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Gatsby
Joined: 09 Feb 2007
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 Posted: Mon Sep 15, 2008 4:33 pm Post subject: Econ 201 -- Understanding America's economic mess |
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A lot of Americans, and more so foreigners, are befuddled by recent business headlines about Freddie Mac, Fannie Mae, Lehman Bros. and Merrill Lynch, to name those still stored in short term memory.
Even business experts who were not employed by those companies don't fully understand what was going on inside.
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The new system was supposed to do a better job of spreading and reducing risk. But in the aftermath of the housing bust and the resulting mortgage crisis, it seems apparent that risk wasn�t so much reduced as hidden: all too many investors had no idea how exposed they were.
And as the unknown unknowns have turned into known unknowns, the system has been experiencing postmodern bank runs. These don�t look like the old-fashioned version: with few exceptions, we�re not talking about mobs of distraught depositors pounding on closed bank doors. Instead, we�re talking about frantic phone calls and mouse clicks, as financial players pull credit lines and try to unwind counterparty risk. But the economic effects � a freezing up of credit, a downward spiral in asset values � are the same as those of the great bank runs of the 1930s. |
http://www.nytimes.com/2008/09/15/opinion/15krugman.html?em
The basics, however, are not so mysterious. The investment banks are sort of like savings and loans and commercial banks in that they make highly leveraged loans (loans backed up with a low percentage of cash on hand in case of a run) to businesses. At least, that's the picture I am getting from reading the news. But they are not backed by federally guaranteed depositors insurance, like American savings and loans or commercial banks. So when there is a run on the bank, there is likely to be a panic, which is what we are apparently witnessing.
Investment banks were separated from commercial banks, and commercial banks were separated from savings and loans, following the stock market crash of 1929, precisely to prevent such runs and to reduce risk to the latter two categories. Now, the United States is allowing them to be folded back into commercial banks, specifically, Merrill Lynch is becoming part of Bank of America. Some say this could be dangerous down the road. What happens to the American economy if Bank of America goes bankrupt? What happens if the U.S. has to prop up this and other commercial banks?
What happens next? What happens several years from now? Even the experts don't know.
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Will the U.S. financial system collapse today, or maybe over the next few days? I don�t think so � but I�m nowhere near certain. You see, Lehman Brothers, a major investment bank, is apparently about to go under. And nobody knows what will happen next.
To understand the problem, you need to know that the old world of banking, in which institutions housed in big marble buildings accepted deposits and lent the money out to long-term clients, has largely vanished, replaced by what is widely called the �shadow banking system.� Depository banks, the guys in the marble buildings, now play only a minor role in channeling funds from savers to borrowers; most of the business of finance is carried out through complex deals arranged by �nondepository� institutions, institutions like the late lamented Bear Stearns � and Lehman....
But the consequences of those rescues are making officials nervous. For one thing, they�re taking big risks with taxpayer money. For example, today much of the Fed�s portfolio is tied up in loans backed by dubious collateral. Also, officials are worried that their rescue efforts will encourage even more risky behavior in the future. After all, it�s starting to look as if the rule is heads you win, tails the taxpayers lose. |
http://www.nytimes.com/2008/09/15/opinion/15krugman.html?em
You would have to be deaf and blind not to realize that America needs change, particularly with regard to the rules regulating the financial industry. The question isn't change, it is what changes?
Will the changes help protect the economy and the average investor? Will the changes be transparent and understandable to laymen? Or will the changes be arcane, with hidden levers that will allow manipulation, making insiders richer and richer?
If you find any insightful articles or columns about the economy, please post them. I, for one, would be interested in reading them, as would others.
Here is another take on the situation:
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The first 12 months of this crisis scrambled that equation. The Fed cut interest rates, as it often does in response to trouble. But this time the world lost confidence in the dollar, which failed to play its traditional role as a safe store of value in tough times and instead seesawed wildly. The innovative U.S. banks lost billions of dollars and were forced to turn for help to the new masters of finance -- foreign sovereign wealth funds. And U.S.-style financial innovation suffered a massive reputational blow. No less a commentator than Paul Volcker, the former Fed chairman, has emerged to denounce it....
