Economy in meltdown?

[The Gardener]

Iamnaked... your friend has the right idea.

The problem that the US has is differentiating between the concepts of "long term" and "short term". Sure, those assets might be worth a fricking fortune in the "long term"... but unfortunately, "long term" assets are worthless if you have a banking system basing all of its long term liquidity on a model that relies on borrowing short term, at lower interest rates or using the carry trade, and expecting to be able to continuously roll this financing over at favorable rates in the "short term" until the "long term" suddenly becomes "now".

This truly is the crux of this problem... all the financial models relied on an assumption that short term liquidity is inherently cheaper than long term liquidity. And it makes sense... when you borrow money over longer terms, you typically expect to yield a higher interest rate. But it all fell apart when short term liquidity reached SUCH a premium that the yield curve inverted due to oversubscription of this trade. This toppled the whole house of cards..... and it did so in MORE than just subprime American mortgages. The entire Western banking system used this "short term debt requires a lower interest burden than long term debt" paradigm as a building block assumption for MASSIVE volumes of derivative investments. They are all underwater, given a short term liquidity crunch.

And, to dismiss the euphamisims, another word for "short term liquidity crunch" is a "SOLVENCY crunch".

 

[Harie]

With all this bailout talk, we are all missing a hugely important part of the puzzle that could potentially screw us beyond our ability to recover. Most of the talk is only about the bailout plan and it's need to buy up mortgages that are in default etc, but they fail to talk about Credit Default Swaps...Which is the real problem.

Credit Default Swap. The current amount of credit default swap contracts outstanding are estimated to be somewhere close to 60 Trillion dollars. For those that have no clue what a Credit Default Swap is, let me help you out.

Think of it like an insurance policy - only in this instance, instead of protecting anything, you are essentially betting that an institution will default on it's debt. Banks and lending insitutions started doing CDS in the mid 90s when the risks of loan defaults by corporations was very, very low. Skip to today and we've got institutions defaulting left and right...Which is making certain people a killing.

CDS is one major reason that AIG went under. They were the worlds largest CDS underwriter of any lending institution around, with an estimated CDS value of 440 Billion dollars. When they defaulted on 14 Billion in CDS contracts, the govt had to step in and bail them out or risk a snowball effect.

For those that are still saying, "What the hell is a CDS?"
Example:

I bet that HairLossTalk.com will default on it's outstanding bond debt of $1,000,000. I pay a monthly payment to the bank that writes this CDS contract. 9 other people think that HairLossTalk.com will go under too and they all have the bank draft up CDS contracts for $1,000,000 each as well. When HairLossTalk.com is making their bond interest payments, things are going great, the bank makes a killing on our monthly payments. But 2 years later, HairLossTalk.com does default on the bond interest and goes bankrupt. The bank is stuck not only with the initial 1 Million HairLossTalk.com defaulted on, but now they owe the CDS holders 10 Million too.

Now just think of the fact that there's 60 TRILLION dollars in CDS contracts floating around out there. That's 4x more $$ than all the stocks traded on the NYSE.

 

[badasshairday III]

Um. So it didn't pass. What is going to happen now? Did we get into this whole mess because people were taking out a bunch of equity on there homes, then couldn't pay both their mortgage and equity loan back, resulting in a shitload of defaulted loans? If that is the case, how did all these banks get rich enough to provide their CEO's (like WaMu's CEO) with multimillion dollar golden parachutes?

 

[The Gardener]

Um. So it didn't pass. What is going to happen now?

We may have to find out first hand. It'll probably start with an increased cadence of bank failures as the unwind continues unabated.

Corporate financing is becoming increasingly expensive, the LIBOR spreads indicate that banks would rather hoard the cash themselves. There is a point where companies that rely heavily on lending to finance their operations will find that the lending rates will exceed their sales margins. To put it another way, if a company needs to spend more money in interest, it will spend less money on things like payroll, for example.

Did we get into this whole mess because people were taking out a bunch of equity on there homes, then couldn't pay both their mortgage and equity loan back, resulting in a shitload of defaulted loans? If that is the case, how did all these banks get rich enough to provide their CEO's (like WaMu's CEO) with multimillion dollar golden parachutes?

From the paycheck that you and millions of other Americans deposited at your bank last week.

 

[Aplunk1]

G, are you going to have a job with this sh*t goin' on?

 

[iamnaked]

Um. So it didn't pass. What is going to happen now?

