A question for American friends - Politics

So now I get to see someone who was irresponsible get to keep their mansion down the road because my tax dollars are helping to bail them out. Sorry, I'm still not on board with that idea.

There is nothing in this kind of plan that lets anything like that happen. I'm sorry, but you are not paying attention.

This kind of reaction lead to the Great Depression and the Lost Decade in Japan and frankly it scares the sh*t out of me to hear otherwise reasonable people get it so wrong on something so important.

If you were responsible and prudent, good for you and you'll do fine. It will cost you FAR more in the long run, however, if you/we do nothing now to save the banking and financial system we all depend upon.

Those people that are suggesting "we just let them fail" do not fully understand the state of the economy, and how interlinked the banking mechanisms are for credit, risk, and liquidity (my father was a sr. executive for the 2nd biggest bank in the world - retired about 10 years ago - he taught me a lot, and has been interviewed for articles in the business press twice this week on just this topic)

My wife and I have good credit, we are both employed by large corporations (she in education, me in software), we are pretty diversified in our banking, and other than looking at sucky quarters from both of the companies we work for (which will mean no bonus) the impact we currently feel directly from this "credit crunch" is minimal.

However, in our immediate vicinity (in Northern CA) there are already 2 car dealerships that have shut down in the last 30 days (not sold, literally shut their doors). The reason is simple: they can't get credit to hold inventory on their lots (car dealers don't "buy" new cars from the manufacturers, they take out short term loans to pay interest until they are able to sell the cars. After selling the car, they then pay GM/Ford/BMW/etc. their cost for the car and pocket whatever markup+dealer incentives they can. The interest they pay goes directly against their profit - which means the longer they hold a car "unsold" the lower the potential profit). At this point w/credit being tight and rates increasing dramatically (and fewer buyers qualifying) it's no longer feasible for some dealers to stay in business. Left alone, this trend will continue (the prediction I saw yesterday was a full 25% of the new car dealerships across the country are "at risk" - representing about 270,000 jobs and over $650M in local sales tax revenue that flows back into our local communities).

Okay - so maybe having less car dealerships is no big deal. Let's look at something else. I have 4 supermarkets near my house (3 large chain markets, 1 smaller independent market that caters to more high-end & specialty food offerings, including things like gluten-free choices that my wife needs). Last night I was talking to the assistant mgr of the smaller independent market as I was checking out - he said they are going to have reduce their stock (on the shelves) by up to 30% because their credit line has been "temporarily" reduced, and their payment increased. Note: this store has been around for 50+ years, they aren't losing any customers, people are still buying the same things from them (even true after they had to raise the prices on various food items earlier this year as did everyone else in the industry), and they are profitable. They have to offer less because of how their credit line is being impacted.

So you could argue the big guys (Safeway, etc.) are less leveraged than the little guys. Actually that's not true - the big supermarket chains are actually more leveraged - and a really severe credit crunch could easily impact the both the amount and quality of food that you will be able to purchase.

So let's bring this much closer to home. How do you think the vast majority of dive operations run their daily business? Only a very few actually don't leverage credit in some way (either w/manufacturers, equipment leases, real estate, etc.). The global impact of this credit crunch (if not addressed) will eventually cause huge strain on the operators (dive shops, liveaboards, resorts) that we all want to continue to exist. If you don't see this then you truly don't get how leveraged our global financial system really is. A small resort or liveaboard will likely be a lot more sensitive to this situation, meaning the places you most likely want to dive may be the first impacted by this.

So what is the right level of leverage? That's an entirely separate question. It's obvious (at least to me) that in the US we live way beyond our means, and the average quality of life here is much higher than our real GDP would dictate if we lived elsewhere. However, to suggest we shouldn't try to prevent a "credit freeze" that will impact virtually every one of us is just being shortsighted.

What I learned in high school was that this is one of the reasons the US is a Republic (vs. a true democracy) - because our founding fathers guessed that as a whole, our population wouldn't be smart enough to rule themselves completely.

Before I get into specific answers, I want to start with a small backgrounder ...