The challenge over the next year or so is to preserve the good parts of the system while embracing necessary change. Paulson's willingness to throw the dice has made the world hold its breath, but it shows that he knows what the stakes are. |
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/15/AR2008091502201.html?hpid=opinionsbox1 |
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sojourner1
Joined: 17 Apr 2007
Location: Where meggi swim and 2 wheeled tractors go sput put chug alugg pug pug
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| Posted: Mon Sep 15, 2008 6:29 pm Post subject: |
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We need leaders who invest in America; not Asia and India. Forget the global economy thing, lets take care of our own people by investing in developing skill workers, new products, and upgrading of our deteriorating infrastructure. The finance industry and executives are mainly at fault.
We let our domestic economy go to waste and put many skilled capable Americans out of work to suffer financial ruin while the rich investors have been pouring all their monies into Asia and India business ventures. They (CEO's and other upper crust) forgot to keep developing the domestic American work force and infrastructure like they are supposed to be doing. They just figure the people and the government would take care of these issues while they got rich. Not so. We need companies that develop skilled career professionals of all sorts, innovate new products, produce products, and add actual value to the economy and the country.
For many years, the high performing stock markets results are not from domestic performance, but performance of investments in Asia and India. This is a deception when it comes to reporting how our economy is growing and performing. The rich are getting richer, but the poor poorer since you have to have money to make money in this environment.
Of course, if it were not for all this doing business in Asia stuff, English teachers probably would not be sought after like they are, but there would a much larger supply of decent mid level skill management jobs at home. We have to produce domestically in a profitable manner to keep the country going. Investing in Asia is not the answer for a long term winning game plan. For every foreign product we buy, that's another dollar poorer our economy gets. Eventually the current account deficit will tip the scales and this business model will crash. It's a zero-sum game. That's a day I don't want to see or be a part of, but its' coming. Invest in America and it's people! That needs to be the central focal point in the coming new revolution.
Our national debt is another country system killer too. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Mon Sep 15, 2008 6:57 pm Post subject: |
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The United States was given the gift of free money in the form of a USdollar as a global reserve currency. It did what any country would do and went a tad too far with it and now the Bretton Woods 2 system is falling apart. The whole bag of assumptions that American finance has operated under needs to be rethought and rewrote. The Bush years sped the process up.
The world lent trillions of dollars to American consumers who bought granite counter tops and plasma tv's and trillions more to the government who built B2 bombers. This system is unsustainable and is ending. Debt is no way to run a country. This here is a paradigm change. |
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Ya-ta Boy
Joined: 16 Jan 2003
Location: Established in 1994
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| Posted: Mon Sep 15, 2008 8:12 pm Post subject: |
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| If Obama can't scrabble together some old clips of Reagan saying things like, "Gov't isn't the solution, it's the problem" and "Get gov't off the back of business" and pin this thing on poor decisions at the top, he deserves to be dropped off the Statue of Liberty head first. |
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Gatsby
Joined: 09 Feb 2007
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| Posted: Mon Sep 15, 2008 8:55 pm Post subject: |
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This article provides an easy to understand explanation for the Lehman Bros. collapse.
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...after you get past the mind-numbing complexity of the derivatives that are at the heart of the current crisis, what�s going on is something we are all familiar with: denial.
Indeed, it is not all that different from what is going on in neighborhoods all over the country. Just as homeowners took out big loans and stretched themselves on the assumption that their chief asset � their home � could only go up, so did Wall Street firms borrow tens of billions of dollars to make subprime mortgage bets on the assumption that they were a sure thing.