Hopefully the Fed will let the zombies fail and normality will be restored.

 

[Cassin]

This will get fixed...this was happening too fast and that scared the heck out of me.

 

[The Gardener]

G, are you going to have a job with this sh*t goin' on?

Well, I don't work for a bank, I work in sort of a financial research role for an electronic company so I'm a bit shielded from the fallout, if not protected to a certain extent. As for your question, that is a question that many people will increasingly start thinking about in the near future. Wall Street is just the tip of the iceberg.

If the credit markets crater, ugh, you guys just have no idea the carnage this would create. I think that people think their employers are rich fat cats sitting on tons of cash. So wrong. Most American companies, especially the mid sized to small companies, but large companies too absolutely REQUIRE credit on a daily basis. Holding cash is uneconomical, people don't realize that most companies tap into money markets for such basic things as meeting payrolls and paying vendors.

Hopefully the Fed will let the zombies fail and normality will be restored.

I wouldn't count on that any time soon.

 

[Starseed]

Gardener, I read this in a UK newspaper blog. It maintains that Wall St were encouraged by (Dem) legislation to embark upon the sub-prime lending path. What's your take on this?

"For those who don't know about the Association of Community Organisers for Reform Now (and the media will not tell you), it's a network of leftist groups whose activities include:
- Registering poorer people to vote, preferably Democrat (not excluding infants, felons, illegal immigrants and dead people).
- Channeling poorer people ino the arms of sub-prime lenders, no doubt reminding them that they owe this wonderful loan they won't be able to repay to their Democrat friends in Congress.

The 'bailout' may avert an economic (not just financial) disaster for the time being, but it does not address the underlying problem, which is that America's financial institutions are compelled BY LAW to provide credit in 'poorer neighbourhoods'. Ever since the Community Reinvestment Act of 1977 ( introduced under Carter, made even more insane by Clinton, and fiercely protected ever since by a heavily-lobbied Congress) loans and mortgages have been granted for socio-political reasons, not commercial ones. Applebaum follows the herd and blames it vaguely on 'Wall Street', but this was never Wall Street's idea. The original crime was a political one. The financiers protected themselves by selling the risky loans they were required to make to someone dumber than themselves (i.e. Democrat-run GSEs like Fannie Mae), and since that was profitable, they did more of it. So we ended up with pyramid-selling of bad debt.

There is nothing to stop this insanity repeating itself unless all that pernicious legislation is removed, and housing finance is allowed to go back to being a commercial transaction, instead of a Democrat vote-buying mechanism. 'Community Reinvestment' aka 'affordable housing' aka government-enforced sub-prime lending is the ultimate in pork-barrel politics. America has sacrificed its economy to political correctness, and the world is now paying the price. The underprivileged communities and 'nontraditional borrowers' who were supposed to benefit from all this political extortion and bribery will of course be hit the hardest. These corrupt practices would not 'change' under Barack Obama, the man the media want to see elected President on the colour of his skin, not the content (if any) of his character. Mr Obama is beholden to ACORN and to the Congressional Black Caucus, which is absolutely committed to 'affordable housing' as a civil right and credit as a form of entitlement. They angrily denounced all attempts to reform Fannie Mae, insisting nothing was wrong with it. In 1995 Mr Obama was an attorney in Buycks-Roberson v. Citibank, on of the class actions that helped pressure government to force lenders into making more loans to those with poor credit.

I urge you all to go and read about the Community Reinvestment Act, and if you are at wikipedia, take a look at the article linked near the bottom - 'The Trillion-dollar Bank Shakedown'. See also Equal Credit Opportunity Act. "

 

[The Gardener]

Good point... I'm very familiar with the Community Redevelopment Act and this is a trendy joust that was being given by some of the Republicans. There is some truth here, the effects are real and tangible, but its total effect is a drop in the bucket in terms of the magnitude of the entire crisis.

It is true that there were policies that gave banks brownie points for giving loans to ethnic minorities, and economically challenged citizens, but these folks buy modest homes in inexpensive neighborhoods, and the dollar volume associated with this market is not a largely material factor in driving the multi-trillion impact of the broader crisis. For example, the CRA gave no encouragement for banks to grant loans to house flippers, condo speculators, people taking out home equity lines of credit (second mortgages) to squeeze every dollar of earned equity out of their homes for consumption, the commercial real estate market, the municipal bond market, nor the auto loan market... all of which are now cratering from bad positions.

