What is the main cause of the current economic crisis?

What was the cause of the 1929 Wall Street Crash and what is the cause of the current economic crisis?

• Answer:

  Ok if you really want to know I will break it down for you in laymans terms. It has everything to do with the federal reserve. In case you aren't aware, we had the roaring 20's which was done through the inflation of the money supply, and everyone got high on cheap credit. This led to a stock market bubble that was all but unsustainable. When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves, through the artificial lowering of interest rates, in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates. The "Fed" succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market -- triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930's. Now almost the same thing happened now, except in a different way. In 2001, we were already facing a recession with the Nasdaq bubble that was exploding, but after 9/11 happened we saw the Greenspan put in action, which in other words is Greenspan lowering the interest rates below what market forces would normally set it at, causing another speculative bubble much bigger than the Nasdaq bubble. With the lax lending processes allowed by the CRA, as well as the SEC's allowing for banks to leverage their money, that is lend out 40 dollars, for every 1 dollar they had, allowed the bubble to get even bigger. To make things even worse, there was a completely unregulated CDS(credit default swap) market. A CDS is like an insurance plan for a banks asset In essence, banks would sell you a house and get a CDS on the house, so that if you were to default on your loan, the insurance company would pay for it. So once a bank got a CDS, they no longer had the money they loaned to you tied up anymore, and could go ahead and loan more and more and more. To exacerbate the problem even more, Fannie and Freddie, who were GSE's(government sponsored enterprises) that got special privileges were able to buy these loans off the bank, and they were leveraging their assets 150/1! And they were packaging up these loans and selling them as CDO's(collateralized debt obligation) which are pretty much bundles of loans they sell to investors, and banks. Now banks are only allowed to buy treasury bills because they are viewed as safe, but they were ok to buy CDO's because these were supposed to be just as safe, but in fact they were toxic assets after the market crashed. Ok so because of all these issues, there was a huge speculative bubble in housing and people were buying like mad. 0% down payments made it ok for almost anyone to buy. Most people had the mentality that they would buy the house for a few years, and sell it at a profit. The problem is that this is a ponzi scheme and it can go on for so long, until there are no more buyers because everyone is already in so much debt. To exacerbate the problem even more, there was so much construction of new homes going on, because they saw the prices of houses going up so much and thought it was a good investment when in fact it was actually not. It was just temporary, all thanks to lax policies set by the government, and also the incredibly low interest rates set by the fed Onto interest rates. Interest rates in a free market are supposed to be based on savings. When everyone is saving a lot, this means that interest rates are very low because there is a lot of excess capital sitting around. When interest rates are low, this tells investors that consumers are forgoing their consumption now for a later time. This gives them the signal that now is the time to invest in long term projects because they will get a very low interest rate, and when they are done and they pay back the loans, the consumers will be more ready to spend money, thus making their investment a good one. But when interest rates are set artificially low, as they were before the depression and in the latest crash, consumers spend because of cheap credit, and investors go for long term projects, like we saw in real estate with the buildup of all these new houses, and shopping centers and casino's etc. However by the time these things are produced, consumers who were borrowing because of the cheap credit must cut back their spending because they are already in debt, and so these investments made by investors are actually bad investments. This is called misallocation of resources. Heres an analogy. A circus comes into town for the month. The restaurants in the area all have exploding business for the time being because of this new attraction. One of the restaurant owners has so much new attraction that he decides to expand the area and double the size of the restaurant to accommodate the new demand which he can barely handle. The problem is, that as soon as he is done, the circus is out of town, and the restaurant owner no longer needs the space, and has just spent all his resources inefficiently. He has an empty restaurant and has wasted his capital instead of using it in a more productive way. The circus is the federal reserve lowering the interest rate artificially. What I just explained to you is called the Austrian Business cycle theory, for which, The Austrian economist F.A. Hayek got the nobel prize in economics for in 1974. PS I better get the best answer for putting in so much time