#212 simple understanding

CNN’s senior business correspondent Ali Velshi gave this layman’s understanding on Oprah Winfrey show:

The first step toward grasping the bailout plan is to understand how we got in this mess in the first place. Ali says it started with three basic assumptions about the American economy: homes will increase in value over time, wages will go up over time and investments in the stock market will go up over time. “Very rarely do all three not go up at the same time,” he says. “So we thought that things will be better for us financially year after year.” The banks encouraged that concept because the more the American people spend, the more money banks make.
 
…since Americans thought their finances would increase over the years, they spent as if that money was guaranteed. “We all lived a little beyond our means and then a lot beyond our means,” he says. “Now, our country, our people, our banks and our government are all heavily, heavily indebted and the money is running tight.”

…a mortgage meltdown is primarily responsible for the economic trouble. The cycle started with regular Americans who were unable to afford their mortgage interest rates. As a result, banks foreclosed their homes. Eventually, the effects of the home foreclosures reached a global scale, causing a financial collapse. “We are very powerful people, because we caused this,” Ali says. 

The other key to understanding the financial mess is understanding credit. “Let’s show you how central credit and banking is to your life,” he says. “The bank gives you a credit card, and you use that to spend money at the grocery store. But the bank also gives the grocery store money because the grocery store has to [borrow] to buy things from a supplier, let’s say the cereal factory. …The supplier [or cereal factory] needs to buy wheat or flour, so they borrow money from the bank [too].” But because of the current economic situation, banks don’t trust anyone to pay them back, Ali says. “Your credit line, if you did nothing wrong, may have been reduced by the bank just because they are scared that you might get into trouble.” 

…due to credit reduction, the cereal factory can’t buy as much wheat, and the grocery store can’t buy as much cereal. When stores or suppliers can’t afford to buy as much they used to, they can’t do as much business. Then, people get laid off. 

As a result, all the people who lost their jobs aren’t paying taxes or shopping as much, Ali says. “They’re a net drain on the financial system. They’re not contributing.” Ali says that in the first nine months of 2008, 750,000 people in the United States lost their jobs. In September 2008 alone, an incredible 159,000 jobs were lost. “This is what hurts this system,” he says. “And that’s why it affects you.”

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