What is wrong with the US economy? Part 2

[Greg Bernhardt]

Previous discussion here:
https://www.physicsforums.com/showthread.php?t=130611

Feds leave interest rate unchanged at 2%

Market reacts in a triple digit loss.

AIG down 45%

 

[turbo]

What do you think, Greg? Will the Feds bail out AIG? From what I've read, AIG has a pretty solid insurance division that could be spun off safely - it's the exposure to derivatives and bundled debt held by their investment wing that are problematic.

 

[Astronuc]

The Dow Industrials just jump 150 pts into positive territory. Perhaps the Fed acted to support AIG, but AIG is still down so some other component must have jumped.

 

[Astronuc]

The Federal Reserve has asked Goldman Sachs and J.P. Morgan Chase to lead a lending facility for AIG of between $70 billion and $75 billion, according to two people familiar with the situation. The New York Department of Insurance has permitted some of AIG's regulated insurance subsidiaries to provide the parent with $20 billion of liquid investments.

Of course, they and others would benefit if AIG went under and they could pick up the insurance business, and leave the derivatives business to the trustee.

 

[Greg Bernhardt]

What do you think, Greg? Will the Feds bail out AIG? From what I've read, AIG has a pretty solid insurance division that could be spun off safely - it's the exposure to derivatives and bundled debt held by their investment wing that are problematic.

I'm certainly not smart enough in economics to know what is best or likely. I see reports that Greenberg's CV Starr may try to take over AIG as early as tomorrow however another source is saying AIG may get loan package from Federal Reserve.

Short covering rally has AIG at down 15% now off of 45% low.

 

[Greg Bernhardt]

wow AIG explodes to the upside! Fed must be bailing them out.

edit: not so fast on that recovery :D

 

[Astronuc]

AIG has recovered from it's lows. Investors are in a buying mood. BAC, JPM and HPQ were positive earlier, but a number of other components have turned positive.

One can watch the action on the Dow30 with this Yahoo interactive (if you don't mind a 15 min delay).
http://finance.yahoo.com/q/cp?s=^DJI

 

[Greg Bernhardt]

AIG looks to blow past 1 billion volume! Anyone know what the record is? It's got to be close.

 

[turbo]

AIG is in billion+ shares traded territory and has given back some of its earlier gains.

 

[Astronuc]

1,027,870,201 shares of AIG traded as of 3:11 pm

They actually went + for a few minutes.

The day started with just over 71 million shares being dumped. The rallies today have been sparked by rumors that the Fed will intervene to support AIG. If that doesn't happen by tonight, look for another drop tomorrow.

 

[turbo]

Citigroup, Bank of America, and JP Morgan Chase are posting gains - seems like there is some comparison-shopping going on, and perhaps speculation about who gets to pick up the pieces of AIG.

 

[Astronuc]

So this explains the rebounds of AIG and the Dow. Earlier in the day, CNBC reported that the Fed was considered some intervention, then that didn't happen and AIG settled down. This afternoon, Bloomberg News reported Fed intervention. Seems like the business news is pumping AIG. The Fed might act, or it might not. It shouldn't, but let the chips fall where they may.

After sliding about 150 points, the Dow Jones Industrial Average pulled into positive territory before lapsing again after the Fed's announcement, only to rise again on the latest AIG report by Bloomberg News.

"The spike was just off Bloomberg's report that the government may provide a loan to AIG. Whether the Fed cuts or not is totally irrelevant," said Peter Boockvar, equity strategist at Miller Tabak.

Of course, Michael Bloomberg has an interest in supporting the battered financials based in NYCity.

 

[turbo]

The Fed might act, or it might not. It shouldn't, but let the chips fall where they may.

I agree - the Feds seem to let the "market work" when everything is going well, then step in when companies are failing. For the market to actually work, we need to let businesses with bad investments fail. It's a big market, and someone will step into pick up the business. Locking in profits for investment banks and dumping their risks on the taxpayers has got to stop.

Thanks to John McCain, his buddy Phil Graham and other de-regulators, the banks run amok then scream for help when they get over-extended - those fellows hate socialism when it comes to the common man, but they worship corporate socialism.

 

[Greg Bernhardt]

I agree - the Feds seem to let the "market work" when everything is going well, then step in when companies are failing. For the market to actually work, we need to let businesses with bad investments fail. It's a big market, and someone will step into pick up the business. Locking in profits for investment banks and dumping their risks on the taxpayers has got to stop.

They didn't bail out LEH. The fed seems to make an argument that they are too big to fail. Too vital to the economy and if AIG fails then it could create a domino effect. I don't know this, but just what I hear. Your thoughts.

 

[Jimmy Snyder]

Of course, Michael Bloomberg has an interest in supporting the battered financials based in NYCity.

But nothing to gain on a short-lived spike.

