economy was the housing market. However, when they finally decided to take action, they raised it sharply, which caused banks lost billions of dollars in three month. At present moment, everyday the Bush Administration is putting up new incomprehensive, indirect, and flawed legislation, and it is no surprise to see most U.S. citizens not happy about the one trillion-dollar bailout plan.
When Henry Paulson was being asked by the media, “who is responsible for all this?” He was not able to provide an answer. Some say it was originally caused by the pressure from European banks reform, while others say it is a crisis that are caused by events that don’t happen at the same time very often. But one thing is clear–this has changed our lifestyle. Many people are struggling with its 401K-retirement plan, while others are having trouble affording tuition. If we compare the economic crisis to what happened to Thailand and Korea during 1997~1998, this is still a minor problem. American should have faith in its country. This recession can be like the Internet bubble in 1990 (we all thought the stock price was going to zero, but it recovered quickly). Stock market will do what it always does, be patient, time will cure the scare.
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