Bubble or Bank for Web 2.0: Microsoft Friends Facebook for $240 million

In October, Microsoft bought a 1.6 percent stake in the social network Facebook (see right) causing a buzz reminiscent of the 90’s dot.com bubble. The international powerhouse Microsoft handed out $240 million for the tiny portion of Facebook valuing the site at $15 billion, the fifth most valuable Internet company after Google, Yahoo, Amazon, and eBay. With 50 million users and 200,000 joining daily, Facebook hosts a significant customer base on which to draw for companies like Microsoft. Microsoft’s investment is not the only one Facebook has received as two hedge funds also put in similar bids, which Facebook accepted according to articles in CNN. In all, the social network picked up $700 million dollars to put towards a badly needed structural overhaul and R&D for the future. However, Facebook’s revenue is one-tenth its $15 billion price tag, and the site produces no profits.

The parallels are glaring, but is this really the harbinger of another collapse? Some are calling the recent acquisition of Web 2.0 companies, like Skype and YouTube, Bubble 2.0. eBay acquired Skype in Sept of 2005, and Google bought YouTube.com for $1.65 billion in November of 2006, but to the trained eye there are distinct differences that should make everyone breathe a sigh of relief (see below right).

The inflated price tag of Facebook is partly the result of an online advertisement war (see below left) being waged by technological powerhouses Microsoft and Google. The investment in Facebook was a defensive maneuver on the part of Microsoft as Google has the upper hand in the online arena. Google already has advertisement deals with other social networks such as MySpace and even has its very own online meeting place called Ortuk. However, some experts like Matt Rosoff, an analyst specializing in Microsoft, believe that even though the deal was a good move, the price tag smells suspiciously of the 1990’s dot.com era. John C. Dvorak of PC Magazine echoes this sentiment calling a collapse “a sure thing.” On the other hand, a recent article in Business Week claims that once “beyond gut feelings, the comparison simply doesn’t stand up.”

The high values for Web 2.0 companies in addition to the skewed price to earnings ratios they enjoy are the cause for comparison to the 90’s e-commerce bubble. However, there are a few significant differences when comparing the two. First of all the business being acquired have active members and are not based on speculation. Internet based companies now have a model to make money by that is centered around advertising and not the idea of e-commerce. Secondly, the 90’s boom was fueled by IPO’s, money those companies never actually had. The acquisitions going on today are bought with cash reserves from well-established businesses. Another reason is a result of changes in the technological market. More than 70% of adults in American are online as opposed to 40% in less than ten years ago. Compounded with the fact that most of the new startup companies, or Web 2.0 companies, advertise themselves online instead of using costly television ads.

In light of this, I believe that there is justification for the price tag and no reason to be worried by a imagined looming bubble. With so many users already and more joining every day, Facebook is a massive potential advertising machine. Traffic is so high on social networking sites and other Web 2.0 applications that revenue from advertising would be more than significant. Microsoft needs this deal to increase its online presence in the face of a looming Internet war with Google. Blocking Google out and increasing advertisement presence is a significant move especially when the price tag only makes up less than a percent of the buying company’s value. In the end, the price tag remains a little excessive, but the scare of a bubble should be left in the 90’s.

Pay to Pollute: The Commerce of Carbon

In light of former Vice President Al Gore’s award winning campaign to battle global warming, the public has stumbled across a very inconvenient truth. In the past fifty years, greenhouse gas emissions have almost quadrupled from 1.6 billion to 6.5 billion tons. (See graph below right) This unprecedented growth of pollution over the past few decades is thought to be the main contributor behind global warming. In efforts to combat these rising levels of pollution, especially carbon emissions, many countries like Brazil, the United States, and most of the European Union have adopted emissions trading schemes that limit the amount of carbon and similar greenhouse gases produced by power plants or their industrial corporations. The process assigns monetary values to “carbon credits” which companies can buy or sell. This is designed to present an economic incentive for polluting less as companies that reduce emissions can sell excess carbon credits for cold hard cash. Though currently fraught with problems, with the right direction, carbon credits could be the currency that buys a better future.

