A “Borrow and Spend” Binge

Our current financial system woes have been blamed on greed and lack of regulation. We heard about “predatory lenders” who took advantage of unsuspecting borrowers by giving them mortgages they could not afford with future rate changes they did not understand.

We also heard about lying borrowers who took advantage of gullible lenders by misrepresenting their income and assets in “no doc” application packages wherein the gullible lenders accepted the borrower’s word on their income and assets in exchange for a slightly higher mortgage interest rate.

We heard about “derivative” securities based on complicated formulae developed by brainiac academics that were calculated to transform risk into safety – QED. I can’t help but quote Warren Buffet here – several years ago he called these securities “weapons of financial mass destruction” and more recently he warned “beware of geeks bearing formulas”. I love that.

We heard that “mark-to-market” accounting requirements caused banks to write down their derivative security assets when no one would buy them anymore.

And we heard about the housing bubble and people in some regions paying millions for modest homes; other people “flipping” houses to catch the capital gain accrued in a few short months and still others refinancing their mortgages to withdraw equity to fund consumer purchases.

This is all crazy stuff. The bottom line is that that whole country was on a “borrow and spend” binge. Individuals borrowed to buy things. Companies borrowed to “leverage” their earnings. The Congress (Republican controlled before 2006 and Democrat controlled post-2006) borrowed to fund pet projects to ensure their reelection.

Since the we borrowed too much at all levels – it seems unlikely that the problem will be solved through the dramatically increased government borrowing we have seen in recent months.

Individuals and companies have started saving and paying down their debts. The government hasn’t figured it out yet.

Links to Other Topics in the Special Report: Economic Stimulus