Explaining the economy

In light of the dramatic and confusing developments on Wall Street, we talked to students to find out what they wanted to know, and talked to financial experts to find out some answers.



What caused it?

The economic crisis stemmed from long-boiling problems in the mortgage lending industry. Interest rates, which are essentially the price for loans, went down. That meant more people could get loans to buy homes, and the housing market boomed.

But at the same time, people with bad credit or no credit were able to get loans, N.C. State University economics professor Michael Walden said.

Then, the downturn in the economy led the housing market to tumble. Home prices began falling, and many people didn’t have the money to pay their mortgages.

When people defaulted on mortgages, the banks seized their homes as collateral. However, the weak housing market made it difficult, if not impossible, to sell the homes at a price that could compensate for their financial losses.

“It really comes down to the individual consumer. Consumers were greedy. They were taking out loans they couldn’t afford,” N.C. State business management professor Robert Handfield said.

The large lending firms couldn’t bear the weight of all the home foreclosures, and many failed or nearly failed.

The firms depended on having investments that could quickly be converted into money that could be used for day to day operations. In a normal housing market, houses turn over into money more easily.

Normally banks lend back and forth, but they lost trust in each other and stopped doing that, further stemming a flow of money, Handfield said.

N.C. State business management professor Mitzi Montoya said eventually the financial institutions couldn’t keep afloat.

“Institutions have lost all kinds of money. Many, many people have defaulted on their loans,” she said.

The firms ended up with thousands of homes that would not sell, and no way to get quick money.

That prompted concern, and investment firms rushed to take money out of the stock market.

“When one person starts to panic, they all start to panic, like lemmings,” Handfield said.



What is the bailout plan?

The bill, passed by U.S. Congress and signed by President Bush last week, aims to pump money into the financial sector to help companies resume normal operations and start lending money again, Walden said.

There are some parts of the bill that change regulations of the financial sector, but financial experts are unsure how effective or restrictive the regulations will be.

The bill gives the U.S. Treasury Secretary Henry M. Paulson Jr. expansive control over the financial sector, enabling him to buy and trade bad loans.

Without his intervention, major financial institutions that make up the foundation of the U.S. economy could go bankrupt.

However, many experts agree that while the bailout is an emergency measure that forestalls a deep recession or possible depression, it does not address the issues that led up to the meltdown.

“This is going to help cut the losses. It’s not going to fix the economy,” Walden said. “It’s taking care of the symptom of the problem.”



What’s happening now?

When Congress passed the bailout plan, it helped restore confidence in the market. The stock market is slowly recovering, Handfield said.

“The stock market went up because people believed that the $700 billion is going to help the banks, and people will start loaning,” he said.

However, Walden said the economy at large is still faltering.

“We’re still looking at an economy that’s very weak; we’re still looking at an economy where unemployment is going to increase,” Walden said.

For now, college students will face three major difficulties: There will be fewer jobs, they will have trouble getting student loans, and they will have trouble getting credit cards.

“The way it affects college students is banks aren’t going to give out college loans. Banks aren’t giving loans to anybody,” Handfield said.

However, students still should be able to find internships. In economic downturns, as companies cut full-time employees because they are more expensive, they often turn to part-time employees and interns, Montoya said.

And most students will fare better overall than other demographic groups because most don’t have many financial obligations.

“The demographic least affected by economic downturn is teens and tweens,” Montoya said. “That’s the group that has absolutely no financial responsibilities.”



What happens next?

Most experts expect a long road back to economic stability.

“I think we’re looking at a few years; that’s not atypical,” Montoya said. “We’re at the beginning of this downswing.”

Handfield, who expects it to take closer to two years, said the housing market will worsen before it corrects itself.

“Home prices will probably fall some more before they go up, which means that we probably won’t be seeing anything stabilizing until the second half of ’09, at the earliest,” he said.

However, Handfield said that he also expects the U.S. Treasury department to make back the money it spends as part of the bailout.

“I think the taxpayer will get that money back in the long term.”



Contact the State & National Editor at stntdesk@unc.edu.