Paul Krugman, winner of the nobel prize in economics, wrote in the New York Times here: http://www.nytimes.com/2009/01/26/opinion/26krugman.html?hp
I'm going to swim upstream a little and say that I'm not in favor of the bailouts. I'm skeptical about the stimulus package, but I have yet to see the specifics of what they are geared for.
I won't get into a lot, but I have this gut hunch that tomorrow, barring drastic action by the Fed., will be one of the bloodiest days in stock market history.
I don't have a ton of evidence, but rather this gut hunch. Perhpas that makes me irresponsible for posting this; I don't know.
Basically, I think that the Fed. is more or less out of options. The consistent drops we've seen in the past five days have all been people eeking out their time in the market, and waiting for a solution and today's talk about a potential buying of equity shares reeks of 'last resort' talk. Moreover, I don't see what the Fed buying shares will accomplish that it won't undo by tipping its hand that whatever company it is buying is in the tank.
Overall, I'm distant and intrigued to watch this happen real time. I know that sounds callous, but this has been something that I have known is a possibility as an abstract concept for years, now I am learning the specifics by watching. I feel like the time I cut my finger and after a nerve block watched the doctor sew it up, and give me a brief tour of the inside of my pinky. The nurse turned a little green, while I'm detached and studious, yet know that what is going on very much affects me as a person.
I hope I'm wrong, and frankly, don't have any experience so it is a high likelihood, but I'm of the opinion tomorrow will beat 777 by a fair margin. Spooky.
This guy Robert Peston puts it the best I've seen it put so far. The question with the 7-800Billion dollar institution is in the long term profitability to the taxpayer.
If this debt is bought up at the price the banks have been labeling it as being worth, then we have a taxpayer issue. We can't really come out even unless we make it up in interest over time, but we almost certainly won't make a profit.
I could deal with breaking even to get us out of this mess, but that does one other substantial thing. It sends a strong signal to all the banks that have had poor lending practices for years, that have overvalued the price of homes, and stock, and played it fast and loose, that it is all A-OK, they'll still get their paycheck at the end of the day, complete with golden parachute attached. That is wrong.
The counter argument is that if we buy all this bad debt at fire sale prices we aren't really helping the economy now. These banks still might fold, it still might ripple through the economy and all we did was incur a whole lot of bad debt.
Chris Dodd has it right this go around, we need to see the details. And I strongly suggest that you and I as taxpayers insist on seeing the details. Schumer, Clinton, and Towns will all be getting a phone call from me.
The only way for this to work is to tie it in with simple oversight. A few rules tied to this money and I will sleep well at night.
A) Define a metric on what makes 'Too big to fail', and prevent it in some way shape or form that from occurring again. In short, no one should be able to hold the American taxpayer hostage. Furthermore, Letting Lehman collapse while A.I.G. doesn't creates a foul moral soup. Did Lehman just not collectively screw America enough?
B) Define future criteria for the government to get engaged earlier. If anyone is interested I've been tracking parts of this issue since 2002, and the REAL time for government intervention was somewhere between Aug. 2007 and March 2008.
C) Push predatory lending laws.
That's all I got for ya right now.
If you've been playing along at home you've seen in the past weeks Freddie and Fannie get bailed out, Lehman Brothers declare bankruptcy, A.I.G. get a largely ineffectual bailout, and today a $180B cash injection from the Federal Reserve. If you don't know what I'm talking about, stop and go read a newspaper, for real.
The papers seem to be writing a whole lot about 'How could this happen?' and in my oh so humble opinion failing utterly to explain in lehman's terms (pun intended) what is going on, so here is my attempt to do so. Partially, I'm writing this cause I've had to explain it verbally so many times in the past few days that I figure I can hone my rhetoric by writing it down.
I'm sharing it for any of my friends who are having issues and concerns with this right now. I can't promised I'm unbiased, as anyone who has heard me rant about economics and the credit market before. I also, will strive to be accurate, but am not an economist, so corrections are *welcome* in the comments. And finally, I've tried to simplify it as much as I can so feel free to skip past things if they seem rudimentary.
First, it is important to understand that what is happening today is not rooted in the past few weeks or few months even. It is the result of years of poor practices in the financial markets.
The second thing to realize is that money is not imaginary, and should not be treated as such. As much as these huge numbers being thrown around may seem daunting and impossibly large, we can trace down through them and see the process that has gotten us to where we are today. Let us start with a simple transaction.
Joe Fatsquatch wants to buy a house. The house costs $575,000 (these are hypothetical numbers, not imaginary numbers) and Joe has $75,000. He needs to get a mortgage to pay the remaining $500,000.
Joe goes to the bank and gets a pproved for a mortgage in which he agrees to pay the bank $500,000 plus 5% (again, hypothetically selected for easy mathematics) interest over the next 30 years. The bank then pays the seller of the house the $500,000, and takes as collateral the house Joe plans to live in.
Over the course of 30 years the bank is going to be paid back much more than the 500,000, and Joe will have paid much more than the initial asking price. In effect what Joe is paying for is the house, plus the luxury of thirty years to pay off the debt, while having possession of the property. Obviously, Joe would have been happier had he not needed a mortgage at all, or not needed to finance quite so much.
