On September 24, 2008, in the early stages of one of the worst recessions in American history, President George W. Bush addressed the nation to propose a dramatic bailout plan for the financial sector. In an attempt to sell the emergency bailout to the American public, Bush spoke of the “need to preserve the foundations of democratic capitalism.” The White House suggested that unless several major global financial institutions received help from the Federal Reserve and the federal government, the entire economy could collapse.
How did the economy spiral into a near-depression? Early explanations were all over the board, but the general story goes like this:
- Between 1998 and 2006, U.S. home prices appreciated in an unprecedented fashion, fueled by poor underwriting standards and ultra-low borrowing rates.
- Dangerous mortgages in the subprime lending industry were purchased en masse by Fannie Mae and Freddy Mac, creating a government guarantee of repayment for creditors.
- Financial institutions, looking to repackage loans and secure new financing on the back of rising rents and home values, collateralized these dangerous mortgages and sold them as investment instruments.
- The Federal Reserve, worried that low interest rates would fuel inflation, began rising rates. When the teaser rates on home mortgages reset, many borrowers defaulted. This created a “domino effect,” eventually putting entire global financial banks at risk when their assets lost large portion of their value.
With the benefit of hindsight, today it’s easier to reflect on the subprime mortgage crisis, the dangerous financial operations of the world’s largest money dealers, and the poor planning from monetary, fiscal, and regulatory authorities. At the time, however, few saw the crash coming. When interviewed by the New York Times in November 2008, economist James Galbraith guessed that maybe 10 or 12 of the 15,000 professional economists in the United States saw the economic crisis coming.
Leading Up to the Crisis: Reckless Inflating, Borrowing, and Spending
Among the few who predicted the financial crisis of 2008, none were more vocal (before and after) than Peter Schiff, CEO and chief policy strategist of EuroPacific Capital. At a now-famous speech given at a 2006 Mortgage Bankers Convention, Schiff explained why a crash seemed inevitable:
“America consumes, and everybody else produces. America borrows, and everybody else saves…this current dynamic, where we don’t save and we don’t produce, is not viable. It’s no more viable than the 1990s with respect to internet stocks or technology companies…we had a bubble in the stock market that was created by Alan Greenspan, the Federal Reserve, and a monetary policy that was too loose and too inflationary. Ultimately, Greenspan started to raise interest rates and…eventually the bubble burst. The NASDAQ lost 80 to 90% of its nominal value.
A lot of people in the real estate market don’t think it can happen to property prices…Well, it happened in the stock market, and it is going to happen in the real estate market.”
Details of the Crisis
Schiff went on to describe how George W. Bush and Alan Greenspan kept the 2000-2001 recession from running its full course. Pushing off the pain only inflated a different bubble—this time in real estate prices. Low interest-rate policies allowed homeowners to over leverage. Home prices skyrocketed, and the financial sector took advantage by securing new types of financial instruments against those rising home prices.
“So the consumer went into debt and spent a lot of money to keep the recession at bay. But, all of that debt consumption has a price: dramatic reduction in future consumption….In America, we indulged ourselves in the present at the expense of the future…Over the next two years, you have about $2,000,000,000,000 of adjustable low-rate mortgages that are going to reset…Some of these people are spending 40% of their income on their mortgage at the low rate. How are they going to afford their payments when the rates are at 8% or 9%?
The people who were buying real estate and are still buying real estate are making the exact same mistake as the people were making in the stock market in the ‘90s. They were not basing their investment decision based on the the fundamental value of the asset. They were basing it on their belief that prices would rise.
“You’ve got this huge moral hazard built in…the government guarantees mortgages through Fannie Mae and Freddy Mac, and a whole lot of banks lend money, but does anybody keep that money? No. It gets sold. It gets re-packaged, and these other companies buy them and then they re-package them again. And then, they get sold to Goldman Sachs and Morgan Stanley who create collateralized mortgage obligations.
The whole market is going to shut down once subprime collapses….Of course, all of this is going to unravel. And as real-estate prices start to fall, nobody wants to buy anymore. Who wants to buy houses when they are falling in value?….Lenders are going to restrict their lending…This is all going to be corrected…You will be completely amazed—amazed—at the low housing prices you’re going to see in the next couple of years.”
We thoroughly discuss Schiff’s explanation for his uncannily prescient detail of the crash and its subsequent fallout and the factors that appeared prevalent in the years leading up to the housing and financial crisis. (More on this later.)
Lessons from the 2008 Financial and Housing Crisis
The Federal Reserve, along with its cohorts in the regulatory branches of the U.S. government, made it too easy for banks to ignore good underwriting standards. They also made it too cheap to borrow money, which meant speculative projects were made too accessible. In turn, investors turned away from traditional savings habits—low debt, slow-growing retirement funds, and precious metals—in favor of dangerous ones. This is the same story that we saw before the Crash of 1929, the Japanese recession of the 1980s, and the Dot-com bubble of the 1990s. Ultra-low interest rates from a central bank, lax borrowing standards, and skyrocketing asset prices.
When the money supply and borrowing terms can be arbitrarily fixed by unelected technocrats, the market economy tends to suffer wild swings. So long as the Federal Reserve exists and pursues pseudo-Keynesian monetary remedies, the chances of another bubble and crash remain elevated. (This reminds us of 2008 when CNBC interviewed investment maven Jim Rogers and asked him how he would react if he were appointed Fed chairman. Rogers responded,”I would abolish the Fed, and then resign.”)
The Fed, ignoring history, launched experimental zero-interest rate policy. The government told major investment banks that it will bail them out if they get into too much trouble, doubling down on the moral hazard problem. As a result, we’ve seen record stock market prices in 2016 and 2017, even though business profits do not seem to justify those stock prices. This looks like more low-interest rate fueled asset bubbles that are detached from the fundamentals.
You do not have to repeat the mistakes of the past. If you are interested in protecting your portfolio from government debt, stock market bubbles, and Fed-driven inflation, talk to American Bullion about opening up a Gold IRA.
American Bullion can discuss your options and help you every step of the way. Our #1 goal is to help you take control of your own finances – and we promise to be transparent, safe, and efficient in the process.
Although the information in this commentary has been obtained from sources believed to be reliable, American Bullion does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice. American Bullion will not be liable for any errors or omissions in this information nor for the availability of this information. All content provided on this blog is for informational purposes only and should not be used to make buy or sell decisions for any type of precious metals.