The Post-Recession World

The world has changed. Many ideologies that were previously thought to be correct by many have now been debunked. We are attaining a new level of understanding of how our society should work, and when governments should intervene in private actions. However, the greatest change is yet to come.

The Profit Incentive
Many conservatives thought that corporations should be in charge of everything, and that the private sector will always operate more efficiently than the public one. They really felt that taking away the autonomy of the health insurance companies was akin to crushing the free market and leading America down a slippery slope to socialism. After all, if the government is controlling your health insurance, what says that they can’t tell you what work you can do or what business you can operate.

The reality is that there has to be a balance in society between private enterprise and public organizations. Our society has decided that fire protection, crime prevention, justice, delivery of mail, national defense, record keeping, education of our children, and several other services are best placed in the hands of the government. Meanwhile, the private sector is in charge of distributing consumer goods, food, professional services and real property, among others. Why is this?

There are certain services for which the profit incentive is fundamentally misaligned with the good of society, whereas there are other services for which that incentive allows more goods and services to be produced, allows society to progress, and gives us the sense of freedom that drives the democratic system.

Policing is a perfect example of this misalignment. Imagine if police would only protect you if you purchased crime insurance. The poor would be subject to murder and violence without any repercussion. Vigilante justice would prevail, and total anarchy would result.

Computers, on the other hand, are best controlled by the profit incentive. Computer companies are incentivised by profits to make newer and greater computers so consumers will buy them. Some individuals may be priced out of the computer market, but that can be considered acceptable by society. Not having a computer may be a disadvantage, but it would not cause pain and suffering like not having healthcare does.

The fundamental difference is whether society decides that something should be a right or a privilege. The privilege of owning a house, getting a computer or hiring an attorney puts those items in the private category. But the right of being protected from fire or crime, or of getting decent medical treatment if sick necessitates government intervention.

The Exchange System
Although I did not get my public option, the Obama health care exchange system will serve to realign the health care system in a positive way. With the public option, the government insurer would be able to bargain with health providers to lower expenses.

The exchange system simply keeps the insurer as a middle man. However, customers are able to collectively bargain with the insurance companies by making individual choices on a grand scale (by simply purchasing the cheapest and best health insurance). The insurance companies will be forced to bargain with the healthcare providers to maintain lower costs. If an insurer does not bargain, a different insurer who does bargain will get their customers. The government will subsidize insurance costs for the middle class, and therefore will be able to dictate which plans get subsidies.

The inevitable result of this exchange will be the emergence of a select group of extremely large insurance providers, possibly just one. The government will either control this one insurer, or break it up into two that would compete. Health care costs will be lower, and insurance will be available to more individuals.

The Regulated Private Sector
There are some categories in society that do not neatly fit into the public or private sectors. Hence, the regulated private sector becomes necessary.

The illicit drug market is a great example of the consequences of a completely unregulated, lawless market. When I say lawless, I realize that there are laws banning drugs. But there are no laws governing the sale, transportation, cultivation, or delivery of drugs, which means that any disputes in the industry must be settled through vigilante justice. Hence the large crime wave that emerged along with the drug wars of the eighties and early nineties. Gangs were fighting for drug selling territory, and since there was no legitimate mechanism for settling disputes, they resorted to violence and murder to do so.

The war on drugs demonstrates that even though society may have an extreme animosity towards certain goods or services, the fact that there is a demand for those goods will inevitably create a market. It is therefore the prerogative of government to provide a mechanism by which that demand can be satisfied through legal means. Otherwise, anarchy results. The government needs to legalize, regulate, and create disincentives for the use of drugs, not simply throw every drug user or dealer into jail or prison.

The Financial Sector
The financial sector is another example of a market that needs government regulation to succeed. The recent crisis has shown us that if left to their own devises, really smart individuals will make poor decisions if their incentives are misaligned. Why would banks take such risky bets on mortgage backed securities when it should have been obvious that the system would be crushed if housing prices fell. The answer is that banks, as public corporations, are incentivised by short term profits, not long term sustainability. Mortgage backed securities provided such great returns that bankers did not think about the risks that they were taking. It is for this same reason that Enron continued its fraudulent accounting practices until it became insolvent, or that Madoff kept taking new money into his Ponzi scheme even though he knew that it would collapse if new money stopped coming in.