In the United States, President George W. Bush’s Clear Skies initiative concentrates its efforts to reduce emissions of SO2 (sulfur dioxide), NOx (nitrous oxides), and mercury from power plants. (see graph below left) According to the White House, the act will emplace “a dynamic regulatory approach – emission caps and trading – that provides power plants with flexibility to reduce emissions in the least costly way.” The government “caps” the level of emissions allowed in the country and doles out allowances to individual companies via an auction. Certain levels have to be maintained and then reduced at predetermined deadlines. In the United States, Clear Skies calls for a reduction from 16.3 million tons of all emissions to 6.6 million tons by 2010 and then 4.7 million tons by 2018, a total reduction of 72%. Personally, I like the cap-and-trade model. It solves an environmental problem with an economic solution. The most basic laws of economics determine the best allocation of credits and ensure maximum efficiency in reducing pollution. Self-interest, not federal sanctions, motivates companies to be more environmentally friendly. In addition, the cap-and-trade method allows the government to take a hands-off approach. Instead of wasting billions of dollars on litigation and manpower, the government simply has to set the limits and distribute the allowances. To contrast directly, the EPA declares that the cap-and-trade program has “achieved reductions at two-thirds the cost of… the same reductions” using the previous system of regulation and penalty over the past ten years.

This glowing picture of emission trading systems founded on solid economics seems too good to be true, and according to the Sierra Club, it is just that. In contrast with the previous Clean Air Act, “Clear Skies” loose[ns] the cap on NOx pollution to… an increase of 68 percent” and SO2 pollution 225 percent from Clean Air. Since this information comes from studies performed by the U.S Environmental Protection Agency, it is difficult to refute. Related to the high caps in the Clear Skies proposal, the United States government, as well as the EU’s Emissions Trading Scheme and the UN’s Clean Development Mechanism, has come under fire due to recent claims from Professor Catrinus Jepma of the University of Amsterdam that these systems have failed to provide “the excepted benefits due to a collapse in the price of carbon credits.”

In short, governments setting limits overestimated. The high emission caps have led to a surplus of carbon credits in the market, and in accordance with economic modeling, the price of the carbon emissions has dropped dramatically. All the way back in May of last year, it was revealed that countries using the European Trading Scheme, think Clear Skies for the EU, had set caps too high “resulting in fewer firms than expected having to buy credits.” This led to a drop of the price of carbon credits from thirty Euros to less than five. If the price of credits drops too low, the incentive to reduce pollution drops next to nothing as reducing emissions will result in insignificant profits when sold on the market. This in turn directly influences companies’ decisions to research new ways to reduce emissions more efficiently. However, this is not a failure of the economic system but a failure of the governments’ ineffectual limits, as seen in the success of the Brazilian model. By setting limits too high, the government does not constrain the firms enough and the whole process fails to achieve market equilibrium.

As an economist, I believe in the “invisible hand” of the free market. Under the proper constraints, I think that the cap-and-trade system will lead to the most efficient use of resources to reduce pollution. The cash incentive of selling surplus credits should encourage industries with already low levels of emissions to invest in R&D to reduce their emissions even further and even provides the capital to do so. Alternatively, the blow to the wallet buying more credits entails should deter companies with high emissions from cutting corners when reducing their carbon footprint. Ultimately, the only way to motivate big business is to provide an incentive that they understand, money. Though the problems surrounding carbon credits are significant right now, I feel the modeling of the system is sound with only the deficiencies of the governments setting limits holding it back. With proper revisions, the country can get right back on the track towards saving the environment.