What does the bank have? The bank now has a piece of paper that is worth $2,058,067, if they wait 30 years. Now, obviously that is a hypothetical interest rate, and amount to be financed, but you can see the high price of having the luxury of credit.
The bank doesn't want to wait 30 years to see that money. They just don't, it's better to use it now, surely there is some way to monetize this immediately. And along comes Fannie Mae. She is a giant institution that buys and sells mortgages by the thousands. The Bank Joe got his mortgage from sells Fannie Mae that piece of paper, along with 49 other pieces of paper and receives slightly less than the price it would be worth had the bank just waited thirty years for it, but that is OK cause they now have significant chunk of cash available *now*.
Fannie Mae isn't naive, she also values these 50 pieces of paper a little less because she knows that she is accepting the risk of Joe or one of his 49 buddies defaulting on the mortgage. At which point the piece of paper is back to being worth $575,000, not $2,058,067 as there is no longer the interest rate attached to it. Funny how paper can change value like that based on outside circumstances, eh?
Now, if we take those 50 pieces of paper collectively, Fannie has paper worth 102,903,389.88 and physical property value worth 28,750,000. In order to obtain the larger of those two values Joe and his 49 buddies need to pay their mortgages, and in order to do that they need jobs. Indeed, vetting the employment and employability was one of the chief things the original bank did in order to give Joe a mortgage.
Fannie Mae wants to raise capital in order to buy more of these bundles of mortgages as they are obviously a good investment. Fannie Mae issues stock, and sets the price fairly high. Higher in fact, than the value she could actually deliver were all those mortgages to foreclose. Naturally we assume *all* the mortgages won't foreclose so this is probably a safe bet. However, Fannie is a little greedy. She knows she is the big kid on the block, and was put there by the government. And while no one has ever overtly said anything, there is an implicit knowledge that should Fannie Mae not be able to cover her issued stocks the government would step in and cover those stocks for her.
This makes those stocks Very Attractive. Fannie can charge prices completely out of line with the value of the mortgages she owns in fact and does. This is the first point in the chain when we have decoupled the value of what we have to the value of what we pay for. Fannie Mae was issuing stock on imaginary assets and implicit value.
However, the market goes along with it, and because they know Fannie Mae would get backed up in a crisis, almost all the investment banks want a piece of Fannie Mae. Which, of course, makes her that much more expensive. All these investment banks need cash to make purchases. They daily take large loans that are paid back before the end of the business day or week to procure an array of investments and make profit. They are working with a large pool of money that isn't theirs. It is a combination of their investors (people like you and me who have mutual funds, and other group investments) and also these short term loans.
Now, say Investment Bank A borrows 100,000 from Investment Bank B, to be paid back on a set term. Where does Bank B get the money? They have it available in their accounts and Bank B trusts Bank A well enough to lend it to them, with a reasonable assurance that it will get paid back. In fact, this is a common practice Just the other day Bank B borrowed 100,000 from Bank C with the same understanding.
Bank C from Bank D, and Bank D from ... Bank A? Somewhere along the line someone lost track and Bank A has both taken a loan from Bank B and given a loan to Bank D. Something is odd here, each of these Banks now has and can spend 100,000, but only 300,000 exists. Money is not imaginary. And this is the second place we see value decoupled from actual assets.
This model is surprisingly workable as long as the money keeps flowing. It is remarkably similar to our mortgage model in which those pieces of paper have an increased value as long as Joe and his 49 friends continue to pay their mortgages. If the cash in the bank situation above were to stop flowing though, someone would be left with the 'hot potato' and have to bow out of the game. Similarly, if Joe stops paying his mortgage, a value suddenly evaporates.
Well, surely there must be a way to game such a system? One can easily imagine a system where a bank wants to make quick cash to use, and is willing to incur higher risk, feeling confident that if anything went wrong they could stick their neighbor holding the debt.
You could in fact, issue a mortgage to Henry, even though Henry doesn't have a job in which he could pay for such a mortgage. Doing so would be a very poor practice, but Fannie Mae is buying al your mortgages anyway, so who cares? She's big enough to take the hit if Henry defaults.
The Lending Bank issues the bad mortgage, knowing that Henry can keep his head above water for 4 maybe 5 years. Sells it to Fannie who issues stocks with a nod and a wink, backed by the government, And it gets thrown into this buying and selling game where Investment Back start passing it back and forth. Henry defaults.
The mortgage piece of paper loses 75% of its value. Trace that up the chain and go back to the banks lending one another cash, and You have Bank A having just borrowed 100,000 from Bank B, from Bank C from Bank D. We already know we are counting 300,000 as 400,000 as long as the cash keeps flowing and suddenly, because of Henry defaulting, you now only have 225,000 in the 400,000 circle. Poof.
Bank A needs cash and they need it NOW or else Bank A folds, of course, they had no real money to begin with, they were just playing with imaginary money. If for some reason it would be Very Bad for America if Bank A folded it might get an emergency loan from the government, in order to give them time to make good on their assets. This would be called a Bail Out, and we've seen several over the past weeks.