The government has to step in to protect investors’ money from people who are investing it unwisely for current gains. The libertarian mantra of less government is always better is now a fallacy. Sometimes, government intervention is necessary. Monopoly busting was an early form of positive government intervention. Post-depression financial reforms kept the financial system relatively stable. It was when those reforms were reversed that this crisis occurred.

The Fed
I recently had a conversation with an individual who claimed to be part of the end the fed movement. He concluded that the Federal Reserve caused the great recession by keeping interest rates too low for too long, thereby encouraging too much borrowing, which led to the mortgage meltdown.

Although keeping rates low may have been a small factor in causing certain individuals to get mortgages who should not have, low rates did really not matter that much. Many sub-prime borrowers were given mortgages regardless of whether they could afford the interest payments. Banks gave out variable rate mortgages knowing that rates would eventually go up and that the borrower would not be able to afford his or her house. It was the banks, who were not properly regulated by the federal government, that caused the recession; not the Fed.

The Federal Reserve, led by Bernanke, has had just as much of an impact, if not more, than the federal government, led by Paulson, Geithner and Obama, in ending the recession and leading to the current turnaround. While the government was managing $350 billion in bailouts to artificially prop up the economy, the Fed was managing trillions. The Fed is like the great counterbalance in our society. It is independent from the government, so as to ensure that economically sound decisions are not affected by politicians judgment. It has to be, and needs to remain independent.

Evolution
I have been thinking a lot about what this all means in the grand scheme of things. The truth is, the economy, law and politics are all insignificant when compared to the revolution that we are currently experiencing. Humanity is at the end of its 60,000 year reign as the most advanced species on earth, and is about to be the first species to be replaced by its own creation.

Humanity
Recently, a 2,000,000 year old fossil was discovered showing an intermediary species between humans and apes. Although this species may not necessarily be a direct ancestor of modern humans, it provides even greater proof of our natural origins, providing evidence of an intermediary species between early hominids and Homo Erectus, the most successful hominid in the history of the world. Homo Erectus roamed the earth from over a million years ago to the time of early humans . The new species is just one species discovered among many that have already been unearthed. We lived alongside one of our inferior relatives, the Neanderthal, for almost 10,000 years in Europe, a period ending approximately 20,000 years ago. That is a period of time longer than human civilization has existed as we know it.

Humans have been continually evolving, even though from a physiological standpoint, we are probably not very different from our ancestors who lived alongside those Neanderthals. Through civilization and technology, we have been able to maximize the productivity of our earthly forms, providing ourselves with extreme amounts of knowledge and using technology to allow us to interact with the world in a more efficient way. We have created numerous ways to express ourselves, and have made the world smaller by creating efficient methods of transportation.

The Singularity
Unfortunately, we have reached the limits of our earthly forms. Futurists predict that within the next 50 years, computers will have matched and surpassed our level of intelligence. They call this the singularity principle, as the distinction between humans and computers will no longer exist, making us one singular being.

The logical conclusion is that humans will have to become one with computers in order to compete. Those of us that survive to that period of time will have to augment ourselves, becoming cyborgs. Those who cannot afford this augmentation will become an inferior species that will likely eventually die out, as the Neanderthals and dinosaurs did.

The only thing that will prevent this from happening is literally a global catastrophe like one never seen by humanity. Technology as we know it would have to be destroyed. Even the greatest catastrophes, the great world wars or global epidemics, could only delay the progress of technology, not halt it. In many cases, those catastrophes actually increased progress. Although an earth shattering event could happen, I would give it an extremely low likelihood, since economics, technology, diplomacy and science have allowed us to progress to a point where such threats are diminished. A great technological roadblock (such as the end of Moores law, which will happen within the next 20 years) may present itself, but it will be overcome eventually, as all technological roadblocks are.

We Become God

After thousands of years of looking to the skies thinking that there were invisible creatures out there more advanced than ourselves that crafted us into being, it is time to realize that we are in fact the creator creature. We will create life forms much more advanced and complex than our naturally occurring selves, and those life forms will create even more advanced life forms. The only thing we can be certain of is that we do not travel to the past to visit our ancestors, at least not in such a way as to make our presences known.