Tax Heaven? : Tax Havens

This week, while exploring the blogosphere, I discovered the topic of tax havens. Tax havens are areas where taxes are very light or not administered at all (see right). These “havens” specifically target wealthy individuals and corporations in their tax policy and aim to exploit the global demand for opportunities for tax avoidance. The Organization for Economic Co-operation and Development uses three criteria for determining tax havens: no or nominal taxes and offer themselves as a place to be used by non-residents to escape taxes in their country of residence, a lack of effective exchange of information which allows for the privacy of those who use tax havens, and a lack of transparency in the operation of the legislative or administrative provisions. These three factors make tax havens a lucrative and secure place to avoid taxation. This week I posted comments on two blogs that both revolved around an article in the London based magazine The Business. The article touts the wealth generated by tax havens and how they occupy the highest slots on the list of the world’s wealthiest nations above what most would consider economic powerhouses. The first blog is called That’s The Way It Looks From Here and is written by Bob Bauman. He is a former Member of the United States House of Representatives from Maryland, a member of the Washington, DC Bar, graduate of Georgetown University Law Center and the School of Foreign Service. He has written several books including Where to Stash Your Cash: Tax Havens of the World and several articles for the Cato Institute. The second blog is called The Liberal Journal, and though the author is anonymous, the site seems to hold up to Webby Award winning criteria with good, frequently updated content, good organization, and transparency in its navigation and setup. Read my posts on theses blogs or on my site down below.

Comment 1
I was interested to find out that a majority of the top twenty wealthiest jurisdictions of the world was composed of tax havens. As a student of economics, I believe little government interference is best when concerning economics, and tax havens seem to be ideal to maximize wealth. However, though tax havens may be considered some of the wealthiest nations in the world, the wealth seems like it would be stratified and confined mostly to the wealthy foreigners who use them to avoid taxes in their own countries. Your stance that these tax havens raise the standard of living seems fundamentally flawed as the local peoples of these tax havens are molded into the servant class of wealthy foreigners. Little real wealth is being accumulated and held by the local peoples and the massive increase in the GDP’s of these countries are not the result of everyone’s standard of living increasing, but of the appearance of a few astronomically wealthy companies or individuals. In a search on this topic in the blogosphere, I also learned that many of these tax havens rely on others for their national defense, and EU countries have such high taxes to ensure many of their social and medical policies. How would these models hold up in a tax haven like policy model?

Comment 2
I have also read the Cato Institute’s blog on tax havens, and I believe that it would indeed be absurd for the United States or all countries to become tax haven like jurisdictions. Maintaining national defense and certain programs like Medicaid and Medicare are needed and along with these programs, a certain level of taxation is necessary. However, I also believe that tax havens have a plus side to them and not just for the tax evaders. In a larger context, tax havens give an alternative route to countries with legitimately exorbitant tax rates providing a check against countries wanting to raise their taxes. This ensures there is no governmental monopoly and maintains choice. Tax havens also demonstrate the economic benefits of low taxation. Lower taxation means more money for consumers to spend and more money for companies to use on R&D and growth, and in response to your note about how much taxes Americans pay, I do not think we’d have to pay as much in tax if our government could keep its debt under control.

Bubble or Bank for Web 2.0: Microsoft Friends Facebook for $240 million

Last week, Microsoft bought a 1.6 percent stake in the social network Facebook (see right). The international powerhouse handed out $240 million for the tiny portion valuing the site at $15 billion, the fifth most valuable internet company after Google, Yahoo, Amazon, and eBay. With 50 million users and 200,000 more daily, Facebook hosts a significant customer base on which to draw for companies like Microsoft, and Microsoft’s investment isn’t the only one Facebook has received. Articles from CNN also mention two hedge funds also putting in similar bids, which Facebook accepted. In all, the social network picked up $700 million dollars to put towards a badly needed structural overhaul and R&D for the future according to British newspaper The Guardian. They also plan to use the money to more than double their staff from four hundred to seven hundred employees. However, Facebook’s revenue is one-tenth its $15 billion price tag, and the site produces no profits according to one. At this point, many might be remembering the 1990’s dot.com bubble and rags to riches and back to rags rollercoaster that ensued. The inflated price tag is partly the result of an online advertisement war (see below left) being waged by technological powerhouses Microsoft and Google. The investment in Facebook was a defensive maneuver on the part of Microsoft as Google has the upper hand in the online arena. Google already has advertisement deals with other social networks such as MySpace and even has its very own online meeting place called Ortuk. However, some experts like Matt Rosoff, an analyst specializing in Microsoft, believe that even though the deal was a good move, the price tag smells suspiciously of the 1990’s dot.com era. On the other hand, a recent article in Business Week claims that the parallel is weak when considering the context of the situation. For one, Facebook is not going truly public for a few more years. Another reason is a result of changes in the technological market. More than 70% of adults in American are online as opposed to 40% in less than ten years ago. Compounded with the fact that most of the new startup companies, or Web 2.0 companies, advertise themselves online instead of using costly television ads. In light of this, I believe that there is justification for the price tag. With so many users already and more joining every day, Facebook is a massive potential advertising machine. Traffic is so high on social networking sites and other Web 2.0 applications that revenue from advertising would be more than significant. Microsoft needs this deal to increase its online presence in the face of a looming internet war with Google. Blocking Google out and increasing advertisement presence is a significant move especially when the price tag only makes up less than a percent of your own companies value.

