I’m not an economist. The only experience I have dealing with inflation is what happens to my eyeballs when I hear people talking about things like “principle” and “subprime loans” and “fiscal propriety” and so on. However, I am thankful that economists exist, particularly ones that care to make things understandable to non-economists like me.

In the most recent issue of WORLD magazine, Timothy Lamer penned an article titled “Anatomy of a Crisis: How Washington and Wall Street Got into Trouble” (pp. 10-11). In it, he explains what brought our country into the economic sinkhole we are experiencing. He does it in six steps, which I will try to reproduce and boil down a little for digestibility.

  1. In an effort to stave off economic recession after 9/11 and the “bursting of the tech bubble,” Alan Greenspan (Federal Reserve Chairman at the time) took bold strides to ease monetary policy, reducing the federal interest rate from 6% to 1% over two years (2001-2003).
  2. Because of the low interest rates, mortgage lenders started offering loans to people with sketchy credit history (called “subprime” loans). This increased demand, housing prices rose, and people started entering the market to “flip” houses (buying houses with debt, fixing them up, and selling them for a higher price tag). According to Lamer, “a speculative bubble began to inflate.”
  3. Mortgage lenders sold their dubious loans to groups such as government-sponsored Fannie Mae and Freddie Mac. The two corporations then “packaged these loans into mortgage-backed securities and sold them to investors.”
  4. These investment banks used these securities to take on dump truck loads of debt. As a result, the state of Wall Street depended on the ability of suspect home buyers to make their monthly payments.
  5. Interest rates began to rise, housing demand fell, and the “speculative bubble” mentioned in step 2 began to deflate. Homeowners who had taken advantage of subprime mortgages saw their interest rates rising at the same time as the worth of their houses either stagnated or sagged. Many defaulted because they couldn’t make house payments, and the Wall Street investment banks of step 4 were left out in the rain, stuck with a bunch of debt that was “secured” by assets whose value was dwindling.
  6. In response, the Bush administration attempted to do what it could to avoid the collapse or recession that was feared. It “began engineering bailouts of some of these firms [see step 4] and, finally, proposed a $700 billion macro-bailout,” which we heard about recently.

Lamer sums it all up by saying:

The fundamental dynamic is this: Washington and Wall Street helped people buy houses they could not afford on such a massive scale that simply letting the lenders and debtors take their lumps would arguably do grave harm to the economy. They will take some lumps (Wall Street isn’t exactly a hot job market right now), but most of the losses will be “socialized,” or spread out among everyone who pays taxes. This includes those who exercised restraint during the bubble. That’s how it is. (pg. 11)