But housing prices did drop eventually. And when people tried to sell their homes in this newly depressed market, many of them had a hard time admitting that their home wasn�t worth what they had thought it was. Their judgment has been naturally clouded by their love for their house, how much money they put into it and how much more it was worth a year ago. And even when they did drop their selling price, it never quite matched the reality of the marketplace. They�ve been in denial.
That is exactly what is happening on Wall Street. Ever since the crisis took hold last summer, most of the big firms have been a day late and dollar short in admitting that their once triple-A rated mortgage-backed securities just weren�t worth very much. And, one by one, it is killing them.
Take Richard Fuld, the chief executive of Lehman Brothers. Last summer, as the credit crisis first gripped Wall Street, Mr. Fuld�s firm, which was fundamentally a bond-trading firm, concluded that the problems would be short-lived � and that those firms willing to take big risks would be the ones that would reap the big rewards once things calmed down. So Lehman doubled down on mortgage-backed derivatives � not unlike a Florida condo owner buying a second one to flip 18 months ago.
Big mistake. Ever since then, Lehman has had a terrible time admitting the magnitude of its mistake � or properly pricing its securities. As mortgage derivatives became increasingly toxic, they also became increasingly illiquid. So firms were left to set their own �mark-to-market� price. And just like so many homeowners, they kept pricing their securities higher than they should have.
Earlier this year, for instance, when the hedge fund manager David Einhorn was making his public case against Lehman (he now refuses to talk about the firm), he stressed his belief that Lehman was valuing its securities too high. He turned out to be exactly right. |
http://www.nytimes.com/2008/09/16/business/16nocera.html?hp=&pagewanted=all
Denial is a good explanation of the failure to adjust to a changing market. But it doesn't explain how suites full of MBAs could make mistakes that any Economics 101 professor would have avoided.
Bubbles burst. Don't put too many eggs in one basket. Diversify. CYA. Hell, you don't even need Econ 101 to know that.
What is causing the collapse of these big firms? Stupidity and greed. |
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Juregen
Joined: 30 May 2006
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| Posted: Mon Sep 15, 2008 9:27 pm Post subject: |
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| sojourner1 wrote: |
We need leaders who invest in America; not Asia and India. Forget the global economy thing, lets take care of our own people by investing in developing skill workers, new products, and upgrading of our deteriorating infrastructure. The finance industry and executives are mainly at fault.
We let our domestic economy go to waste and put many skilled capable Americans out of work to suffer financial ruin while the rich investors have been pouring all their monies into Asia and India business ventures. They (CEO's and other upper crust) forgot to keep developing the domestic American work force and infrastructure like they are supposed to be doing. They just figure the people and the government would take care of these issues while they got rich. Not so. We need companies that develop skilled career professionals of all sorts, innovate new products, produce products, and add actual value to the economy and the country.
For many years, the high performing stock markets results are not from domestic performance, but performance of investments in Asia and India. This is a deception when it comes to reporting how our economy is growing and performing. The rich are getting richer, but the poor poorer since you have to have money to make money in this environment.
Of course, if it were not for all this doing business in Asia stuff, English teachers probably would not be sought after like they are, but there would a much larger supply of decent mid level skill management jobs at home. We have to produce domestically in a profitable manner to keep the country going. Investing in Asia is not the answer for a long term winning game plan. For every foreign product we buy, that's another dollar poorer our economy gets. Eventually the current account deficit will tip the scales and this business model will crash. It's a zero-sum game. That's a day I don't want to see or be a part of, but its' coming. Invest in America and it's people! That needs to be the central focal point in the coming new revolution.
Our national debt is another country system killer too. |
Welcome to globalization.
Money is more important than your nationality. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Mon Sep 15, 2008 9:46 pm Post subject: |
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| Gatsby wrote: |
Denial is a good explanation of the failure to adjust to a changing market. But it doesn't explain how suites full of MBAs could make mistakes that any Economics 101 professor would have avoided.
Bubbles burst. Don't put too many eggs in one basket. Diversify. CYA. Hell, you don't even need Econ 101 to know that.