King of the Road: Who Owns The Highway

In the past few decades, states having a hard time balancing their checkbooks have looked for creative ways to avoid costs and produce revenue. One choice these states have been turning to is the option to privatize their highways. This alternative to fully public funded construction and maintenance allows states to cut costs in production and gain significant revenue from the selling or leasing of the highways (see right). However, some detractors are afraid of giving the private sector too much control over the roads and worry that maintenance will decline.
Lately, states like California and Texas have used privatization to create roads and revenue in one swoop. With the war and the general overspending of the current administration, the budget belt for states has been cinched tight, and states have been worrying where they can cut costs or generate revenue. In addition, the infrastructure of many existing highways has been called into question especially in light of the summer’s collapse of a bridge in Minneapolis. An article in Newsweek quotes the American Society of Civil Engineers estimating a cost of about $1.6 trillion over the next five years to bring highway infrastructure up to date. Needless to say, states that need to expand or renovate their highways do not have the money to fund these projects. If public funds come up short, who can bridge the gap? Companies like the Australian based Macquarie and Spanish based Cintra do not need any encouragement. In the past few years, Macquarie and Cintra have built and leased back highways in Indiana, Texas, and California with some projects having price tags upwards of a billion dollars like the new Chicago Skyway (see bottom right) which earned $1.8 billion for the city after being leased back to Maraque for 99 years. In total, about $25 billion dollars in projects are in development with private firms states a Wall Street Journal article. States set the terms and “force the owner (or leaser) to provide certain levels of service and maintenance and to keep tolls and other costs under control.” The companies then build the highways and sign ownership over to the government. Almost immediately, the government leases the toll roads back to the private companies for a certain amount of money upfront, which they can use for whatever reasons. The companies get a long-term cash cow, and the government gets liquid capital to use upfront. Using an economic model, the privatization should promote competition between firms. This would lower final costs and increase efficiency on the roads, as private firms would want greater quantities of people using their roads instead of an alternative. The firms might produce a solution to traffic the government has not cared too.
All in all, this solution sounds like it works out for both the private firms and the state governments with firms getting profits and the government getting revenue and cutting the costs of maintenance on highways. However, critics argue that private firms might raise tolls to high and drive motorists back onto the already overloaded public highways, and Newsweek cited Fortune magazine’s Bethany McLean “raising questions about the sustainability of Macquarie’s business model.” Selling these highways is a one shot deal for states and promises no future funding for state governments. As a way to make a quick buck for states and perhaps promote efficiency in the construction and maintenance of highways, this model has been fairly successful; however, I think state governments need to find a more permanent solution for the problem they think they are fixing. I doubt owners of highways will raise tolls enough for drivers to avoid them all together. In the end, these private firms want to make money and gain nothing if people do not travel on their highways. Privatization may clean up highways, decrease traffic, and promote efficiency on a general basis; however, I believe state governments are making a mistake in banking on highways to fill their coffers.

Crimson Skies: The Dogfight over Dollars

Recently, there has been a clash between the two major producers of aircraft (see right) and the subsidies they get from their respective countries. Airbus Industrie is a joint venture between the British, French, and German governments. It is Europe’s leading producer of commercial aircraft and takes up around half of the global market share in the industry. Boeing is Airbus Industrie’s American counterpart and covers the other half of the global market share (see below left). Both have been firing shots at each other across the Atlantic over their respective government’s subsidies, the beginning, perhaps, of a international trade war. Each is convinced that the other’s government is giving unfair advantages to their domestic industries.

