Everyone right now is focusing on the financial crisis and with good reason. There are so many claimed causes spanning decades. What really caused all this is the government monkeying around with the basic rules of capitalism, and by that I mean hard-core basic economics.
The first basic rule: Price is set by one thing only – Supply and Demand. Cost is NOT relevant to price. It is only relevant to whether the price you can get on the streets will net you a profit as against your costs. The amount of supply and the demand of people to purchase that thing drives prices.
When supply exceeds demand, as in the market for finished single-family homes, the market for Auction Rate Securities, etc., the price goes down. Lots of product. No buyers. Have a sale to clear out the inventory.
When the demand for something exceeds the supply, as in the demand for new mortgages and loans, the price goes very high. Right now if you are a bank and you have cash, you have two choices:
a. Buy really good loans on the street from struggling banks for below par guaranteeing a great return, or
b. make a new loan at par.
No one in their right mind would do the latter. So we wait for the market for loans to run its course and prices to get back to par, and then the supply of loans will go up to meet demand.
I realize this is late and the bail-out has already occurred, but what the government needs to do is get out of the way and let the stupid greedy companies fail. Nothing will happen. The solid banks, and there are many, will buy all the loans out there for pennies-on-the-dollar in bankruptcy. When the banks buy these loans at well below par, they hold them on their books at a lower value and need a much-lower return to make money on them. So they can more easily renegotiate or refinance them so that borrowers can pay them.
The longer we let failing banks stick around with a hope of getting back on their feet, the longer they will hold these loans for a better price and the process takes much longer. Whenever the government gets involved, the process takes much longer.
Author of five novels available on Amazon, numerous articles and other commentary.