The current housing and banking crises are both unique and severe. Billions of dollars of wealth have disappeared over the last year, in some cases in just a matter of days. Companies that have been household names have gone bankrupt, with others on the verge of failing as this article is being written. Make no mistake; these are scary times with both professionals and the public wondering if their money is safe. Is this the end of the U.S. financial system?

Although we cannot predict the future and suspect that anything is possible, history suggests that this is just another crisis like so many others that will eventually pass until a new crisis is born to take over the headlines.

If one looks at history, the two past crises that probably most resemble this one would be the Latin American debt crisis in the 1980s and the Savings and Loan crisis in the late 80s and early 90s. During the Latin American crisis, most major U.S. banks had made large loans based in U.S. dollars to Latin American countries. When these respective countries’ currencies dropped relative to the dollar they were unable to pay back the debts. At the time the Latin American indebtedness was in excess of $314 billion. The default on this debt threatened the solvency of the entire U.S. banking system. Suffice it to say, this would have been unacceptable. To make a long story short, some creative financing called Brady Bonds was implemented that essentially took the bad loans off the banks’ books and provided liquidity and payment of principal and interest, helping both the lender and borrower.

In the Savings and Loan crisis, real estate was the culprit. Sound familiar? S&Ls had most of their capital tied up in long-term, fixed-rate mortgages, many of them to questionable borrowers, while their customers started withdrawing funds to invest in the new higher-yielding money market funds. Their solvency quickly eroded and the assets of the insurer, the FSLIC, were inadequate. Wikipedia estimates the total loss was in excess of $160 billion with the taxpayer paying roughly $124 billion of the total. Over 1,000 S&Ls went out of business. To get the bad loans off the banks’ books and to once again provide liquidity, the Resolution Trust Corporation was created in 1989. A recession subsequently followed but the country survived and our stock market eventually moved to new highs before the next crisis struck.

The United States Treasury was founded during crisis, so this is nothing new. Alexander Hamilton, our first Secretary of the Treasury in 1789, lobbied that the federal government should be responsible for the states’ debts that were accumulated to fund the Revolutionary War. Even though our democracy was fragile and practically bankrupt, he wanted the world to know that the United States’ word was good and that we would always honor our debts.

The same is true today. Yes, we have a large national debt, but by taking over Fannie Mae (NYSE: FNM, Stock Forum) and Freddie Mac (NYSE: FRE, Stock Forum) and helping troubled companies, like AIG (NYSE: AIG, Stock Forum), the government is once again announcing to the world that America stands by its debts. If it eventually requires the taxpayer to ultimately be responsible for some of the debt, so be it. Americans will pay it and move on with the process of creating the freest country and most dynamic economy the world has ever known.

Although the Latin American debt crisis and the Savings and Loan crisis resemble this one, the list of other crises is quite large. This country has also been through the Great Depression (the result of which was the creation of the FDIC), two World Wars, the 1987 Stock Market Crash, the Internet bubble bursting, and most recently, September 11th. Just seven years ago a trillion dollars of wealth was destroyed, airlines were going bankrupt, and close to 3,000 people died. The economy and stock market then proceeded to go to new historical highs. We suspect this country will make it through the current crisis and emerge even stronger.

Managing Money
Guest Contributor