Right now, the two companies have lodged complaints with the World Trade Organization over the apparent use of illegal subsidies on both sides. The European Commission, representing Airbus, claims that Boeing receives illegal state subsidies in the forms of “federal, state, and local programs that could total $23.7 billion.” This money includes contracts from NASA and the United States Department of Defense. The EC also called into question the export subsidies Boeing receives that violate global trade laws and the lack of paperwork showing Boeing will give them up. The United States Trade Commission, representing Boeing, presented a case complaining that Airbus had received $15 billion in what is called “launch aid” which, after compound interest is added in, amounts to $205 billion. Airbus also receives loans from the EU “below commercial rates that Airbus uses to launch new projects and which are repaid only if the aircraft are a commercial success.” In addition, Airbus receives aid in the form of state “infrastructure projects” which provide Airbus with money to establish new buildings and infrastructure as well as expand on existing facilities.

Misinformation has also been playing a large part in the scandal as each accuses the other of distorting figures by exaggerating aid given by the other’s government while underplaying the aid they receive themselves. Comparing the numbers side by side, the discrepancy is huge. The EC accuses Boeing of receiving upwards of $10 billion from NASA for R&D in an indirect subsidy. Boeing, however, presents $750 million as the true figure. The EC also cites a $2.4 billion contract from the Defense Department, but Boeing refutes this as inaccurate as military contracts are not visible to the public eye.
Either way, both companies are clearly getting illegal subsidies from their governments. In a way, the subsidies provide security for each country. In an industry as specific as the aircraft market, having a domestic producer for military as well as civilian aircraft can provide security in times of war and a level of secrecy and confidentiality in times of peace. Subsidies can also look attractive to domestic workers as large projects by domestic aircraft producing firms provide massive employment opportunities. However, these subsidies make both companies weak in the long term and reduce the growth as a whole in the economy. By providing a crutch on which to lean, the governments breed inefficiency in the companies, as there is no impetus to streamline production and bureaucracy. These subsidies may also be a harbinger to a greater trade war across the Atlantic. Both sides agree that a trade war would be detrimental to each party as well as those not even directly involved since all countries need airplanes. The economic implications of these subsidies, in themselves as well as in the context of a greater looming trade war, draw a picture of economic disaster. In my opinion, the existence of these subsidies is economically unsound and provides a staging ground for a detrimental snowball effect that ends in a big explosion of money and fuselage.