 

[Astronuc]

But nothing to gain on a short-lived spike.

No, certainly, but he and Wall St need to prevent panic and instill confidence, so others don't go down like LEH.

One would only benefit from a spike if one was doing insider trading, which some companies and individuals have done.

 

[turbo]

They didn't bail out LEH. The fed seems to make an argument that they are too big to fail. Too vital to the economy and if AIG fails then it could create a domino effect. I don't know this, but just what I hear. Your thoughts.

I have read that parts of AIG could be spun off safely and securely. If that can happen, the remainder with large exposures to risky speculative investments should be allowed to fail. Share-holders can hold stock in the stable insurance sector of the company, though the stock values of the segments with high debt ratios will tank, and shareholders will lose money. At least they wouldn't lose as much as if the entire company was allowed to tank, and give up its insurance business.

If the Fed steps in with the taxpayer's piggy-bank to rescue investment banks, it degrades the value of our currency because we are assuming debt that once made tidy profits for the investors. The only way to get the banking industry re-regulated is if the Feds let banks fail so that share-holders get stung and demand greater regulatory oversight. Share-holders don't demand greater regulation during boom-times, and if they are shielded from busts by infusions of our tax dollars, they never will. Just my opinion - I'm not an economist and I don't play one on TV.

 

[Astronuc]

They didn't bail out LEH. The fed seems to make an argument that they are too big to fail. Too vital to the economy and if AIG fails then it could create a domino effect. I don't know this, but just what I hear. Your thoughts.

According to some financial summaries, AIG has a market capitalization of about $10 B, but that's probably with their stock beaten down. On the other hand, they apparently have their hands in about $1 trillion of financial instruments (how much is debt?). Now the question is how much of that is under the insurance business, and how much is under the financial engineering part of the business. LEH had about $0.6 trillion in debt.

The Fed should audit the heck out of AIG, but that would take time. Will the Fed act without due diligence? Wall Street is wanting action now, at least by tomorrow.

Interest position they are in.

Experts have saying for months that the derivatives markets are so complex that no one really knows how much debt there is and how much of it is bad or uncovered.

 

[Astronuc]

U.S. Trade Deficit of $62.2 Billion Exceeds Forecast (Update2)
http://www.bloomberg.com/apps/news?pid=20601103&sid=ajxmHgy3j8Dg

Sept. 11 (By Timothy R. Homan, Bloomberg) -- The U.S. trade deficit widened more than forecast in July as oil imports soared to a record, overshadowing gains in exports.

The gap grew 5.7 percent to $62.2 billion, the largest in 16 months, from a revised $58.8 billion in June that was bigger than previously estimated, the Commerce Department said today in Washington. Total imports and exports were the highest ever.

Americans paid a record $124.66 a barrel for foreign crude oil, more than offsetting increases in shipments of automobiles, aircraft and machinery to buyers overseas. While a weak dollar has made U.S. goods more affordable, shrinking economies in Europe and Japan may stifle export growth in coming months.

The weakening dollar is a double edged sword. It is supposed to spur exports, but the imports, particularly oil and energy products are still significant.

This should turn around in Aug and Sep as oil prices have dropped considerably in the last 4 weeks. But still - the trade deficit means the US is losing capital and accumulating debt.

 

[quadraphonics]

But still - the trade deficit means the US is losing capital and accumulating debt.

The trade deficit, on its own, doesn't imply either of those things. There are numerous other avenues besides trade that capital follows into and out of the United States (FDI, for example), and numerous other factors that come to bear on debt growth (the budget deficit not least among them). And that's without considering the particulars of the interactions between the trade deficit and other factors, such as inflation and real growth.

 

[Astronuc]

The trade deficit, on its own, doesn't imply either of those things. There are numerous other avenues besides trade that capital follows into and out of the United States (FDI, for example), and numerous other factors that come to bear on debt growth (the budget deficit not least among them). And that's without considering the particulars of the interactions between the trade deficit and other factors, such as inflation and real growth.

How is the trade deficit financed? By borrowing - which means paying back more than borrowed? And how about sovereign investment funds - and are those sovereign investments funds loaning capital, or are they actually 'buying' assets, i.e. spending.

By themselves, a monthly or yearly deficit is not bad, but the US has had chronic deficits (both in trade and in the federal budget - and the federal government is still financing the wars in Iraq and Afghanistan by supplemental spending which doesn't count against the deficit - except that it really does ) and there is no sign the situation will change.

What real growth? I'd like to see real growth - particularly in infrastructure - or energy development. But 66% of the US economy is consumption - of stuff - that depreciates or wears out.

By themselves - one failure wouldn't be a big deal except for the investors and employes. But there has been a string of failures - and perhaps more to come.