When 'people' talk about 'the market', they are usually referring to the market for stocks. Stock equity represents the ownership of a firm and is an important part of the financing of any business. Owners take the first dollar loss in return for unlimited upside.

Stock markets are very transparent, liquid and deep. They quote prices all day long publicly and get covered in the press.

The reality is that company treasuries/coffers touch equity markets infrequently - often only once or twice in the history of the firm.

Debt capital markets - on the other hand - are opaque, often illiquid and sometimes very thin. They don't get covered well in the press. The interaction of corporations and banks and savers and investors in the short term debt markets is the grease that keeps the economy running. Corporate treasuries borrow and lend on short term basis all the time. This is critical for the smooth functioning of our economy.

You could shut down the stock market for months and little harm would come. Shut down credit markets for even hours and things start to go bad fast.

>>> I know the "bubble burst" but I don't know exactly what burst, how it burst, and what precipitated the bursting. I believe decisions were made that exposed these crappy loans. I don't believe it's simply an upturn in the rate of loan defaults that has caused multiple gigantic banks to fail throughout the world. I believe that's a naive view. These banks are short on capital. Is it the failure of the loans that has caused the shortage of capital or is it a shortage of capital that has exposed the loans? I believe that those who are truly in a position to answer that aren't going to say.

What burst? A twenty-five year bull market in credit products. In 1981, long term interest rates were in the 16% range. By Jnauary of 2008 they had fallen, almost continuously, to 3.5%. As interest rates fall, the prices of interest-rate sensitive securities rise. This was a bull market (i.e. Wall Street party) that lasted from 1981-2 until the end of last year. That's a big bubble ... and it is not just housing. It is an overall credit bubble that got ahead of itself after 25 years ...

How did it burst and what precipitated it? Well, the immediate cause was the near siumultaneous decline in home prices that began in 2006 across a huge swath of the country faster and farther than anything since the 1930s.

The bad loans and securities that have caused $500+ billion in direct losses and hundreds of billlions of un-realized and ancillarty losses made the banks and other institutions shaky ... which chokes off growth as they hoard cash ... the cash hoarding stiffles growth ... the slowing growth makes people nervous ... so they spend less and hoard cash ... which makes things worse ... and then Lehman fails and everyone gets really nervous ... and they pull money out of banks and money markets ... and credit markets seize ... and the Fed and Treasury try to help ... but people cut off their nose to spite their face ... and things get way worse ... and 5 million people are out of work.

We are currently at "and the Fed and Treasury try to help".

Hopefully, we do the right thing and backstop ourselves before this really goes south.

Well, I had second thoughts about my original post, but I've since learned a lot about the American perspective on this. Thank you all. Let's hope a free-market solution to the crisis doesn't end up in a free-for-all because it will finally end up with a shoot-out and not at the OK Corral. See you at DEMA (if the airline is still in business!)

There is nothing in this kind of plan that lets anything like that happen. I'm sorry, but you are not paying attention.

One other question...if you're going to bail out the banks are the insurance companies next? Then who is after that?

I believe that those who are truly in a position to answer that aren't going to say.

I don't understand. Are you saying there is some root caused that hasn't been revealed anywhere? Lending is a transactional business. That is where the income is derived. Originators make their money on the origination. They sell the loans to fund their next transaction. When the secondary starts wondering what is rotting under the top layer of lettuce in the salad, they quit buying the salad. If you buy a portfolio of loans with an expected default rate of say 2% and default rates exceed 2%, your asset gets marked down. This immediately limits your ability to borrow and loan money. Once a trend toward higher delinquencies starts, you no longer feel comfortable pricing the next bundle of loans.

I disagree and others do as well. As for who loses, for every winner there's a loser since nothing is produced in futures trading. If you think no one is making a profit from oil futures, I'd say really? Funny how Goldman Sachs advises on $150-200 a barrel oil prices after they apparently invest heavily in oil futures. Yes, Goldman Sachs.

Who believes someone has cornered the market? Nor did I imply that there are losers=winners. That's not why a futures marker exists.

