Sunday, December 14, 2008

What Really Caused The Financial Crisis

I don’t get it. I read the papers and the news articles on the web services, supposedly full of wisdom from the financial experts who tell us what we must do to fix the financial crisis. The talking heads on television ramble about how we need to revive lending and free up the credit market. These so-called experts are presented as the unquestioned authority on finances and what is required to get us out of the mess that we are in.

Look, I didn’t get my MBA. I finished college with a simple (!!!) Engineering degree, and enough credits for a minor in Mathematics. The math I waded through didn’t really count toward traditional financial understanding, but I did take classes in macroeconomics and microeconomics, so I’m not a complete dunce on the subject. But more importantly, twenty years after leaving college, I spend less money than I make, and our family is essentially debt-free (discounting a very reasonable amount remaining on our mortgage). I think I have a pretty good practical sense of financial wisdom, even if stock derivatives and short-selling are not topics that I can readily explain. But let me try to detail what I see going on around us at this moment in the financial world.

We are currently in a crisis created primarily due to a number of risky mortgage loans which were made to people who can no longer pay them back. You could blame the “evil predatory lender” for offering the loans in the first place. You could blame the government for mandating that the lender offer loans to people who were not qualified to pay them back. Or you could blame the individuals themselves, who wanted a house they couldn’t afford or a car they really didn’t need. Maybe all three are to blame, but one simple financial rule should overshadow it all. If money is to be borrowed, it should be given to people who demonstrate the ability to repay the loan. It’s that simple. It’s biblical, too. Romans 13:7 - ”Give everyone what you owe him.”

Good lending practice is pretty straightforward. A lender gives money with the expectation that it is returned over time with interest. They will plan for a certain percentage of borrowers to default on their loans, but this is never the most desirable end. To make the whole system work together, the lender will develop complex models that measure the ability of the applicant to repay the loan. And when the numbers don’t add up, the lender should refuse the individual’s application. It’s painful, but necessary for sound business practice.

Designing rules for the borrower is much more difficult. Many people fail to “count the cost” before applying for a loan. Instead, they are often blinded by the prospect of a new car or a larger house, assuming that their financial situation will improve enough over time to allow them some financial flexibility. How many people wish they had never taken on the loans that they possess, choosing instead to wait for some of the things that they desired? I’ve been there in the past.

The bottom line is this – a sound financial environment relies on good financial stewardship -- not on risky loans made to financially strapped individuals who will eventually default on their debts and leave the burden to other taxpayers. So, here is where I get to the part that I don’t understand.

Several weeks ago, our government approved over $700 billion of “bailout” money to give to financial institutions, wishing them to lend this money to people. These institutions were suddenly hesitant to loan money to people under risky circumstances. Imagine that… And recently, I read that the government desires to give an additional $800 billion to the lenders to encourage them to loan even more money to people. These actions beg several questions. Should we continue to make loans to people who shouldn’t be applying for them? Is it wise to float so much credit into the market instead of encouraging personal savings? And finally, is the government simply perpetuating the crisis by loaning even more money to people who will likely default on their obligation in the future?

It seems to me that loaning more money does not solve the problem – it only makes it worse. We have reached a point in our beloved America where we need to take a step back from the wealth and affluence which crowds out the system that God designed. The Bible is full of references to economic principles, most of which discourage excessive borrowing and living beyond our means. God does not promise that we will enjoy wealth or a life free from worry if we follow Him. However, He does promise an eternity with Him and the benefit of other non-financial blessings in this life. But God wants us to follow Him first and foremost, and His principles revolve around that relationship. God knows more about economics than any man, committee, or political system. If we design a financial system that forgets this basic principle, then we are doomed to fail. And, sadly, it appears that we are doing just that.

Luke 16:11-12 gives us Jesus’ view on the proper handling of money and debt – “So if you have not been trustworthy in handling worldly wealth, who will trust you with true riches? And if you have not been trustworthy with someone else's property, who will give you property of your own?” Many of us have made financial mistakes in the past, me included. Let’s not allow our government to make the financial problems even worse. Tell them to keep their loan money away from bad borrowers. Or better yet, give it back to the place where they got the money in the first place. Where did they get an extra $700 billion anyway? Hmmmmmm…

No comments: