For Nations or Firms, Economic Sinkholes Need Not Be The End

When fundamental flaws in business practice or economic philosophy swells into a major crisis, most media attention is focused on finding out how and why things went wrong, and considering who to punish. The last major economic disaster in 2008 had many causes, but the consensus is now that banks sold products and derivatives to people incapable of paying it back. Worse still perhaps were those who exploited blind spots in regulations, maximizing profits in a myriad of ways.

But the way such crises are confronted (or they way they aren’t) is rarely addressed. Banks became accustomed to selling mortgages to people incapable of repaying because the Federal Government backed them with “Freddie May” guarantees. As this carried on, the U.S. government borrowed much more than it could have possibly repaid.

Federal Mortgages Extend Economic Damage

Federal Mortgage guarantees seemed like a good idea because they allowed Joe Anybody to buy a house. However, to fatten bank portfolios, many agents sold to people even more hopelessly incapable of repaying the loans. Imagine one person paying mortgages for a $200,000 house. Say he’s offered the chance to move into a new $400,000 house. It’s located in a gated housing development with gardens, swimming pools, and the like. And to boot, it’s mortgage rate is comparable to his present one, so he’ll probably take the deal and move out. As he leaves, his $200,000 house is then sold to someone who can’t afford more than $100,000 in the same manner as the first guy.

Since mortgages are guaranteed, bankers can repeat this method until they receive big bonuses for “improved performance.” Creating an economic sinkhole ready to fall with something as simple as rising oil prices, or foreign goods flooding the market. A handful of people representing the house of cards at the bottom of the precarious system fail to make mortgage payments, and the whole thing comes tumbling down.

But by this point, the entire nation is in economic meltdown. The government decides banks shouldn’t be allowed to fail, and steps in with artificial buffers. They seize a percentage of the banks’ shares, but this, in turn, forces the government to realize they can’t afford to pay its bills. Then the system continues feeding on its dying self like a self-consuming Medusa. Finally, the entire western world capitulates to an economic catastrophe.

Possible Strategies to Economic Crisis

There are several ways governments respond to such crises. One is to arrest every banker who made unethical profit through exploitation of the system. They could reassess the price of houses in the past, to see if they were over-inflated. These would be ways to cut the cause of economic meltdown – whatever it ultimately was – out of the equation.

Government Alters the System First

But instead, the government froze interest rates at 1%. Then they prepared new policies they believed would restart the economy by inserting new growth factors. By inserting more money into the economy via domestic industries, the government hoped to catch the falling economy on its way down. This involved banning gas guzzling vehicles, recalling cars more than ten years old, incentivizing the purchase of new cars, strong-arming manufacturers to produce better cars, more fuel-efficient, and so on. Beyond the automotive world, the government’s policies of modernization applied to the country’s shipyards, commercial airline fleets and engine optimization.

Insufficiency of Systematic Adaptation

These efforts began the necessary process of repairing the nation’s infrastructure, but it isn’t quite complete. Blaming corrupt bankers and bad policy makers is useless. But taking them out of the equation guarantees two important changes in the economy. First, those known to make bad loans with people who can’t afford it  are removed from the situation. Second, rising stars in the financial sector might learn from examples that the nation’s economy is not a casino, and will think twice before making the same mistake their predecessors did.

Whether on a national or a single firm’s scale, when economy and finance fall into a sinkhole, the first step is to shore up all loose ends and ensure there is a floor to stop the fall. From there, one can assess total damage and pursue personal or legal action.