Either:

1) Someone has cornered the market

2) Someone has tried to corner the market and failed

3) No one has tried to corner the market

Are you saying GS has either done 1) or 2) ? If you think it is someone else, then the mere fact that GS has invested in the futures means that someone else hasn't cornered the market, unless it is a conspiracy. Perhaps a misunderstanding of the term "corner the market".

If only that advice were helpful in anything other than hindsight.

 

Investments of all kinds are subject to the arbitrariness of mass crowd ignorance and emotion. Logic works on markets over the long haul but it doesn't tell you what to do from day to day.

This is exactly why my observation is forward looking. It the reason people answer say that "real estate is a great investment". That's a hindsight assessment. If real estate prices are increasing at a real rate of say 25% a year and real income is increasing at say 5%, it is inevitable, absent exogenous variables, that the market will halt its ascension. The end point is that people can no longer afford housing. They must stay in the same house they own. The only way to maintain the growth in the market is to change another variable, loan qualifications, allowing people to spend more of their income on housing. This works until, well, you know.

I'm saying that this is an extremely high stakes game being played by the wealthiest, most power-hungry, most ruthless, most dishonest and amoral people on the planet and whatever it is that any of us are being told, we should be suspicious. Odds are nearly 100% that we are being lied to.

Makes for a good novel. A conspiracy against the people of the world by some international cabal and no one can see through it.

This kind of reaction lead to the Great Depression and the Lost Decade in Japan and frankly it scares the sh*t out of me to hear otherwise reasonable people get it so wrong on something so important.

 

If you were responsible and prudent, good for you and you'll do fine. It will cost you FAR more in the long run, however, if you/we do nothing now to save the banking and financial system we all depend upon.

Maybe you're right. Maybe a 700B bank bailout will "save" me from another great depression. My gut tells me that all we've done with this bailout is stave off the fall for a few more years.

Thanks Jeremy for your explanations. It is obvious that you spent a lot of time trying to help us better understand the issues. One of the things you've helped me understand better is the link between the motgage situation and the financial one. Having said that, I still find it very disconcerting that the initial attempt to address a large root cause -- that fact that many, MANY, people are in over their heads on their mortgages and unable to make their payments -- failed so miserably. That Congressional effort failed because it was optional (despite all the positive press releases) and the institutions that hold the mortgages are basically refusing to renegotiate with homeowners. Then we have this new bill that appears to reward them for that decision by handing them money and leaving it to the government to sort it out, using the same companies as contractors! In short, the original mortgage assistance bill encouraged the lenders, with federal help, to renegotiate mortgages, therby allowing more people to actually make their (admittedly lower) payments. This divided the risk and loss between the homeowners and the lenders. In theory, this would help keep people in their homes and split the losses. However, hardly any lender elected to do this, and it appears to many that they have now succeeded in getting the feds to pick up the risk, while at the same time, the homeowners are still screwed. I admit to not having a complete understanding of all this crap but I think I am accurately paraphrasing why a lot of people are a bit bitter about this pill.

I have to admit that I'm also a bit leery of the whole mark-to-market thing as it sounds to a lot of us poor ignorant people like a new shell game to let the finance companies hide more bad debt to trick investors into giving them more money . . .

I understand the whole, "if your house is burning dowm, you first have to put out the fire" argument but the road to hell in Congress is paved with efforts like this that are never followed up with the means to pay for them (I don't care qhat anyone says, we're never gonna pay for this, AND a war by LOWERING taxes on everyone -- remember, the all too fleeting budget "surplus" we heard about a couple years ago was based mostly on collecting taxes based on the same over-inflated values that we're bemoaning now) or the new regulatory framework to address the causes.

Mabye I'm wrong on this Jeremy, but there were people out there in the political world championing the fact that people wouldn't lose their homes. Joe Biden said it, Barney Frank said it, Senator Dodd said it, GW said it, and the political pundits are saying it.....so what's a guy to believe?

 

One other question...if you're going to bail out the banks are the insurance companies next? Then who is after that?

I think I can shed some light.

Second question first: Insurance companies will be able to participate in this program as I understand it.

What Democratic lawmakers are pushing for is a proposal that would allow defaulted mortgages to be worked out in bankruptcy court.

When a person defaults on a mortgage - particularly if the market equity (ie Market Value - Mortgage) is near or below zero - and the bank forecloses, the bank on average loses 35% of the loan. Some suggest allowing people who are defaulting to go to court and work out a deal that could be win-win for both as opposed to a foreclosure and a forced short-sale. If the bank would accept a revised mortgage with 20% of the principal reduced, they might make out better in the end than if they foreclosed.

Corporations that get into this kind of trouble get to negotiate in court and I actually think there is some merit in this kind of idea.

Having said that, I still find it very disconcerting that the initial attempt to address a large root cause -- that fact that many, MANY, people are in over their heads on their mortgages and unable to make their payments -- failed so miserably. That Congressional effort failed because it was optional (despite all the positive press releases) and the institutions that hold the mortgages are basically refusing to renegotiate with homeowners.

True, but the problem is two-fold - many of these borrowers just can't qualify for ANY kind of renegotiated loan and the actual loans themselves are held in trusts and there is no good mechanism in place for the securitized trusts to enter into those kind of discussions.

Then we have this new bill that appears to reward them for that decision by handing them money and leaving it to the government to sort it out, using the same companies as contractors! In short, the original mortgage assistance bill encouraged the lenders, with federal help, to renegotiate mortgages, therby allowing more people to actually make their (admittedly lower) payments. This divided the risk and loss between the homeowners and the lenders. In theory, this would help keep people in their homes and split the losses. However, hardly any lender elected to do this, and it appears to many that they have now succeeded in getting the feds to pick up the risk, while at the same time, the homeowners are still screwed. I admit to not having a complete understanding of all this crap but I think I am accurately paraphrasing why a lot of people are a bit bitter about this pill.

Well said and sensible ... but slightly off the mark in one sense. As I said above, the banks and other financial institutions don't own and control the mortgages ... they hold securitized debt and derivatives whose value is determined by underlying collateral values (ie the values of the mortgages). The actual mortgages reside inside trusts setup to be run in a certain way ... a way that did not anticipate re-negotiating loans.

The other aspect is that they are not being rewarded. Most of the money will go into reverse auctions where those banks willing to accept the least for these assets will get to sell. There is far more than $700bn worth of this stuff out there, so banks and others will compete to participate by accepting payments for these assets far below what they paid for them.

I have to admit that I'm also a bit leery of the whole mark-to-market thing as it sounds to a lot of us poor ignorant people like a new shell game to let the finance companies hide more bad debt to trick investors into giving them more money . . .

It is an arcane and stupid argument some are making that "blame" this whole mess on mark-to-market accounting. There is something to it, but it is truly "inside baseball" and not something we should be focusing on now in my opinion.

I understand the whole, "if your house is burning dowm, you first have to put out the fire" argument but the road to hell in Congress is paved with efforts like this that are never followed up with the means to pay for them (I don't care qhat anyone says, we're never gonna pay for this, AND a war by LOWERING taxes on everyone -- remember, the all too fleeting budget "surplus" we heard about a couple years ago was based mostly on collecting taxes based on the same over-inflated values that we're bemoaning now) or the new regulatory framework to address the causes.

The double whammy of excessive tax cuts and a couple wars combined with a new load of unfunded entitlement spending blew the Clinton/Rubin/Summers surplus within months of W arriving in Washington.

What an a**.

Our true "economic" debt is close to $50 trillion. That is the actual debt + the net present value of unfunded entitlements. We are leveraged, but not overly so even at that staggering level of obligation. We have a (normally) healthy and vibrant economy with many, many advantages.

We will get through this and we have it within our grasps to restore credibility and fiscal responsibility in Washington. I actually believe that Obama can do it. I'm hopeful today.

The Wells Fargo offer for Wachovia is a hugely positive sign ... let's hope the good news continues.

Thanks Jeremy. I, too, see the Wells Fargo offer as very positive. We actually have two companies bidding against each other for Wachovia rather than only one being subsidized by the government to take them.