And So It Goes
We stand at the foot of the great turning point in humanity. We are about to experience the greatest global economic and technological boom that the world has ever seen. We have braved the storm of the great recession, and now will be passengers on this great ride to the end of humanity as we know it. Hopefully, we will maintain our health and life so that we can be a part of it. Otherwise, c’est la vie.

How The Recession Happened

1. The Olden Days
Dave needed a place to live, had a job with a steady income, a good history of paying back any money he borrowed, and a little bit of money saved up. Unfortunately, he didn’t have enough money to buy a piece of property outright. So, Dave went to his bank and said “let’s make a deal. You lend me the rest of the money to buy this property, and I’ll pay you back in monthly instalments over the next 20 years, plus some extra money every month (interest). If I don’t pay you back, you can take my property and sell it, pay yourself whatever I still owe you and I’ll get the rest” The bank agreed, knowing that Dave was a good guy and would pay them back. Plus, if he didn’t, they could just take the property, sell it, and get their money back. The bank got their money from cash they were holding on to, and borrowed the rest from a bigger bank or the country’s central bank. Dave got his house, and was happy. The bank was paid back over 20 years, and made a nice profit.

Alice had no money saved up, a crappy job, and didn’t pay back money she borrowed. Alice wanted her own place too. She went to the bank, but was denied because they didn’t think she would pay them back.

2. Mortgage Backed Securities
One day, a bunch of investment bankers had a great idea. Instead of getting the money to give Dave to buy his property from money already in the bank’s hands, they would get a bunch of Investors together to put money into a pot. Dave would get his loan from the pot of investor money. Then, whenever Dave made his payments, the bank would take a chunk for themselves, and the investors would get the rest. These investments would be called “mortgage backed securities” because the investments were backed by mortgages.

This worked great for a while, except eventually the investors started to get angry because they weren’t making enough money. The bank had a great idea. They would give a loan to Alice so she could buy her property too. Because they were worried that Alice wouldn’t pay them back, they charged her a lot of extra money in interest on top of what she owed. If Alice couldn’t pay the full amount, they would just add what she couldn’t pay to the total amount she owed. If she stopped paying, they would sell the house, and hopefully it would be worth more. The bank then bundled a whole bunch of loans to people like Alice and made the bundles into an investment that investors could invest in.

The bank took their investments to a rating agency, and asked the agency to tell them how risky the investments were. The rating agency looked at the bundles of mortgages to people like Dave, and said they were not risky, and gave them a good rating. They looked at the investments to people like Alice and said they were very, very risky, and gave them a bad rating.

The banks needed more money. They decided to take a bundle of loans to people like Dave, and a bundle of loans to people like Alice, and put them together into an even bigger bundle. They then went back to the rating agency, and asked how risky these loans were. The rating agency thought that this big bundle would really spread out the risk, since there were so many little bundles in it, and gave the bundles a good rating.

The rating companies screwed up, because the risky investments were still risky, they were just in a bigger bundle. Investors flocked to these big bundles, thinking they were not risky, when they really were, and bought them in large quantities.

3. Credit Default Swaps
The investors were worried though. What if they lost money on their bundles? Insurers like AIG came along and had a great idea. The investors would pay money to AIG. In return, if the investors lost any money on their bundles, AIG would pay them back whatever they lost. This was called a credit default swap. AIG was confident that people could only lose a little bit of money on these investments, since they were all backed by hard, tangible, real estate. Historically, real estate prices had never gone down very much, and had a steady increasing price trend.

Banks all over the world bought billions of dollars of these big bundles of mortgages. They invested all of their money in them, and were so happy that they were getting so rich. Plus, if they lost money, they had insurance.

4. The Beginning of the Collapse
Dave started making more money, and decided that he was going to buy a nicer house. He sold his house and went to buy a bigger one. He found a house he really liked, and put an offer on it. But, it turned out that Alice made an offer on the same house that was $100,000 higher, and got the house. The investors gave the bank money to give to Alice so that she could buy the house.

One month later, Alice didn’t make her payment on the house, and the bank took it back. They put it up for sale again at the amount that Alice had bought it for to get their money back. But, no one would pay that amount. Dave came back in with his offer that was $100,000 lower. The bank did not get any other offers and had to give Dave the house.

