Anatomy of the Economic Crisis

1 10 2008

Much fuss has been made about the nature of the current economic crisis and the potential beneficiaries of a very likely federally-sponsored buyout (I don’t call it a bailout) of unmarketable assets.  Whether folks are pitting Wall Street against Main Street or lamenting the private profits and socialized losses suggested by the federal plan, I don’t think the average American going to work this morning yet understands how the situation came about and could get MUCH worse without intervention.

So I’ve diagrammed out this little sketch of how the money flows – and where it stopped.  Hopefully this is a simple way to wow your friends at this week’s happy hour.

Capital is needed to purchase large assets and finance regular business operations

Capital is needed to purchase large assets and finance regular business operations

To put a size on the increased demand for housing, I’ve heard that during the past five to eight years, the number of Americans owning their home (or at least owning the mortgage liability for it) grew from the long run average 50% to 60% of households – an increase of over 10 million families.

The constriction of lending isn’t just a Wall Street problem.  Businesses are going to have trouble when accounts receivable don’t get paid, inventory can’t get financed, and employees can’t get paid.  Main Street people are going to get shocked by rising unemployment, tighter credit standards, and no available cash to help make ends meet at the end of a month.  Folks will have greater difficulty financing car or home purchases and students (as well as those newly-unemployed seeking to advance their education in the downturn) may have trouble finding lenders to finance their tuition bills.  Drops in income – or even fear of future unemployment – will constrict charitable giving, putting essential non-profit services at risk as well.

This isn’t a problem just for Wall Street, and they’re certainly not the only ones who shared in the gains of home ownership.  I lament the transaction profits predatious mortgage brokers earned in the heat of the housing market and I hope for a better system (and better educated and protected buyers).  But let’s fix the liquidity problem that will affect everyone and not spend our breath pitting Americans against each other.