The economic crisis due to more than greed

What should Christians be doing about the current economic crisis? CC.com consulted a number of economic and socio-political leaders for faith-based perspectives on the subject. First in a series.

Click here to read Part 2 | Part 3.

In discussions about the ongoing financial crisis, the word ‘greed’ keeps popping up. But that is the simple answer. According to some experts, the situation is more complex than that.

There are both a “short-term cause and a long-term cause” to the current problems, according to Paul Williams, associate professor of marketplace theology and leadership at Regent College in Vancouver.

Housing markets

The short-term cause was the collapse of the sub-prime housing market in the United States.

Essentially, said Williams, “banks sold mortgages to people with poor credit ratings on less desirable properties.” Often, these mortgages offered very low introductory interest rates (as low as two percent) for the first couple of years, after which the rates would rise to above-average interest levels.

The buyers were told that, after a couple of years, the house value would rise. They would then have equity — i.e. they would own part of the house — and they could then negotiate a mortgage with a better interest rate. Often, the mortgage given was for 100 percent or more of the purchase price and/or value of the house — again on the assumption that houses would continue to go up in value.

The problem was compounded by new means of spreading the risk. These means have been called “recently invented financial instruments” by Carsten Hennings, assistant professor of business administration at Tyndale University College and Seminary in Toronto.

Williams explained that banks are normally limited in how much money they can lend by the “capital ratio” — which means that a considerable proportion of the money they lend out must be supported by money they have on deposit.

In this case, regulators allowed the banks to ‘sell’ the mortgages to other investors, and then agreed that these mortgages would not be included in the banks’ capital ratios. This enabled the banks to issue mortgages many times the value of the money they had on deposit. The mortgages were bought by other banks and investors both in the U.S. and around the world. Bond rating agencies rated these investments as ‘safe,’ since they were backed by tangible assets — i.e., the houses.

This system worked for a while. The massive infusion of credit into the U.S. housing market kept driving house prices higher. However, eventually borrowers who were unable to make the mortgage payments began to default on their loans. This caused house prices to drop, and “the whole pyramid scheme started to collapse,” Williams said. Several things began to fall: the value of the investments, bank profits and stock prices.

Stock market

Something similar occurred with the stock market, Hennings said. Investment money had poured into the market, driving up stock prices and making big profits for investors. However, the investments did not increase the real value of the companies being invested in; because of this, stock prices eventually began to fall.

“What we often call investing is not what economists call investing,” said Elwil Beukes, professor of economics at King’s University College in Edmonton. Much of the ‘investing’ that was going on was “financial investing,” he said — i.e. bidding up the price of stock and houses; very little investment was put into “the real economy.”

Real investing, Beukes clarified, increases “the capacity of the economy to produce more”; but even while stock prices were going up, real industrial capacity was dropping. As jobs were shifted overseas to increase profits and stock prices, “U.S. industrial indices have been in recession for a long time.”

Bubbles burst

Virtually all of the experts CC.com consulted agreed that the ‘bubble’ in the stock market and the housing market were bound to burst, and that a recession was inevitable. However, the recession is now affecting more than the financial markets. Those who lost houses or lost money in the stock market slowed their spending, and this began to affect the ‘real economy.’

As soon as banks started to report losses on their mortgage debt, said John Boersema, a business professor at Redeemer University College in Ancaster, Ontario, people started selling bank shares — and that precipitated the stock market crash.

As well, since the transfer of debt from one financial institution to another had caused such problems, “banks were afraid to lend to each other or anyone else,” said Williams — and this also affected the real economy.

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