1. The economy is all interrelated. If your neighbor loses his job, he is very likely to cut back on spending. Let’s say he cancels his vacation. That hurts the airline and the travel agent and the hotel. If enough people cancel their vacations, then the airline and the travel agent and the hotel may need to lay people off. Then those people will cut back on their spending and not buy as many Christmas presents or cancel some of their cable channels or not go out to restaurants as much which will cause the department store and the Cable company to fire some of their people. Etc. Etc. and this his how recessions get started, and if there are enough industries going through enough difficulties all at the same time, this is how recessions get really bad and once every 50 or 100 years or so you get a really bad one which is called a depression which is where we may be now.
2. What does a credit crisis or credit freeze mean? Well, if you know anyone who got a little worried the past few weeks and went to the bank to take some actual cash out for a rainy day, imagine that happening on a huge scale. People don’t realize the extent to which an economy relies on credit. If you look at the balance sheet of most companies, they have assets and liabilities, and some of those liabilities are very short term. If someone wants to buy a car that costs $20,000, they rarely pay $20,000. They usually pay $2,000 and get a loan for the other $18,000. If the car finance company is not willing to loan them the other $18,000, then they can’t buy the car and both they and the car company are screwed. For the last 10 years, it was easy to get that car loan (”no money down!”). Now there are fewer places for that car loan to come from. The car companies themselves have finance companies that do a lot of the loans, but those finance companies are in danger of going bankrupt and have been for several months. Your finances are in much better shape than GM or Ford. But it’s not just the car companies. General Electric is in horrible shape. They have huge amounts of very short term loans that they constantly refinance. This is called commercial paper. Who is giving them the money? Well, a lot of it comes from money market funds that want to buy very short term safe assets…..let’s say they invest for 30 days at 3%. Those funds come from people like you and me that have money market funds and also from companies that have extra cash that they invest short term. What’s been going on in a massive scale in the past few weeks has been that people like you and me have been selling money market funds and getting the cash or just putting the cash in their bank account AND companies that would normally invest their cash on a short term basis either directly or indirectly with General Electric have elected to not reinvest when they get their money back, so GE is having some trouble borrowing money which is why they did the deal with Buffet and the big stock sale. GE’s problems stem from their GE Credit Company, which has huge amounts of investments in loans and bonds which needs to be financed. And GE is rated AAA. Now, one place companies go for in times of trouble is the banks. They generally have contractual agreements which say they can borrow for several years at a specified rate. What we’ve seen lately is several companies “drawing” on these revolving credit agreements. But the banks don’t really want all the companies to do this…….the banks are in horrible shape and are having the same trouble borrowing money as everyone else. The whole system is based on Trust and once you lose that trust, the whole system can fall apart.
In times like this, the only one people trust (at least for now) is the Government, which is why they have been getting so involved with everything. And you can’t stop people and companies from doing what they will do to survive, even if it hurts the system. In other words, Bush can’t go out and give a speech that tells everyone to just be happy and go back to doing what they were doing a year ago with their money. The natural reaction for everyone is to cut back and tighten lending standards, but that’s actually the opposite of what we need right now.
3. It’s annoying to listen to people call this plan a “Bailout” and for politicians to talk about “Wall St. greed and corruption”. This has been a case of a massive deleveraging. (Leverage means credit is flowing freely, and lots of stuff gets financed easily and prices tend to rise. In deleveraging, everyone is trying to sell assets and pay down loans, and if it happens all at the same time it’s a vicious circle). Basically, Wall Street is caught up in something very powerful that it can’t really contain……you can probably call Wall St. stupid, but not really corrupt. And I’m sure there’s been plenty of cases of individual bad behavior, but not that many cases of real corruption. Think about who has been hurt worst in all this and it’s the people on Wall St. The job losses their will be huge. And the $$ lost in investments in stocks like Bear Stearns and Lehman Brothers…not to mention Merrill, Morgan Stanley, Goldman, etc., has been massive in the extreme. The plan is not a “bailout”…a bailout is when you give someone money free and clear. This is a case of the Government making investments. If enough people pay their mortages, the investment will probably work out reasonably well. But if they actually do invest $700 bil, it’s pretty likely in my mind that your downside is probably $500 bil and your upside is probably $800 bil…or something like that.
