Worst Still to Come

The United States may soon realize that the worst of the financial crisis is yet to come, according to Reuters.

Kenneth Rogoff, a professor at Harvard University and former chief economist of the IMF, warns that the coming crisis will likely hit large financial houses as well as the more vulnerable medium sized firms.

It may come as little surprise that the firms highlighted for a possible future collapse were Fannie Mae and Freddie Mac. These institutions represent nearly half of the U.S. housing market, backing $5 trillion of the $12 trillion worth of American mortgages and home loans.

It was revealed Monday that a Treasury Department takeover of the two government-endorsed giants was imminent. News of the deal sent Fannie and Freddie shares plummeting in afternoon trading sessions as shareholders dumped stock to avoid losing everything to the government reorganization.

The loss or complete restructuring of these financial institutions would have a far-reaching negative effect on the U.S. economy, but there are still other problems at hand. The housing crisis is just a part of larger issues which undermine the economy. In an attempt to gain capital and stabilize themselves against the coming storm, major lenders and financial firms turned to foreign wealth funds.

The funds were set to make large profits while the firms were given the liquidity they needed, but it “neglected the point that the financial system has become very bloated and needed to shrink,” said Kenneth Rogoff. Instead of responding to the issue, the firms borrowed foreign money to maintain the status quo. The real issue was predatory and sub-prime lending practices which needed to be reined in. By giving massive flexible-rate loans to individuals who couldn’t afford them, the lenders should have expected future delinquencies. Somehow that simple fact was overlooked.

When foreign capital failed to solve the problem, the Federal Reserve rushed together a group of interest rate decreases, dropping the rate from a stable position of 5.25 to a ridiculous 2 percent. By essentially giving money to institutions which had proven themselves to be poor managers of it, the Fed not only set itself up for massive losses as its own loans went unpaid, it set the entire economy up for accelerated inflation.

Source Reuters:

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