What is causing the collapse of these big firms? Stupidity and greed. |
Too early to talk about the specifics of the Lehman collapse. Naked short sellers likely played a massive role, but they only respond to fundamentals (no matter how garbage they are). This is the second time Lehman has gone *beep* up.
Anyways, about the MBA's. They are taught quant risk modeling, which I believe to be garbage as they rely on past performance to predict future results which is not smart. In fact, every investment book I have in my house -all mainstream- drill about why past performance of a particular instrument is not a reliable indicator of future performance. Lehman will not be the last and the god-like Goldman's might actually be at risk. Their level 3 exposures are massive.
Hubris, as the FT reported Monday, is a huge factor. But even the most humble manager couldn't have avoided aggressive pressure from shareholders to match the gains of competitors during the housing boom. I'm two farts from supporting a classic gold standard, at this point. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Mon Sep 15, 2008 9:59 pm Post subject: |
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Here is Peter Schiff and some Australian econ prof talking about these issues. Schiff is full of hyperbole, but on the ball.
http://www.youtube.com/watch?v=YsoeVL5biq8 |
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Adventurer
Joined: 28 Jan 2006
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| Posted: Tue Sep 16, 2008 5:47 am Post subject: |
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| I think the summary of the situation can put down to "wishful thinking combined with greed and major risk taking occuring with the hope that everything will be all right". It reminds of addicted gamblers, and now we have to pay the price for this. I am not an economist, so I don't understand exactly what happened, and since I am not in the U.S., and I am in Korea I am kind of lost on this one. I should pick up the next issue of the Economist or Mother Jones to figure out went wrong, but it does remind of the people who traded on margin in the 1920s. Let's hope the damage won't be severe, fellows. |
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Gatsby
Joined: 09 Feb 2007
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| Posted: Tue Sep 16, 2008 6:28 am Post subject: |
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Good link, Mises.
http://ie.youtube.com/watch?v=YsoeVL5biq8
Sadly, Schiff is right about the international borrowing by the U.S. government through Treasury Bonds. It is not financing capital investment, it is funding deficit spending, and indirectly, consumer consumption. And it has gotten totally out of control.
If foreigners, especially foreign governments, stopped buying U.S. Treasury Bonds, the house of cards would collapse. They, the Arabs, Chinese, Japanese, etc., know this, and that they would be hurt by such a collapse. If it weren't for this, a rational investor would not be buying Treasury Bonds, which would probably be rated "junk."
Will it get to the point that the market for Treasury Bonds evaporates? It seems impossible. But the "impossible" happened this weekend, has happened before, and will happen again. The U.S. economy has not collapsed as a result, but it keeps getting weaker. And foreigners keep buying up more and more of our assets.
If the U.S. economy slows down, tax receipts will decline, for the federal government, as well as state and local governments. Real estate values have already declined, affecting property taxes, at least until the mill rate is increased. It seems like a vicious cycle. How is the U.S. to pay off its national debt if this continues?
The classic Keynesian approach was to stimulate the economy with deficit spending. But that's what we were doing during the 12 years of the Reagan and Bush Sr. administrations, and now the Bush Jr. administration, and to a lesser degree the Clinton administration.
So what is left? Deficit spending to put money in taxpayers' pockets, again? Tax cuts to the middle class?
I think Schiff is on to something. America needs to stimulate investment in production, somehow. We need to create more jobs that produce something. Spending to upgrade our aging infrastructure of roads, bridges and water systems would be a good place to start, it seems to me.
And we need to stop spending borrowed money on a war to protect Iraq, which has plenty of wealth from oil. We are borrowing money from Arabs to invade Muslim countries and protect them from extremists. What's wrong with this picture?
On the other hand, with the Baby Boomers starting to retire, we may have missed the window to get out of deficit spending.