4. As far as why this happened, I have a few points. First, stuff like this happens every once in a while. It’s a combination of human nature and financial markets. It’s hard to explain, but it’s not really anyone’s fault. But on the specifics, we have seen a massive increase in home ownership which was brought about by a) official government policy to encourage home ownership, perhaps driven by “liberal” laws that forced banks and institutions like Fannie and Freddie to increase their portfolios to weaker borrowers despite “conservative” attempts to force Fannie and Freddie to get smaller and raise more capital and b) the securitization process which let companies like Countrywide make loans and then sell them to investment banks which packages them together and sold them to investors. The total value of all the houses in the U.S. is huge. I think one number is $14 trillion. Let’s assume the value of that housing stock 10 years ago was $7 trillion and it doubled. Against that $14 trillion there might be $12 trillion of loans….I’m totally making up that number. Let’s say the value of the houses drops from $14 trillion to $10 trillion….not impossible that the market “overshot” by 30%. So now you’ve got $10 trillion worth of houses with $12 trillion of loans and there are $2 trillion of losses. That’s a huge number. It’s 3x the $700 billion and it would mean that ….no, the value of your house may not come back…or at least not for a very long time. But….like I said, these things have happened before and it usually works out….but there will be winners and losers for sure. It’s quite annoying that the value of the S&P 500 is about what it was 10 years ago. It’s not really supposed to work that way, but of course sometimes it does.
I could go on
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ReplyDelete"Its annoying" to hear Mr. Wall street attempt to defend the financial industry bailout as something other than a handout from Uncle Sam to the people who least need it. These clowns made many bets that they could never cover and then used what money they had left to buy influence with the government. These are the same people who would take your house in 5 minutes if you made a bet you could not cover.
ReplyDeleteWhere are the government's 'investment dollars' today ? Well lets look.... a Jan 27 Bloomberg story reports that an index composed of the TARP funded companies is down 45% since Oct. 28. The government money is going down the toilet to the tune of over $50 billion a month. That's because the financial industry continues to understate and hide liabilities [John Thain@Merrill], pay inappropriate outrageous compensation [AIG] and buy corporate jets [Citi]even though they should be in front of a bankruptcy judge. Then they disclose more liabilities and ask Uncle Sam to cover their sorry gold plated behinds.
This is an industry with an unjustified overwhelming sense of superiority and entitlement. For example AIG recently disclosed that it has handed out a $450 million dollar 'incentive retention package' to their 400 person derivatives group which has lost over $37 billion dollars since 2007. [Bloomberg Jan. 27] Any other business would see the wisdom of letting these people and their so-called business go. Instead Uncle Sam is floating money so each of these destructive morons can get on average over a million bucks. AIG was paying Joseph Cassano over a million dollars a month until Congress called them on it on Oct. 7, 2008. Since 2000 he's walked off with over $280 million bucks. These companies act suprised when called on these sickening deals - yet they are not able to continue without billions of public dollars, which they see as a daily entitlement. I could go on, but I would throw up all over my sneakers. Mr. Wall street, your turn.
See also New York times story Jan. 29th that discusses the use of Uncle Sam's dollars to fund bonus compensation.
ReplyDeletewww.nytimes.com/2009/01/29/business/29bonus.html?em
I don't mean to jump in, but in simple layman's terms, I do believe that you both are correct.
ReplyDeleteLet's take the parable of the talents. Not to go biblical out of the gate, however, I think there is something that we can all learn from this story. You see when the wealthy master gave out talents to his three servants, they each had a different mind set. The first servant multiplied his money at a much higher return than the others. The second servant doubled his investment. The third servant buried his talent. When the wealthy master realized what the servants had done, he rewarded the first two and gave the buried talents to the one who had gained the most increase. I believe what the true message of this story is that of stewardship. In many ways the servant who had increased his talent the most really did not deserve the buried talent of the third servant, who neglected to as much as earn any interest on the gift, but rather the master realized that he could trust the first servant with multiplying the gift moving forward.
To haphazardly segeway back into the subject at hand, America has trusted the increases of monetary investments to the banks and asset managers who make their living at eeking out annual returns greater than the annual interest earned on bonds and T-bills. I do not want to lay it all on Wall Street, however, as we live in a very diversified economy. In fact the actions of many local realtors, mortgage loan brokers, and expensive mermaid clad coffee shops who shall remain nameless, have also been trusted with the handling of tremendous amounts of hard earned American greenbacks. Now that the eras of Made in the USA and Pull Yourself up by Your Bootstraps are over, let us consider for a moment the purchase of a tractor as opposed to a car.
When an ordinary farmer wants to buy a new tractor to help him with his farming business and livelihood, he initially perceives the purchase to be that of an investment and a write off. Unfortunately, although food prices may be escalating due to alternative forms of energy production like ethanol and international runs on rice, creating a false sense of demand for product, the farmer has to reconsider the tractor purchase as his wallet is tucked somewhere between the mortgage on his house, his higher cost of fuel, and the challenges in the labor market for things such as insurance and government intervention without subsidies.
Working backwards, the farmer may also have problems in getting financing (more so for business purposes), as Mr. Wall Street previously suggested.