Banks just plain loaned out way too much money because they created phoney risk management schemes that allowed them to hold these loans on their books at a value that significantly understated their risk.

KEEP in mind that even if the government mandated a certain percentage of loans be given out to minority purchasers who had less that stellar credit ratings, there is nothing inherently wrong with a subprime real estate market. The CRA should have been attainable and sustainable, PROVIDED that the mortgages to these less creditworthy buyers were marketed on the back end in a way that honestly associated the risk associated with the loans. There is nothing wrong with doing a subprime mortgage as long as the mortgage security is marketed as being subprime when its sold to an investor... there are plenty of high risk investors who would be willing to put money on that activity. The problem is that the banks took the subprime loans and marketed them, dishonestly, as something of higher value than they are.

The crux of this problem IMHO is the manipulation of banking reserve ratios through the use of derivatives, the credit default swap instruments that were supposed to be a form of insurance on these derivatives, but instead have performed more like "all or nothing" casino bets, the phoney "credit ratings" that banks literally bought from rating agencies at a price to package high risk investments as "AAA" rated investment paper, and outrageous leveraging on these investments provided by cheap short-term capital from Asia.

 

[iamnaked]

Arguably the involvement of the Fed has created more problems than it has solved. They created the anonymous term auction facility that stopped banks from knowing which amongst them were full of junk, and thus made them paranoid lenders. The prospect of a bailout is stopping takeovers from happening (who wants to sell when the government might offer you something for your otherwise worthless shares?)

Just to kick something out there. Is there anything inherently wrong in allowing unstable banks to go bankrupt? It's not like they disappear... The only losers are the shareholders. I'd rather a few shareholders got burnt than each taxpayer fronting 6000 USD to pay for something with seriously unpredictable consequences.

 

[Aplunk1]

I saw this little vignette online:

It's called a credit crisis because most people don't realize how desperate we are.

I like to think of it this way: Lets say a bank is a pot dealer. This dealer has been a nice guy in the past, fronting OZ's, eighths, and grams because his customers are good customers. They keep coming back for more. The dealer usually thinks something along the lines of, "GREAT! More money!"

Recently, however, the dealer keeps fronting more and more pot, and not seeing any return. His customers smoke all their weed and never pay the dealer back or offer any kind of collateral (like an Xbox or a t.v.). Now the dealer is getting calls from his grower who says, "I need to pay my rent, where's the money?"

"Well I don't have it, I've been fronting to most of my customers." replies the dealer.

"Well it's time to go collect, or it's YOUR ***!" responds the grower with anger in his voice.

So the dealer starts collecting on his debts. Those who can't pay get an Xbox, a nice watch or a t.v. stolen. "Not Fair!" say the customers! "That was mine and you took it!"

"You should've payed your debt," replies the dealer, "And now I have to pawn this stuff to pay off my grower. You should've payed me the money you owe me!"

This go's on and on for a few weeks, and eventually the dealer makes some of his money back from his customers, but he still has all this money he's still owed and his customers don't have anything left for him to pawn.

So a new guy, we'll call him John Smith, moves in town. He seems cool enough, his car is hooked up, he has a really nice apartment. He comes to the dealer and says, "Let me buy an OZ. I'll give you half now and the rest later today after I cash my paycheck." The dealer refuses and says, "No, I need the cash now, or no deal."

John Smith gets pissed, "Why not? I'm good for it."

"I can't front anything anymore," says the dealer. "I don't have enough to cover me if you can't pay, no matter what. I just can't really risk fronting to anyone anymore because I'm so broke that I can barely pay my rent. I might get kicked out of my apartment soon because I can't pay my bills and my grower still wants the money I owe him or he'll take all of my stuff!"

Now the dealer can risk going to his parents and asking for money, which they have a lot of, but they'll want the money back as soon as possible, and b**ch every chance they get. What's more, the dealer might get in serious trouble with his parents if they find out why he has no money.

Panicking, he begrudgingly asks his parents for money, "I'll explain later, but my bills are due by the end of the day or my power gets cut off and my landlord kicks me out."

"That's ok," his parents say, "we'll cover your debts...again...but you have to move back in with us until you can learn some fiscal responsibility!"

 

[Harie]

I don't see why we can't just let the orgs declare bankruptcy? The airline industry were all bankrupt a few years ago, but they stayed in business.