The Fed made $180Billion available for these emergency loans today. And what you are seing is everyone playing with funny money close up shop.
I'd been contemplating this scenario for a while when back in August of 2007 the Federal Reserve and nations around the country injected raw cash into the market to stabilize it. Kind of a 'free loan' day for all the people holding the debt. Think of that maneuver as priming the pump. If Bank A, in the above scenario could get a loan, we could keep the money flowing and sustain the status quo. Over several days the other mortgage payments come in, and that missing 75% gets absorbed into the whole.
But here is the issue, we're still playing with fake money. All the bailouts do is maintain the existing system. Would it be more or less effective to regulate what mortgages can be given? Or how one bank lends to another bank on trust?
I'm still thinking on that one. The one thing I am pretty certain on is that if Bank B knew that Bank A had debt outstanding past the loan requested, they might think twice about lending. Transparency in lending could go a long way towards noturally stabilizing this situation.
That's it. Hope it helps and also hope I'm not dead wrong on how all this works.
Oh yes, How could anyone have possibly known this would happen!
Really folks, we've known for over 6 years, that these guys were playing poker with the new improved "Taxpayer's Gambling Insurance" and almost exactly nothing was done to stop it. Incidentally, that implicit knowledge of a bailout gave them an approximate 40% edge when raising money from investors.
If you want big money, don't bother stealing it, get the feds to back you then drive your company into the ground.
I've been doing some thinking lately and it is leading me in a new direction on my thinkings about a fluid economy. We are in a recession. People can debate me about the technical meaning of the word recession, and those people can feel free to employ the term 'economic downturn' or 'slowing economy' - whatever; recession.
I had been of the opinion that 'economic downturns' were a fixture of a regular economy. That these things happen in pendulum swings of sorts, like the world economy breaths in and out and nations are just taken along for the ride. Breath in: growth and prosperity, breath out: recession and job loss. And that, to some degree, this was a good thing, as semantically everyone everywhere couldn't always be profitable.
But now, I feel I've been alive long enough, and have personally witnessed enough of these events that I think I can call that line of reasoning wrong. This change in thought comes at the heels of a LOT of thinking about sustainability. Every one of these economic downturn's in the U.S. has been caused in turn by a trail of overspending, poor accounting, and frankly bad common sense. That is to say, there is no chronological swing of the economy.
There are, natural economic events, that, I'll grant can cause micro-setbacks - as the recent events of the river have shown us; or rather our corn crop. But these events cause smaller ripples, and short of a long chain of natural disasters aren't going to provide the basis for a nationwide, or global economic downturn.
The difficulty lies in tracing any economic downturn to any single event and then quantifying a ruleset that is sustainable. Well, heck, what is a poor practice? I'm working my way towards a set of Sustainable Business Rules - which someday I may publish, but for the purposes of today's article, lets just look at some cases from this particular economic crunch. I like the fact that my blog has been online that I can point to some old articles where I spoke about these things as they were happening.
Freddie Mac and Fannie Mae just slid 18% on the market in a single day. Interestingly, recent accusations of cooking the books go back to 2004 http://www.workers.org/2005/us/housing-0505/ So, while it may seem like new knowledge now that the entire housing market was propped up on false data for an extended period of time, it wasn't. These early warnings were ignored or dismissed. Overstating profit of GSE's (government sponsored enterprises, or limited monopolies) seems to be a common factor in these things.
When Entire Stock Markets need to be bailed out by the Feds - Aug. 2007 - we should probably acknowledge that something went screwy and do something about it, instead of burying it in the news.
Congress allows National Debt to top 9 trillion (insert previous high water line here) for first time in history "The Senate voted Thursday to allow the national debt to swell to nearly $9 trillion, preventing a first-ever default on U.S. Treasury notes." in Mar.2006 - currently $9,506,133,823,396.86 - National debt in and of itself isn't a bad thing. Rising national debt out of proportion with revenue is.
I realize I most recently wrote this - about poor accouting in Iraq http://www.treslervania.com/node/427 , I had forgotten that I had also written this, long before the fact. http://www.treslervania.com/node/149 - "Funnelling Taxes Through Iraq" - the point isn't to say "I told you so" but that Government Accounting in general needs to be tighter on the Military Industrial Complex - particularly the contractors.
There are many more than that, but those are just grist for the mill. The larger point is that I think a periodic downturn, is really a periodic 'forgetting of the rules and why they are there.' Wealth - Disaster - Recovery - Caution - Laxness - Wealth cycle makes a pretty good sine wave, and it is easy enough to make Time the X axis, when perhaps "Recent Human Memory" would be a better X axis.
Of note, we also have tendency to refuse to look at the bigger picture, wanting to deal with specific issues. It is too big to think of changes in the housing market, student loan market, credit card market, national spending and taxation, hedgefunds, etc, but many of us feel we have a handle on any one or two of these. Too bad it is the big picture that matters.
Has anyone else noticed the World Economy collapsing over the past week or so? I mean the markets aren't great in the US, but the ECB has also injected 7.7 billion euros into the world money market today following a whopping 61bn last Friday.
The US Federal Reserve... $38billion Friday, more today.
Is this normal? It can't be.