Pay to Pollute: The Commerce of Carbon

In the past fifty years, greenhouse gas emissions have almost quadrupled from 1.6 billion to 6.5 billion tons (see graph right). This unprecedented growth of pollution over the past few decades is thought to be the main contributor to everyone’s favorite sometimes myth, global warming. In efforts to combat these rising levels of pollution, especially carbon emissions, many countries like Brazil, the United States, and most of the European Union have adopted emissions trading schemes that limit the amount of carbon and similar greenhouse gases produced by power plants or their industrial corporations. The process assigns monetary values to “carbon credits” which companies can buy or sell. This is designed to present an economic incentive for polluting less as companies that reduce their emissions can sell their excess carbon credits for cold hard cash.
In the United States, President George W. Bush’s “Clear Skies” initiative concentrates its efforts to reduce emissions of SO2 (sulfur dioxide), NOx (nitrous oxides), and mercury from power plants (see graph left). According to the White House, the United States government uses a cap-and-trade system to regulate emissions without having to get too involved. The government “caps” the level of emissions allowed in the country and doles out allowances to individual companies. Certain levels have to be maintained and then reduced at predetermined deadlines. Companies that reach the reduced levels before the deadline are allowed to “trade” their extra credits on the market to plants that have not reached their reduction levels. Personally, I like the cap-and-trade model. It solves an environmental problem with an economic solution. The most basic laws of economics determine the best allocation of credits and ensure maximum efficiency in reducing pollution. Self-interest, not federal sanctions, motivates companies to be more environmentally friendly. In addition, the cap-and-trade method allows the government to take a hands-off approach. Instead of wasting billions of dollars on litigation and manpower, the government simply has to set the limits, distribute the allowances, and make sure each plant has enough allowances to get them through the year. To contrast directly, the cap-and-trade program has “achieved reductions at two-thirds the cost of achieving the same reductions” using the previous system of regulation and penalty over the past ten years.
This glowing picture of emission trading systems founded on solid economics seems to good to be true, and according to some, like the Sierra Club, it is just that. An article from the Sierra Club states that the “Clear Skies” proposal actually increases pollution levels. In contrast with the previous “Clean Air Act,” “Clear Skies” loose[ns] the cap on NOx pollution to… an increase of 68 percent” and SO2 pollution 225 percent from “Clean Air.” Since this information comes from studies performed by the U.S Environmental Protection Agency, it is difficult to refute. Related to the high caps in the “Clear Skies” proposal, The United States government, as well as the EU with their Emissions Trading Scheme and the UN’s Clean Development Mechanism, has come under fire recently due to recent claims from Professor Catrinus Jepma of the University of Amsterdam that these systems have failed to provide “…the excepted benefits due to a collapse in the price of carbon credits.” In short, the governments deciding how many carbon credits allowed overestimated. The high emission caps have led to a surplus of carbon credits in the market, and in accordance with economic modeling, the price of the carbon emissions has dropped dramatically. All the way back in May of last year, it was revealed that countries using the European Trading Scheme, think “Clear Skies” for the EU, had set caps too high “resulting in fewer firms than expected having to buy credits.” This led to a drop of the price of carbon credits from thirty Euros to less than five. If the price of credits drops too low, the incentive to reduce pollution drops next to nothing as reducing emissions will result in profits next to nothing when sold on the market. This in turn directly influences companies’ decisions to research new ways to reduce emissions more efficiently. This, however, is not a failure of the economic system but a failure of the governments setting the limits. By setting a limit too high, a government does not constrain the firms enough and the whole process fails to achieve market equilibrium.
As an economist, I believe in the “invisible hand” of the free market. Left alone and under the proper constraints, I think that the cap-and-trade system will lead to the most efficient use of resources to reduce pollution. You catch more flies with honey in the same way you catch more people with the promise of money than the fear of litigation.

Going Up?: Dollars and Yuan

In exploring the realm of information that is the Internet, I have discovered the fluid medium of the blogosphere to be an ever-morphing arena of common knowledge and technical expertise. During my adventures in this online arena, I discovered two blogs focusing on economics with interesting things to say about the status of the American dollar. Searching for a way to enter the online fray, I’ve loosed my initial informational volley in the form of two posts on different blogs. The first blog is written by CLS, a Blogspot user with a frank partiality for liberalism. The blog itself is called “Classically Liberal” and holds no illusions concerning bias. Though the author is not known to be of great repute, his stances, though partial, are based in solid groundwork for the most part and meets the criteria of a Webby Award winning website. His focus is the effect the Bush administration on the strength of the dollar, and how the incompetence of the administration has directly led to the devaluing of U.S. currency in comparison to the other major currencies. The second blog is titled Thomas Palley: Economics for Democratic and Open Societies. The author is Dr. Thomas Palley (see left), an economist with a degree from Oxford University and Yale University. He has written for several magazines including The Atlantic Monthly, American Prospect, and Nation. He was also the former Chief Economist with the US-China Economic and Security Review Commission. His post revolves around the issue of rampant inflation in China and the Chinese response to it.

Comment
First off, as a fellow detractor of President George W. Bush, I agree to an extent that the blame for much of the economic disaster ensuing today should be laid at the feet of the current administration. Their disregard for long-term economic stability and basic theory has earned them spots on my economic black list. However, I was wondering what the specifics of your disagreement concerning the Bush administration’s handling of economic policy revolve around. Links to evidence might be appreciated and formally strengthen your argument against the opposition and make it more persuasive for the layman. Also, in response to you comment about the charts, I realize that the downturn of the dollar happened soon after “King George’s… coronation,” but consider the lag between policy implementation and actual economic fluctuations as well as the introduction of a new strong currency. “It wasn’t long ago a Euro was worth about 90 cents.” Well, this is true, but it is also true that it wasn’t long ago that the Euro just did not exist. The consolidation of European currency was bound to have effects in the U.S. concerning the strength of the dollar. On top of that, the emergence of China as a growing economic power can be seen in the increase in the value of the yuan. This might be indicative of a decrease in the value of the dollar, not as a function of American incompetence (which it still is in part), but of Chinese growth. In addition, I was under the impression that a low strength dollar would increase the amount of exports from the United States and increase demand for the dollar in the international market, which in turn, would increase the strength of the dollar in general.

