Donald Rapp has authored books on a variety of subjects including Bubbles, Booms and Busts - The Rise and Fall of Financial Markets.

1. Which FCIC View best represents the causes of the Financial Crisis?

Majority Conclusions

2. Which narrative presented by Douglas Elliott and Martin Baily of the Brookings Institute in Telling the Narrative of the Financial Crisis: Not Just a Housing Bubble best represents the causes of the Financial Crisis?

“Everyone” was at fault: Wall Street, the government, and our wider society

3. I believe the Global Financial Crisis is ongoing and will end in the year

2013 or beyond, and will not end until there is a cataclysmic structural change in the entire financial system.

4. What were the primary causes of the Global Financial Crisis?

Starting with the great stock bull market of 1982 to 1999, proceeding through the dot.com balloon, and thence to the housing bubble of 2002-2007, and finally the stock bull market of 2009-2011, we have become too reliant on paper assets (rather than earnings from work) as a source of wealth. We keep bidding up paper assets (mainly real estate and stocks) to outrageous levels thinking that this is a real source of wealth – until they collapse of their own weight. This sawtooth pattern of overbuying and overselling leads to excessive spending during boom times and reluctance to pull back during slack times, further exacerbating the debt problem. The growth of stock prices has hugely outpaced the growth of productivity and production. Governments aid and abet bubble formation through fiscal policies and lack of regulation, because they want to get reelected and people are happier while bubbles are expanding.

The policy of free trade has allowed transfer of many manufacturing facilities from the U. S. to overseas, particularly China, allowing them to produce cheaper goods with cheaper labor, which is a boon to those in America with jobs who can purchase cheap products made in China, but at the same time causes a shrinkage of job availability in America. As a result, a growing fraction of the population cannot afford the cheaper goods from China. Related problems occur in the problem of balance between the poorer and richer countries within the European Common Market.

Since Reagan was elected in 1980, the Republican Party in the U.S. (with acquiescence of the Democrats) has enacted tax policies that greatly favor the rich, that has led to an upward redistribution of assets in America, with an unprecedented number of very wealthy people sucking up the wealth of America, leaving the middle classes struggling to get by, and at the same time, removing funds from the marketplace into sequestered paper investments. This money is like a tide pool, surging in and out of asset markets, but it is insulated from consumer purchases, which are the backbone of our economy. It is like putting a dam on the river to restrict water flow. Since 1980, tax rates on the upper brackets have been the lowest in history except for the roaring 20s. It is interesting that taxes on capital gains (where the rich make most of their income) has always been much lower than earned income from wages. While the Republicans complain that the Democrats want to “redistribute wealth” by taxing the rich, the fact is that it is the Republicans who have done all the redistribution of the past three decades, and that redistribution was upward, not downward.

Another factor is that job elimination from automation, Internet sales and non-human communications have finally caught up and surpassed the gains in productivity produced by automation, Internet sales and non-human communications. When automation was first introduced into the marketplace several decades ago, there were many dire predictions that jobs would be lost and there would be negative impacts. Actually, that did not occur because the gains in efficiency led to expansion of the economy, and the old jobs lost by automation were replaced by new jobs created by the expanding economy. However, that is no longer true. Corporations now find that they don't need as many employees as they used to. Internet sales are beginning to dominate. The main weapon against job loss by the Obama administration is to cut interest rates. However, dropping interest rates to zero will not restore former jobs. We are now approaching a situation where we will permanently have a lot more people of working age than we need to conduct the commerce of our nation. Thus, we will divide into three classes: the rich, the workers, and the out-of-workers. The rich and the workers will go on as usual and that part of the economy will not change; it will just be a decreasing percentage of the total. They will buy cars and other products, and provide economic data that is encouraging. The growing ranks of out-of-workers will remain outside this mainstream putting a growing drag on the economy.

All of the above factors are greatly amplified and exacerbated by our need to spend more than we earn at the international, federal, state, county, municipal and personal levels. At all of these levels, people, organizations, institutions and governments have continued to spend beyond their means for decades until finally, it seems to be coming home to roost with the growing realization that this is no longer viable. So, we find that at all levels (international, federal, state, county, municipal and personal) we are overspent with phantom money that exists only as loan balances on paper that will never, ever be paid back. And at all these levels, people have become used to a higher level of spending and resist strongly any proposed cutbacks in spending or increases in taxes to cover these excessive spending habits. Back in 1983, when the U. S. federal debt was a mere $1.4 trillion, a noted economist said: “The debt burden today is awesome and its constrictiveness is permeating our economic life and suggested that a depression from a deflating debt bubble might be beyond the power of the authorities to counteract it." Today, the debt is ten times that amount, amounting to over $40,000 per man, woman and child in America. Some day, I don’t know when, the world will realize that the U. S. Government budget is a Ponzi scheme.

5. What still should change as a result of the crisis?

I am not fully sure how to answer this and I don’t think that anyone has a complete answer. I am pretty sure however, about some things that must change. First we need to understand that we are not in the midst of a temporary downturn and all we need to do is ride it out and when we recover, everything will be OK. More than any specific policy change, we need to understand that what we are going through now is a fundamental breakdown of capitalism due to the factors listed in the answer to the previous question: dependence on paper assets rather than salaries, free trade, automation, too much concentration of wealth in the upper bracket, and above all, spending beyond our means at all levels building up debt and obligations that can never be paid back. The purpose of corporations is to maximize their profit, not to maximize production. They can now do that with fewer employees. Some specific things we need to do:

1. balance the federal and state budgets yearly – cut spending and do not allow them to borrow any more; for example, the federal government can get out of the education business – we do not need a Dept. of Education with its “no child left behind”
2. severely raise taxes on the rich, particularly for capital gains which should be taxed much higher than salaries
3. require that mortgages issued by local banks be held in those banks for at least ten years and not be packaged into mortgage securities during the ten year grace period
4. require that for any real estate transaction, the history of previous sales on the house be provided, and down payment must be at least 20% of a conservative appraisal
5. require that public and private pension funds place less than 50% of their funds into stocks
6. enact widespread tariffs to jump start manufacturing in the U. S.
7. do not engage U. S. troops on the ground in the Middle East firing rifles at natives firing back with rifles
8. raise interest rates to help middle class savers
9. if any business (e.g. AIG) is too big to fail, require that they spin off all their subsidiaries
10. regulate!

Compiled by Gary Karz, CFA
Host of InvestorHome

Global Financial Crisis Survey

Please send suggestions and comments to Investor Home

Last update 11/8/2011. Copyright © 2011 Investor Home. All rights reserved. Disclaimer