Ch. 12 Class Notes

Ch. 12 Class Notes - Federal Bureaucracy The financial...

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Federal Bureaucracy The financial crisis illustrates the role of the federal bureaucracy in the policymaking process. Here is a simplified explanation: Banks, mortgage companies, and other financial institutions loan money to individuals to purchase homes. In the old days, financial institutions required individuals to produce documentation to show they could repay their loans and insisted on a down payment, typically 10 or 20 percent of the purchase price of the property. The financial institutions made money on interest paid on the loan. If the buyer defaulted, the bank could sell the property and recover its investment. In recent years, financial institutions, in search of higher profits, have gone after what is called the sub-prime market. These are individuals who may not have the best credit history. The financial institutions have also developed creative approaches to financing. As long as housing prices rose and times were good, these investments paid off handsomely. When the economy slowed and housing prices fell, however, things began to sour. Rising gas prices made it more and more difficult for homeowners to meet their payments. Many defaulted, leaving the financial institutions holding the bag. The home mortgage crisis has become a problem for the economy because of its impact on the credit market. Financial institutions, burdened by bad debts, don’t have money to loan. Health banks have been wary about loaning money to other banks, an essential part of the credit system, because they don’t know which banks are healthy and which are not. If credit is hard to get, business doesn’t expand, companies may lay off workers, and individuals may have difficulty borrowing money to buy cars and houses. A recession is likely. The Department of the Treasury has asked Congress give it authority to purchase as much as $700 billion worth of properties from financial institutions. The purpose of the plan is to take foreclosed properties off the books of the financial institutions and give them some cash that they could then turn around and loan. Secretary of the Treasury Paulson hopes that action would free up the credit market. The government would hold onto the properties for a few years and then sell them to recover the investment. With any luck, the government might actually make money. The Treasury plan, which is widely regarded as a bailout, is unpopular. Conservative Republicans oppose it because it involves an expansion of government activities and a governmental interference in the marketplace. Liberal Democrats oppose it because it isn’t focused on helping individuals and families who are hurt by foreclosures. Why should we rescue mortgage companies and banks, they ask, but not help out consumers? Three executive branch agencies were involved in the financial bailout—the Department of the Treasury, Federal Reserve, and the
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Ch. 12 Class Notes - Federal Bureaucracy The financial...

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