Analysts Say Economic Crisis Started with Bad Housing Loans

The economic crisis has spread into many areas of the U.S. economy--banks, investment firms, insurance companies, and even the oil markets. But as VOA's Kent Klein reports from Washington, experts seem to agree that the trouble started with bad loans in the housing industry, and grew into a widespread crisis of confidence.

Gus Faucher, the Director of Macroeconomics at the economic website Moody's Economy.com, is one of many experts who say the crisis began in the U.S. housing market. He says prices rose unrealistically high and credit was given too easily. "We had people who, in retrospect, were given mortgage loans but should not have been given mortgage loans because they really could not afford them. So now we are seeing the effects of that," he said.

International economist Robert Scott, at the Washington-based Economic Policy Institute, blames the Federal Reserve--the U.S. central bank--for allowing housing prices to rise too high. "For the last seven or eight years, until just the last year or so, Alan Greenspan, the former Chairman of the Federal Reserve, said that the housing market was sound, that there was nothing wrong with the rise in housing prices, (which) many, many economists were saying was unsustainable. So he let that bubble build up, he did nothing about it, and he bears a lot of responsibility for this crisis," Scott said.

But that may not be the whole reason. Ted Truman, a senior fellow at the Peterson Institute for International Economics, says while the financial woes started in the mortgage lending industry, the causes of those problems have been afflicting other financial markets. "Everybody calls it a subprime crisis, in the sense that if no subprime mortgages had ever been made, we would not have had a crisis. And even the thought that it is all about housing, I think, is an exaggeration. It is about easy credit, and financial engineering that went wild, and people who thought that the good times would never come to an end and were planning accordingly," Truman said.

According to Faucher, the bad loans that were handed out by mortgage lenders are still causing trouble for consumers and for financial institutions. "There are simply a lot of bad housing-related securities out there. Those are falling in value. The problem is, we are not sure who is holding all of those. And as we find out about institutions that are holding them, those institutions start to fail, and that is causing problems throughout the entire financial system."

Faucher says banks are reluctant to lend to one another, because they are not sure which institutions are holding bad debt. He says the banks are also reluctant to make loans, so the entire system is coming to a halt. According to Faucher, worries that one failing financial institution could drag down others led the U.S. government to buy out most of the huge insurance company A.I.G.

"The Federal Reserve and the Treasury Department were concerned that A.I.G. is involved in many different financial markets. And they were concerned that if A.I.G. failed, that would bring down the entire financial system. So therefore, they decided to step in and have, essentially, the federal government take over the firm."

Many economists, including Scott, believe tighter regulation could have prevented the crisis. "Mistake number one was failing to regulate the financial sector. We should have required them to hold much greater reserves. They are not required to hold any reserves now. Secondly, we should have limited which they can invest in these high-risk assets," Scott said.

Robert Reich, who was Labor Secretary under President Bill Clinton, says the troubles have worsened to this point because there was not enough regulation of the financial industry between 2002 and 2006, when the economy was strong.

"Wall Street increased its borrowing dramatically. Our financial institutions increased borrowing much faster than economic growth. Individuals increased their borrowing, also, much faster than economic growth. But nobody was minding the store. Our regulators were not overseeing the system to make sure that there was adequate disclosure (and) capital requirements, so that information could get to the right people at the right time. The system was no longer transparent," he said.

Reich says America's financial markets need to adhere to the same standards that the U.S. encourages in other countries. "The United States continues to tell developing nations, as the I.M.F. and World Bank continue to tell developing nations, that they have to have a transparent capital market before capital will be attracted to them. Well, the same principle applies to the United States. Unless our markets are transparent, capital, at some point, is going to be afraid and start stampeding out of those markets, and that is exactly what has happened," he said.

In recent days, both U.S. presidential candidates, Republican John McCain and Democrat Barack Obama, have advocated tighter regulation of financial institutions. And U.S. Treasury Secretary Henry Paulson is said to be considering creating an institution to deal with troubled banks and investments.