For anyone else, I was sent this link, which has some pretty good explanatory information both for and against the current plan:

http://www.fool.com/investing/general/2008...0-billion-.aspx

Mike

I think I can shed some light.

 

Second question first: Insurance companies will be able to participate in this program as I understand it.

 

What Democratic lawmakers are pushing for is a proposal that would allow defaulted mortgages to be worked out in bankruptcy court.

 

When a person defaults on a mortgage - particularly if the market equity (ie Market Value - Mortgage) is near or below zero - and the bank forecloses, the bank on average loses 35% of the loan. Some suggest allowing people who are defaulting to go to court and work out a deal that could be win-win for both as opposed to a foreclosure and a forced short-sale. If the bank would accept a revised mortgage with 20% of the principal reduced, they might make out better in the end than if they foreclosed.

 

Corporations that get into this kind of trouble get to negotiate in court and I actually think there is some merit in this kind of idea.

Isn't this very similar the the terms in the "optional" mortgage restructuring bill? Reduce interest rate and/or pricipal and go on with life? Sad, given the earlier bill, that the only way to do this is to get the courts involved.

Jeremy,

I'd note a couple of points. First, my understanding is that CDOs in particular were valued largely on models, and the extremely thin markets were willing to accept the models' valuations while everything was going well. Once things were going badly and default rates began to exceed those predicted for any given tranch, the models fell apart. Now, the market doesn't know how to value these, so there really is no market. This opacity is a big part of the problem. No one can really figure out what this stuff might be worth. Vulture investors will pay 20 cents on the dollar, but banks still think it's worth 60 cents. And the markets have dried up. When there's no market for a security, it's market value is $ 0. And when you're leveraged 13 to 1 or 17 to 1, even a small decline in the value of securities can take you down pretty quickly.

Second, bankruptcy is a way around the trust problem. An individual can't negotiate with a trust but, with a change in the law, a bankruptcy judge could cram down the debt. This actually happened occasionally before the new bankruptcy act.

Jeremy,

 

I'd note a couple of points. First, my understanding is that CDOs in particular were valued largely on models, and the extremely thin markets were willing to accept the models' valuations while everything was going well. Once things were going badly and default rates began to exceed those predicted for any given tranch, the models fell apart. Now, the market doesn't know how to value these, so there really is no market. This opacity is a big part of the problem. No one can really figure out what this stuff might be worth. Vulture investors will pay 20 cents on the dollar, but banks still think it's worth 60 cents. And the markets have dried up. When there's no market for a security, it's market value is $ 0. And when you're leveraged 13 to 1 or 17 to 1, even a small decline in the value of securities can take you down pretty quickly.

 

Second, bankruptcy is a way around the trust problem. An individual can't negotiate with a trust but, with a change in the law, a bankruptcy judge could cram down the debt. This actually happened occasionally before the new bankruptcy act.

Good points.

The whole "mark to maket" / "mark to model" controversy stems from FASB statements 157 and 159 which categorize assets into three "Levels".

Level I assets have deep, transparent and liquid public markets. Level I assets are to be "marked to market" based upon these market prices.

Level II assets they are harded to value as the markets may trade less frequently, but there are markets and prices to use for valuation.

Level III assets (including more exotic credit derivatives like many CDOs) are impossible to value with market information and must be valued according to forecast and valuation models. Even the most sophisticated models are rife with assumptions - some of which may NEVER hold under even normal circumstances, others which are violated when the "unexpected" happens. We have had a lot of "unexpected" things happen ... some of which some people should have expected even if the models didn't.

The 20-60 cent range is very accurate. There are banks holding Level III assets at 20 and some at 60. The total amount of Level III assets in some of the investment banks books were larger than their equity and therefore substantial write downs to these assets have wiped or nearly wiped out their equity.

Hence the solvency issues which are now causing runs on the bank and more serious liquidity issues.

Thanks guys for the extended discussion and information. Leave to the Wetpixelians to take a great big subject and break it down into little bitty terms that no one else understands. So Jeremy I understood everything you said except for the part about when I get a new BMW

Steve

... I understood everything you said except for the part about when I get a new BMW

Steve

I think my Subal D700 housing is in the trunk of your BMW!

