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Simple Explination Of What Caused The Current Economic Problem

Americans are continually bombarded with news of the sorry state of the economy with expert after expert on panel after panel on all the TV and radio news stations, newspapers and magazines. There is a continuous flow of information and explanations on how it happened, finger pointing as to who is to blame, predictions (mostly bad) as to what will happen as a result and on and on. You cannot turn on the TV or radio news or pick up a newspaper or news magazine without a constant overflow of INFORMATION.

Most of the information is geared to move you in one political direction or another and therefore suspect. The information, is also provided in complicated terms or lost in the rhetoric of self serving experts or those with a political agenda.

So in the simplest terms I can muster, here is what happened:

1. For many years banks made a good profit by buying treasury bonds from the Federal Reserve Bank - much like individuals buy savings bonds. After 9/ll the Federal Reserve, in order to stimulate the economy dropped the interest rate to 1%. Buying bonds was no longer worth the effort. However borrowing from the Feds at a very low rate became VERY lucrative for the banks.

2. Banks now make their money by borrowing from the Federal Reserve at low interest and loaning that money to it's customers at a higher interest. As their customers repay their loans the banks repay their loans to the Federal Reserve. Good deal and everyone makes a little money.

3. Another way banks found they could make money is by buying mortgages from banks holding the mortgages. These mortgages are bought by paying the holding banks a fee. After paying the fee and the cost of servicing the mortgage (processing payments) while it is paid off by the homeowner, the buying bank will not realize the full interest due on the initial loan but will still realize a good profit after paying back the Feds or other low interest creditors/investors. For example a Mortgage broker finds a potential home buyer that qualifies for a loan. He does the paperwork and for a fee turns the buyer over to a bank that makes the loan. Since it is costly to service these mortgages, They sell the mortgage for a fee on top of the principle, to another bank to service. The bank uses the principle and some of the fee from the sale to pay back their loan from the Feds. Everybody makes money so everybody is happy. The servicing bank may sell the mortgage again if it is profitable to do so.

4. Banks then discovered that if they bought mortgages from lender banks in large blocks of say 100 mortgages for maybe, $3,000,000 interest due in the long term with money they had borrowed from the Federal Reserve Bank at low interest over the life of their loan. The servicing banks then have a large number of home owners paying them on a monthly basis. From this they pay off their low interest loans to the Feds and make a fantastic profit. If some homeowners defaulted, no problem. The bank simply sold the house in an ever appreciating sellers market. Great, everyone is making lots and lots of money and everyone is happy.

5. This process continued for several years with mortgage brokers, banks and investors all doing well. Employment is high and all is well with the world. However there is a cloud on the horizon. Most of the people that were considered low risk and with good credit that wanted a house had a house. The boom started to slow and the banks, being spoiled to having huge amounts of money rolling in, began to look for ways to continue the cash flow. I might add they were cheered on by political and effected business representatives both national and local. The public in general and stock holders in particular applauded efforts to keep the economy growing. The Federal Government even relaxed the oversight regulations to help further stimulate the economy.

6. Now came the critical changes that lit the fuse to the current crisis bomb. The banks began to make loans to people that were clearly unqualified for a mortgage loan. Not just a few but thousands upon thousands. These loans kept the banks and economy going for several years but as more and more people could not pay on their mortgages the banks in turn could not pay back their loans to the Feds or other investors they may have borrowed from. They could no longer buy mortgages because their credit rating had dropped and/or they no longer had the funds. Also, there was the fact that banks had a large number of houses they could not sell and on which the value was dropping monthly. Many banks were on the verge of collapse. Money was not being made and no one was happy.

This is by no means a full explanation and I have left out a great deal of thedetails and explanations of all the buzz words associated with the industry. Keep in mind that the six point explanation above is just a skeleton outline for understanding the basics.

Today's U.S. Economy is run on credit. The Dollar is backed by nothing of value other than the Government's word and promise to pay. These are, in themselves not a bad thing. On the contrary they are good when used with just a little common sense. The situation that the banks created began to threaten the U.S. and indeed the world economy. Credit lending is currently very limited and businesses that need the money to keep going can not get loans. Businesses are folding and along with them jobs. The more jobs that are lost, the more mortgage defaults. More defaults for an already collapsing banking system.

At this point the Government found itself between a rock and a hard place, Bailout the banks or let them collapse. There is good argument that if most of the major banks went down they could well take the Nation with them causing default on debts or bankruptcy. As I am sure you know, the decision was made to save the banks.

This brings us to the next problem, Debt. Though this is a different subject and will be discussed in a later article, I will point out a couple of facts. The bail outs of the Banks and the Auto Industry along with the unabated spending by Congress for war efforts, foreign give away programs/pay offs, internal social and stimulus programs, so on and so forth have left the country in debt over its head. Debt has far out run any predictions of tax revenues. The Government is paying for all these efforts by printing more and more money. As I said this money is backed by nothing except a big Government "TRUST ME". How much trust do you have in the Federal Government?

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