The whole problem with this bailout plan is that the govt keeps saying the assets have value...Well, if they had so much value, why aren't they trading on the open market currently? If the govt is so sure they'll make $$ on the deal, why has no one else started buying up the defaulted notes? This is the crux of the problem...Well, that and the fact that the bailout plan balooned from 3 pages to over 100 pages in a week. Those politicians gotta get their pork added to the bill.

$$ for La Raza, $$ for ACORN (which is being investigated for fraud in something like 15 states), $$ for their good ol' buddies etc. This isn't a bailout - it's a scare tactic to try and ramrod a pork laden bill through to line their pockets and the pockets of their powerful friends. Anytime Shrub and his cronies say things like - "No time to think, just vote yes...VOTE NOW or we're all doomed. Don't even read what you're voting for, just take my word on it and vote yes." - you know the taxpayers are going to take it in the ***.

Thank God that some people were smart enough to vote that abomination of a bill down.

 

[The Gardener]

The whole problem with this bailout plan is that the govt keeps saying the assets have value...Well, if they had so much value, why aren't they trading on the open market currently?

Firstly because the situation has created a "Lemon Market" phenomenon, and secondly because banks are forced by law to "mark to market" their holdings each quarter. Government does not need to do "mark to market" each quarter, and the government doesn't need to adhere to lending reserve requirements like banks do.

Just to kick something out there. Is there anything inherently wrong in allowing unstable banks to go bankrupt? It's not like they disappear... The only losers are the shareholders.

I think you are confusing the difference between a market, and a market participant.

The banks are participants in the credit market. What's cratering here is not a particular credit market particpant, its the credit market itself that is cratering. And if it goes, ALL participants will be wiped out.

And, no, the shareholders are not the only losers. Remember that a failed bank has peoples deposits and savings in it... and "the government" insures this. Well, where does "the government" get its money? You know who.

 

[Starseed]

BAILOUT PACKAGE REJECTED BY CONGRESS

Europeans who are capable of thinking will, despite their anger at the US bankers at the root of all this, gasp at the way Congressmen have responded to the grassroots objections of their constituents, something that can never happen in the European Union.

Granted, they're facing re-election, but the way the people's wishes are adhered to makes me envious. Over here, we have a Europe-wide quasi one-party system, which suppresses the wishes of the people (notably over immigration) and then slanders the parties that are prepared to stand up for the people, as in the case of Austria, where once again, the Freedom Party has done well in a democratic election.

Last time this happened, Austria was blackballed & blackmailed by the EU masters, for whom dissent is equated with "Far-Right neo-fascism". They don't see that the continued suppression of democracy in Europe (repeated rejection of democratic voting results) is nothing less than fascist itself.

 

[Aplunk1]

Glad to hear you're keeping up with American affairs, Starseed. I'm really pleased that our Congressmen rescinded the bill-- I think it was a democratic justice. In some ways, I would have liked to have seen the bill passed, but I sided with Ron Paul's views on this one: Less government intervention, accountability.

I argued with my friends that the European Union is aiming for a World State, much like the ones George Orwell visioned would come. They told me I was crazy, but I believe we're starting to see it. We have similar trade deals going on here, and once we have a transnational currency, it'll be the demise of traditional American government.

 

[Slartibartfast]

...and secondly because banks are forced by law to "mark to market" their holdings each quarter.

Any chance that the revised bail-out package will scrap/suspend this insane system and so allow a reversion to the previous method of assessing a bank's solvency?


Starseed, nicely put. Who will be getting your vote in next year's charade of EU democracy?

 

[Starseed]

UKIP.

I vote differently domestically, but since the EU elections are Proportional Representation, then UKIP can do well, and what's desperately needed in Europe is real political opposition, as there is in Westminster, and Congress. Everyone else is part of the cosy cartel.

Do I support Britain leaving the EU? I doubt it, but UKIP are the only ones who vigorously challenge the EU Establishment, along with courageous individuals like Paul Van Buitenen, Marta Andreasen, Hans-Martin Tillack etc.

 

[SkipTracer]

Well said Starseed!

 

[JayBear]

Watch for a bastardized version of the bill to come before the Senate. They have less concerns about reelection, so they might try a back-water way of pushing the house to take action. Its a terrible mess and, while in the interest of full disclosure I should mention that I work for the Democrats, the GOP is really killing us. Pass or fail, the GOP has set us way back this week.