Independence Day is rapidly approaching–a day when Americans celebrate freedom around the country. Unfortunately, lawmakers in Washington won’t be celebrating with the rest of us as they work through their July 4 recess in order to solve the national debt issue.
The United States has a long history of both good and bad money management. So to celebrate this Independence Day, let’s take a look at the history of U.S. debt, how we reached the debt ceiling and hopefully, how we can enjoy the holiday despite fears of default.
United States No Stranger to Debt
The Declaration of Independence was adopted by the Continental Congress on July 4, 1776, which marked the 4th of July as Independence Day and marked the start of our true freedom. But it was also during this time that America experience financial panic, crashes, recessions and depressions, similar to modern times.
What were the causes of these crises? Upper-level greed, investments gone wrong, big business takeovers, falling stock prices, high interest loans and defaults. Sound familiar? It should, as we’ve seen these patterns of money mismanagement that has resulted in struggles within the financial sector.
Panic of 1792
The Panic of 1792 was eerily similar to the financial crisis of 2008, when a few ambitious people hoped to gain riches from their investments but sent the country into a frenzy instead.
One of those people was William Duer, a delegate of the Continental Congress and contracted supplier of the army. His goal was to take over the Bank of New York and possibly the Bank of the United States by investing in paper assets, stocks, government warrants, state securities and more. But when stock prices fell, his high interest loans and leveraged purchases defaulted, causing the major panic.
Panic of 1873-1878
Another important time in United States debt history is the Panic (sometimes referred to as the first Great Depression) that occurred from 1873-1878. It started with an economic reversal in Europe that then hit the U.S. and resulted in a massive investment bank failure.
The failure prompted investors to sell stocks in droves to protect their capital. New York Stock exchange stocks dropped so low that it was forced to close for 10 days. During this time, credit dried up, businesses had to let thousands of workers go, homes and businesses were foreclosed and bank failures occurred. Again, very familiar.
Great Depression–1929 to 1942
We have all heard about the horror that occurred when the stock market crashed in 1929 and was followed by the Great Depression. During this time, millions of Americans were unemployed, tens of thousands of companies went bankrupt and thousands of banks failed.
It would seem that among these panics and depressions–along with many others–that changes would have been made to our system to prevent such loss, but as of 2008, much has remained the same.
Corporate Deregulation Set the Nation Up for Failure
What led up to the financial crisis in 2008 and recession that began one year earlier is said by experts to be the result of several decades of mismanagement, greed and risk-taking. The culprit at the helm of it all was deregulation.
After the Great Depression wreaked havoc on the nation, lawmakers made it a point to set up strict financial regulations that would prevent such devastation from occurring again. One big change was that small banks were prohibited from speculating with depositor’s savings. This was left to major investment banks that handled stocks and bond trading.
The result of regulation was 40 years of economic growth without one single financial crisis. However, in the 1980s, the financial sector began to take off. During this time, investment banks, which had once been private firms, went public. This allowed them to take advantage of huge amounts of stockholder money and helped Wall Street workers increase their salaries from thousands to millions of dollars a year.
The 1980s were also a time when the lines began to blur between government and financial corporations. In 1981, President Ronald Reagan chose the CEO of Merrill Lynch, Donald Regan, as the Treasury secretary. The following year, the Reagan administration deregulated savings and loan companies, allowing them to make risky investments with depositors’ money.
This deregulation encouraged the financial sector to consolidate into a few major firms–making them so large that the failure of one could threaten the entire system. The bigger the financial sector grew, the more lobbying power and influence over financial laws they had. This meant they acquired even more freedom to make up the rules as they went along.
One major result we saw from deregulation was the internet bubble burst that occurred in the early 2000s. Investment banks had fueled a massive bubble by investing in the biggest tech stocks like Microsoft, Intel, IBM and Dell. Combined, the stocks had a value of $1.65 trillion, which was 20 percent of the U.S. debt GDP.
With stocks grossly overvalued, a crash occurred in 2001 that resulted $5 trillion in losses. During that time, there were hints of fraudulent activity, such as Eliot Spitzer revealing that banks promoted internet companies they knew would fail.
Similar revelations would come to light after the financial crisis of 2008, which was encompassed by the Great Recession of 2007 to 2009.
The Financial Crisis of 2008
One of the biggest crises of modern time came in 2008 when a number of financial firms, including mortgage lenders and insurance companies, participated in risky investments tied to overvalued debt securities.