You see what I am getting at is the practicality that inevitably comes with the excesses of impracticality. With 3/4 of the GDP annually used for consumer spending, with the challenges in the current marketplace, the farmer is no longer spending, neither is the housewife, and even Starbucks is not even as busy as days gone by. I heard that some of these have even closed and turned into foreclosure bars. Not to mention that Americans typically save 2% and give 2% to charity on an annual basis, the old ATM in the house, the IRA, or the old pot of gold between the mattress and the box spring just ain’t there any more, honey.
In summary, let's take the quote from the famous Talking Heads song Same as it ever Was...when the singer rings out with imagine yourself in a beautiful house, with a beautiful wife, and he goes on to ask... HOW DID I GET HERE?
The only answer that I can come up with is a mere conclusion based upon the directives relinquished by the experts above. We live in a cult of personality, or to accurately put it SPECULATION. Whether you are a CFO at WorldCom and you are building your dream home along the Florida Coast with other people's money, or you are Andre Agassi at a photo shoot...Image is everything. Americans just can't seem to get their eyes off of the MATERIAL prize.
Unfortunately, as we saw in the parable of the 3 talents, the true prize is really the capacity within all of us to grow, increase, and be thankful for the things that the Good Lord has trusted us with. If we are successful and play it straight, prosperity is sure to come. If we falter, then what we have witnessed worse case scenario is that the government may come in and save us from ourselves, and find a way to take those non performing assets and place them in more prosperous hands...wherever that may be.
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ReplyDeleteResponding to Guy
ReplyDeleteThe purpose of Government investment in the banks is not to help the bankers....that's just a consequence. The purpose is to help keep the plumbing working so we're not all covered in shit. The bankers have already paid a very steep price. If you look at some of the companies in the headlines - Lehman, Bear Stearns, Citi, Merrill, Bank of America, AIG --- those stock prices are down about 85%. Guy --- if you have any 401K plans or other brokerage accounts, you tell me if they are down 85% or anywhere close to that. I bet no way. And the employees of these firms are naturally way over-invested n their own companies.
Now let's say you are a car salesman and you are one of the best in your state. You generally get paid $500 per car you sell and you've had a great year despite the economy and sold 1000 cars so you expect to make $500,000. Unfortunately, your company has accepted a loan from the Government and as part of that you are only going to make $50,000 this year. Don't you think you'd be pissed? What do you have to do with the Government loan or car sales dropping like a rock -- you just know that this year you sold lots of cars.
If you read the press it conjures up a vision of clowns making bad bets like a bunch of drunks in the casinos at 1 am. What most of it really is are purchases of mortgages that would be fine except the clowns that bought the houses can't afford them. Or loans to Companies that can't afford to pay them back because their downside scenario assumed no growth in sales when in fact sales are actually down.
Last point --- there's nothing like a corporate jet to grab attention. If you are the CEO of a big company, your time should be worth a lot. So is it justifiable to have a corporate jet that can get you to perhaps make 2 trips in a day instead of one which results in an extra meeting with a client that might get you one more deal? And what if that might make your company enough money to pay for that corporate jet for the whole year - or does it make sense to fly commercial which takes a lot longer and also prevents you from talking to your colleagues since you are not in a confidential setting. The car guys driving from Detroit to Washington was a pure publicity stunt which was the backlash from their first trip. Does that mean they should drive everywhere they go all the time? It takes longer and it's less expensive. Just like flying commercial takes longer and is less expensive than a corporate jet.
Do some companies go overboard and have more jets than they need and waste money? Yes, they do. But the Congress and the press pay attention to corporate jets in a way that doesn't really help anyone. And the executives are stuck up their looking like a bunch of idiots because they can't tell Congress or the press what they really think. How would you like to be CEO of a private jet company this year? Or CEO of a restaurant or convention center or hotel that relies on Companies using their services?
And for Mr. Main Street,
ReplyDeleteYour parable makes no sense. I'm sorry, but is that a famous parable that I just missed along the way? The third servant buried his talent.....what does that mean? Is it a metaphor, or did he actually bury a bone or something. Makes no sense to me. Is it like hiding your light under a bushel? And what are mermaid clad coffee shops? Is that Starbucks? Do you realize that if you talk/write that way all the time, people won't know what you mean?
What else....."We live in a cult of personality or should I say speculation" WTF are you talking about?
But to go to what I think is your general point is that you are a very religious person who wants to believe that if you do good you will do well, and that if the whole country was less materialistic we would all be better off. While I have some sympathy for your viewpoint, MATERIALISM which you are implicitly criticizing is really people's desire to have the freedom to provide for themselves and their family for now and for the future.