Comment
I think this post has an interesting point. The exploration of the Chinese problem with inflation reflects the United States own problem with its currency. I see how many of the Chinese solutions to inflation mirror actions taken by the Fed with an emphasis on monetary tightening and altering interest rates. I think if you compared how each of the economies has handled the problem, you could draw a convincing parallel. I realize that this is probably your specialty and by no means my own, and I respect your credentials. However, I want to know more about how one economy affects the other specifically. You explain that the Chinese strategy is to “shift the onus of global trade adjustment on the U.S.” What exactly is the process by which the Chinese do this? How do the differences in situations effect the implications of the policies taken by each respective government? How do the problems surrounding the Chinese economy directly affect the U.S. economy?

Subprime Lending: The Problem Behind the Wall

The word “Sub-prime” has been tossed around a lot in the past few months, especially in conjunction with the phrases “real estate” and “recession.” When talking about the housing and stock markets, the sub prime is generally blamed for the recent dip in the economy. The emphasis is placed on the inability of the lenders to collect on their high-risk loans. Sub prime loans are loans targeted at people with low credit scores and bad credit history. The boom in the housing market over the past few years (2001-2005) made lenders more willing to take on high-risk loans in the search for greater profits. “‘Clients started to get harder to come by and the brokers started shaking the trees a little harder,’ says Allen Hardester, director of business development for mortgage broker Guaranteed Rate.” However, the recent downturn in the housing market left many sub prime borrowers forced to default on their loans, and many sub prime lenders were unable to collect any of their investments. Companies such as the New Century Financial Corporation have been forced to shut down or file for bankruptcy because of the prodigious amount of mortgage foreclosures caused by the bursting of the housing bubble.

While most of the spotlight has been shone on the effects of the sub prime rippling throughout the housing markets and in turn the stock market, the sub prime itself is quite a controversial subject. Sub prime lending, by its very nature, targets those who have bad credit histories with credit risk characteristics such as two or more loan payments paid past ninety days due in the last 12 months, foreclosure or repossession. Compounded with the high rates and additional fees used to offset the risk for lenders, this can spell disaster for borrowers. Sub-prime lenders have also been accused of fraudulent and illegal practices. Mortgage fraud in some areas has increased 500% in some areas in just three years. Lenders often try to confuse borrowers with complicated loan terms and take advantage of their lack of knowledge and need to refinance their homes quickly. Sub-prime lenders will even offer sub-prime rates to borrowers that qualify for traditional loans.

Though sub-prime lenders have often taken the blame for unscrupulous activities, the sub-prime also offers an arena in which individuals can improve their credit scores. With the right facts and determination, an individual with bad credit history can use sub-prime loans and credit cards to reestablish their credit by meeting the terms of their contracts. In many cases, random events such as job loss or divorce can impact finances in a large way. The sub-prime gives these individuals a chance to regain their credit when nonsub-prime lenders would merely turn them down. The sub-prime provides an opportunity for an individual with bad credit history to even take out a loan at all.

Recently, the government stepped in and announced a plan to help borrowers in peril from foreclosing. The Federal Housing Administration provides mortgage insurance to borrowers in the private sector, and President George W. Bush has pushed to change policy to allow more homeowners to qualify. Bush also announced plans to reform housing policy in the federal tax code and provide assistance to non-profit groups that offer counseling for foreclosure and refinancing.

Though the situation has obviously gotten out of hand, the federal government’s stance towards the sub-prime borrowers seems lenient. The blame is partially on the borrowers. One of the tenants of a market society is “Let the buyer beware,” and sub-prime borrowers should do the necessary research or hire someone with the proper expertise to ensure what they get is what they want.