Much of the problem occurred when banks began taking on derivatives, which were complex financial products that allowed bankers to gamble on just about anything, including the rise and fall of oil prices, the bankruptcy of a company and even the weather.
In Dec. 2000, the Commodity Futures Modernization Act was passed to ban the regulation of derivatives. This allowed companies to put together any type of complex investment package they desired. Born from this new freedom given to Wall Street were mortgage (and other loan) securities.
To explain this as simply as possible, once upon a time, homeowners who took out a mortgage loan or other loan from a bank were required to repay the loan to their lender. Because this type of loan could take decades to repay, lenders were careful about who they loaned money.
However, debt securities changed the entire lending process. Now, lenders would issue loans to borrowers and then sell the debt to a bigger bank. That bank would package the debt with other loans (auto, personal, student, etc.) and credit card debt into a complex derivative known as a collateralized debt obligation (CDO).
These CDOs were sold to major investors all over the world, leaving the borrowers with a new and unknown lender to repay.
Lenders realized they didn’t have to wait for a borrower to repay their loan in order to recoup the principal (because they could sell the debt instead), and became more lenient in their lending standards. This is when subprime mortgages and balloon-payment mortgages became extremely popular, allowing individuals with questionable income and credit to purchase homes with little-to-no money down and low initial monthly payments.
However, problems arose because the mortgages came with adjustable rates that often doubled or tripled payments overnight. The CDOs that carried millions of these mortgages suddenly experienced a high level of default, making them completely worthless to the investors who’d purchased them.
Even worse was the fact that insurance companies like AIG that were supposed to insure these debts if they defaulted, but didn’t have the money they promised.
Just like that, numerous major companies and banks lost out on their investments. As a result, the stock market crashed, companies had to let go of millions of workers, millions of borrowers who had taken on subprime mortgages were suddenly in foreclosure and hundreds of banks failed.
Because many of the major companies (i.e. AIG, Goldman Sachs, JPMorgan Chase) were tied to too much of the financial sector and were deemed “too big to fail,” instead of filing for bankruptcy like smaller entities, they were given bailouts from the government in the form of the Troubled Assets Relief Program (TARP).
This tied the U.S. Treasury debt to the Wall Street companies. While many companies have managed to repay the money they’ve borrowed from the government, others like Fannie Mae and Freddie Mac are still very closely tied to Treasury dollars. This is said to have largely contributed to the national debt issue we are facing now.
Fixing the National Debt Issues of 2011
If you’ve taken a recent look at the U.S. national debt clock, you may have noticed that it’s ticking beyond the national debt ceiling of $14.3 trillion that was reached and surpassed in May 2011. This means the government has borrowed so much money from creditors that it is now in danger of defaulting on its debts.
Currently, the deadline for lawmakers to decide how to manage the debt is Aug. 2. At this point, some experts say that if the country defaults, America will be facing one of the largest crises ever experienced–one that far surpasses the crisis in 2008.
As of July 1, President Barack Obama and Senate leaders had come up with an outline that would cut federal spending by about $1 trillion over at least 10 years and lower the debt enough to avoid default. However, the plan includes tax increases that the House of Representatives is opposed to.
To get the matter under control, Obama is requiring lawmakers to decide how to manage the debt by July 22. Congress has decided to give up their July 4 holiday to get this goal accomplished.
So until the Aug. 2 deadline, it will be up to us to enjoy our holiday. We can reflect on Independence Day history positively while hoping that lawmakers can set aside their differences long enough to give us the permanent break from panics, recessions and crises that we truly deserve.
Check out your title. Should that be 1776 not 1976?
I question this since you start the history with the 1792 market. You have to love it…..even without Government regulations The Market is not “Pure.”
Yeah, she means 1776. A nation’s debt is managemable so long as the country’s economy can grow its way out of it. But that’s impossible in the here and now. We may be able to inflate our way out of it. Not a new tactic but a newish one for the world’s reserve currency. I wonder why more people aren’t concerned with the fact that the American Dollar has diminished in buying power from 2002, by more than 50%. That is real “inflation”. ooh baby, are we in for a rough ride in the next fifty years. Nice legacy for our kids. Like making them come to a dinner to watch us eat and then ducking out leaving them with the tab and no ride home.
Oops! Thanks for catching that error!