Now, the bank had lost $100,000 that it owed to investors!

All of the sudden, the prices of houses everywhere started going down. Alices all over America stopped paying, and banks lost billions of investor dollars. Real estate prices started tanking. In the past prices had never gone down much because they never got too high. They never got too high because loans were always made to low-risk people like Dave. But prices got too high because anyone, including people like Alice, could get a loan for however much they wanted.

The investors asked for their money back from the banks, but the banks didn’t have it. The investors then went to AIG and said “I want my insurance money”. AIG started paying out insurance money.

By the end of 2007, this caused the American economy to stop growing. It slowly started to decline, but the problem got worse. Eventually AIG had no more money to compensate investors and banks, and the banks were losing billions of dollars.

5. Lehman Brothers
One of these banks was Lehman Brothers. Lehman had been in business for a long time, and lots of people put their money in Lehman thinking it was safe. Lehman realized that they had no more money because they had too many investors trying to get money back. Lehman owed billions of dollars to these investors, but didn’t have it . Lehman asked the government for help, but the government at the time (Republican) did not want to interfere with the free market, and decided to let Lehman fend for itself. Lehman realized that it couldn’t pay money back, and went bankrupt.

6. The Catastrophe
Banks and investors all over the world were terrified. If investments in a secure bank like Lehman were unsafe, then any investment could be unsafe. Investors decided that they wanted all their money in cash, and really safe investments, because they didn’t want to lose it. So they all started selling all their shares and bundles of mortgages. But, no one wanted to buy their investments at a regular price, so they had to sell them at a really low price.

These lower prices caused the stock market to start crashing. People started selling stocks in regular companies that had nothing to do with investments because they were worried about their money. This sent share prices crashing. People who were just regular investors saw their share prices crashing, and decided to sell before prices got too low. This sent prices even lower.

This could have spiralled into another great depression. If more banks went bankrupt, and more investors lost more and more money, then all sorts of companies would go bankrupt. Banks owed hundreds of billions of dollars and had no way to get that money. It appeared that civilization as we know it could come to an end.

7. How the world was saved
The federal government saw this problem happening and realized that something had to be done. They knew that if the banks kept making loans like they did in the olden days they would surely make money again. So, Treasury Secretary Paulson decided to loan money to all the big banks and to AIG to compensate them for all the money they lost in the crisis. Paulson convinced president Bush, and a majority of congress that this was a good idea. The media called this a bailout, but it was really necessary to prevent another great depression.

With the billions of government dollars in hand, the banks could pay their investors back, and pay for all the losses that were occurring. Countries all over the world undertook similar bailout plans to keep their banks from going out of business.

8. Why there was still a recession
Unfortunately, the damage done was already severe. The banks had lost so much money that they didn’t want to make loans to companies and lose more money. Companies were losing money, and realized that the only way they could save money would be to cut costs. They started laying off workers and shutting down operations.

People who lost their jobs stopped spending money, and lived off of unemployment insurance. People who did have jobs got paranoid, especially after losing so much of their investments when the market crashed, and started putting away any last penny they could. This meant that stores and companies were selling less stuff and making less money. Stores had to shut down and lay off more workers.

9. The Aftermath
Although the recession is/was the worst since the great depression, the new Obama government and the Federal Reserve have fought to end it. The reserve made it very easy for banks to borrow money to lend out to good customers like Dave, charging really low rates of interest to banks, and making lots of money available.

The federal government’s stimulus package was designed to give the economy a boost at the other end, by creating actual jobs, extending unemployment benefits, and spending money on government programs.

In the end, this recession will be looked at as a wakeup call in the history of modern human civilization. The free market works brilliantly when it is monitored and regulated. But, it has the capacity to spiral out of control when people make the wrong decisions. If it was not for secretary Paulson and the TARP bailout, the free market would have self destructed, and would have taken years to correct itself.

This recession has been horrible, and has negatively affected the lives of millions. However, it would have been much worse if it were not for the bold and swift actions of the responsible bodies, guided by hundreds of years of economic thought. Hopefully, we can learn from these mistakes, and try to make sure something like this never happens again.