I think my Subal D700 housing is in the trunk of your BMW!

Just make sure you do not take the Canon 5D Mark II housing w/body I left in there.

We will get through this and we have it within our grasps to restore credibility and fiscal responsibility in Washington. I actually believe that Obama can do it. I'm hopeful today.

 

The Wells Fargo offer for Wachovia is a hugely positive sign ... let's hope the good news continues.

Jeremy,

Thanks for your explanation; puts a lot in perspective. I simply don't see the connection however between the mortgage issue which you've explained pretty well, and the tax cut, wars, fiscal responsibility of Washington issue. There is simply no assurance that Barack Obama or anyone else will restore any more credibility or fiscal responsibility in Washington. His voting record has not demonstrated this previously, and the gross fiscal irresponsibility of congress shows no sign of abating. One only has to look at all the crap earmarks etc added into the bailout by our Washington leaders. Wishful thinking at best.

Jeremy,

Thanks for your explanation; puts a lot in perspective. I simply don't see the connection however between the mortgage issue which you've explained pretty well, and the tax cut, wars, fiscal responsibility of Washington issue. There is simply no assurance that Barack Obama or anyone else will restore any more credibility or fiscal responsibility in Washington. His voting record has not demonstrated this previously, and the gross fiscal irresponsibility of congress shows no sign of abating. One only has to look at all the crap earmarks etc added into the bailout by our Washington leaders. Wishful thinking at best.

Jeremy has done a great job explaining the issues.

I take it you mean here

I simply don't see the connection however between the mortgage issue which you've explained pretty well, and the tax cut, wars, fiscal responsibility of Washington issue. There is simply no assurance that Barack Obama or anyone else will restore any more credibility or fiscal responsibility in Washington. His voting record has not demonstrated this previously, and the gross fiscal irresponsibility of congress shows no sign of abating. One only has to look at all the crap earmarks etc added into the bailout by our Washington leaders. Wishful thinking at best.

is tied in more to the concept of nothing getting done still overall as oppossed to the actual econonmic tie in between

the connection however between the mortgage issue which you've explained pretty well, and the tax cut, wars, fiscal responsibility of Washington issue

As to wishful thinking perhaps, and it always seems to be many dissapointments. It is hard to believe that 35 years or so after having to wait in line at gas stations based on your license plate that nothing really has been done. I always am hopeful that perhaps they get their act together and maybe this is the time. I am not sure how many wake up calls are needed to get these people off dime and truly put most of the politics aside.

As to the earmarks, I have not gone though the bill (I though I heard it is 450 pages now? The second link below contains a link to one that is 250 pages) and the naive part of me wants to believe that some of them were somehow would be helpful at this time as a form of help in connection with the total bill, but in the context of this rather extreme situation it would have something that could have left by the door.

One News Account, Another and Other Accounts

I am always hopeful after elections that perhaps things will get done. And hopefully it is not just wishful thinking once again.

Try this one from Master Jedi Obi Wan.............

Great depression depends on ur point of view....and all the views expressed here are first world views....I think you should all contemplate the image of Paul Kay's post on this thread...........all this talk of economy, stocks and shares, U.S. doom and gloom....guess what? the whole western world is in the fox hole together....

We can contemplate all these recent economic upturns and down turns- theorize on where the mistakes were made, where the money went, and where the money is now, the power struggles, the blame laying- all are facet's to man's monumental greed...a greed which we are all guilty of, one way or another

We are photographers- amateur or otherwise- we should never loose sight of the bigger picture.........

We have the health, the happinness, and the resources to go where most people dare to dream and take beautiful images, to show to those who never can...

Let us celebrate our good fortune...be thankful for all the good things we can do, and for the miracles that we are allowed to see and the images we are allowed to take beneath the waves....

And by doing this alone- finally realise- how lucky and happy are we....may the force be with you

This post is dedicated those who are lying on a scratch of earth for a bed this day-those who go to sleep this nite malnourished, sick, uneducated, unloved, and forgotten-all to satisfy the wants of the greedy few...