Unlike McCain, I do not believe the U.S. economy's fundamentals are sound. The last time the U.S. economy was totally sound was in the 1950s and early 60s. When you see the unimaginable happening, live on television and the internet, the impossible becomes all too conceivable. I really fear the worst for the American economy.
At any rate, that's my two cents worth. |
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Adventurer
Joined: 28 Jan 2006
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| Posted: Tue Sep 16, 2008 7:10 am Post subject: |
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| Frankly, I would like to see a democrat win the white house, because I think someone needs to raise taxes and start paying off th deficit, but there is a concern regarding doing that when the economy is in bad shape. The economy cannot afford the deficit spending. I suppose people could argue for cutting social programs, but what can you really cut? What should be done to restore confidence in the U.S. economy? |
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Pluto
Joined: 19 Dec 2006
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| Posted: Tue Sep 16, 2008 7:44 am Post subject: |
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| mises wrote: |
Hubris, as the FT reported Monday, is a huge factor. But even the most humble manager couldn't have avoided aggressive pressure from shareholders to match the gains of competitors during the housing boom. I'm two farts from supporting a classic gold standard, at this point. |
Goldman's in trouble
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Goldman profit falls 70%, rules out bank deal
NEW YORK (MarketWatch) -- Goldman Sachs added to the mounting sense of gloom on Wall Street Tuesday when it reported that third-quarter profit plunged 70% from a year ago as business slowed across the board and the firm posted more than $800 million in losses from sour residential and commercial real estate assets. |
Although, despite this news, the Dow is down only 40 points at mid-day trading. And don't forget that, as of right now, the DJIA is still considering the terminally ill AIG in its calculations too. Perhaps, GM should go too. |
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bacasper
Joined: 26 Mar 2007
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| Posted: Tue Sep 16, 2008 8:04 am Post subject: |
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| Gatsby wrote: |
Good link, Mises.
http://ie.youtube.com/watch?v=YsoeVL5biq8
Sadly, Schiff is right about the international borrowing by the U.S. government through Treasury Bonds. It is not financing capital investment, it is funding deficit spending, and indirectly, consumer consumption. And it has gotten totally out of control.
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I agree with everything Schiff says although when mentioning that the US had nothing to show for all it has borrowed he leaves out the biggest culprit: massive military spending, 55% of our discretionary spending, which mostly just blows up, becomes obsolete, or even just "gets lost" (anyone remember the $2.3 TRILLION Rumsfeld announced on Sept. 10, 2001 that the Pentagon had "lost?") and leaves little tangible in its wake. |
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blaseblasphemener
Joined: 01 Jun 2006
Location: There's a voice, keeps on calling me, down the road, that's where I'll always be
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bucheon bum
Joined: 16 Jan 2003
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| Posted: Tue Sep 16, 2008 8:17 am Post subject: |
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| Pluto wrote: |
| mises wrote: |
Hubris, as the FT reported Monday, is a huge factor. But even the most humble manager couldn't have avoided aggressive pressure from shareholders to match the gains of competitors during the housing boom. I'm two farts from supporting a classic gold standard, at this point. |
Goldman's in trouble
| Quote: |
Goldman profit falls 70%, rules out bank deal
NEW YORK (MarketWatch) -- Goldman Sachs added to the mounting sense of gloom on Wall Street Tuesday when it reported that third-quarter profit plunged 70% from a year ago as business slowed across the board and the firm posted more than $800 million in losses from sour residential and commercial real estate assets. |
Although, despite this news, the Dow is down only 40 points at mid-day trading. And don't forget that, as of right now, the DJIA is still considering the terminally ill AIG in its calculations too. Perhaps, GM should go too. |
I wouldn't say Goldman is in trouble. It still made money last quarter. It is just finally being stung by the financial crisis like every other financial institution. The fact it managed to go this long and avoid huge losses is pretty impressive.
And who knows about GM, it still might be able to pull something out. Chrysler is probably in worse shape (albeit privately owned now). |
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