Big firms' failures aren't the last of it
http://marketplace.publicradio.org/display/web/2008/09/15/pm_recap_q/

An example of how convoluted the financial markets are -

And don't forget that Lehman Brothers had a very big closet and there are still some very big shoes in there to drop.

Let me give you a case in point there: Today's bankruptcy filing lists the biggest single creditor as a Tokyo-based bank, Aozora Bank. It's on the hook for a $463 million bank loan. Well, it turns out that Aozora may be based in Tokyo, but it's actually controlled by Cerberus Capital Management, the big U.S. private-investment firm. Now, Cerberus issued a statement today that its exposure is really "significantly less" that Lehman's balance sheet might indicate because it's protected by what it calls "risk-management instruments." Well, guess what they are? They are essentially these exotic insurance policies that others are going to have to cover now -- if they can afford it.

 

[quadraphonics]

How is the trade deficit financed? By borrowing - which means paying back more than borrowed?

I'm not disputing that the United States does a bunch of borrowing and is accumulating debt. But the fact of a trade deficit, even a sustained one, is not sufficient to conclude that debt is accumulating. There are any number of ways to fund a trade deficit without borrowing money.

And how about sovereign investment funds - and are those sovereign investments funds loaning capital, or are they actually 'buying' assets, i.e. spending.

Either way, it's foreign capital that ends up in America, and so must be taken into consideration before the claim "trade deficit = net capital loss" can be taken seriously. Note that the annual FDI inflow to the United States is on the same order of magnitude as the trade deficit.

By themselves, a monthly or yearly deficit is not bad, but the US has had chronic deficits

I would contend that the budget deficit is more worrisome than the trade deficit; I'm not convinced that even sustained trade deficits are necessarily a bad thing, depending on how everything else works in relation to them. They often keep inflation down, and in order for them to be sustained, the suplus countries must loan their dollar earnings back to the US in order to keep their currency from equalizing the trade balance, making it cheaper to borrow money in the US (which boosts business investment and dampens the effects of the budget deficit).

There's also the issue that much of the trade deficit is simply an accounting artifact. A huge portion of China's exports, for example, are actually from American companies who built or otherwise invested in China, and so a big portion of the captial "leaving" the United States is still owned by Americans. There are rules for retaining this capital in China, but the end result looks a lot more like FDI from America into China than a simple transfer of capital.

What real growth? I'd like to see real growth - particularly in infrastructure - or energy development. But 66% of the US economy is consumption - of stuff - that depreciates or wears out.

Real growth is a technical term that refers to growth in inflation-adjusted GDP. Everything depreciates or wears out. Also, a consumptionp-led economy is a *good thing*. The only alternative is an export-led economy, which is only appropriate if you're a lot poorer than most of the world economy.

 

[Astronuc]

http://news.yahoo.com/s/nm/aig_loan_dc

(Reuters) - The Federal Reserve is negotiating a $85-90 billion secured bridge loan for American International Group, according to a report on CNBC.

Shareholders would be severely diluted by the bailout that involves the bridge loan. The government would receive AIG warrants for most of its equity in the bailout being negotiated. CNBC said the deal would give AIG incentive to sell its assets quickly to help pay off the bridge loan.

Tough love.

 

[Greg Bernhardt]

Fed takes over AIG to the tune of $85B
http://money.cnn.com/2008/09/16/news/companies/AIG/index.htm?cnn=yes

 

[turbo]

Fed takes over AIG to the tune of $85B
http://money.cnn.com/2008/09/16/news/companies/AIG/index.htm?cnn=yes

we are screwed! Once again, the feds have used their infinite wisdom to screw the taxpayers to support the crooks that have de-regulated and gamed the banking/investment scams to make fortunes. Thanks Bush/McCain!

Edit: I should have included a nod to McCain's butt-hole buddy Phil Graham, who engineered so much of the the financial de-regulation in the first place, but that would play into McCain's hands. He is a creep, he has always been a creep, and he always will be.

 

[Astronuc]

Interesting terms

The line of credit to AIG, which is available for two years, is designed to help the company meet its obligations, the Fed said. Interest will accrue at a steep rate of 3-month Libor plus 8.5%, which totals 11.31% at today's rates. AIG will sell certain of its businesses with "the least possible disruption to the overall economy."

The government in turn will receive a 79.9% equity interest in AIG. It will also have the authority to veto the payment of dividends to common and preferred shareholders.

Sensible. It will be interesting to see if the dividends are paid or vetoed. Let's see what assets are sold.

They only have to sell about 7-8% of their $1.1 trillion.

AIG might be a good long term investment. Two years will pass quickly.

 

[Greg Bernhardt]

AIG might be a good long term investment. Two years will pass quickly.

Maybe, but it should open around $1 tomorrow with the share dilution.

 

[Astronuc]

I'd like to see the details. The common stock won't necessarily fall to $1, unless there is another class of stock being issued, which will be held by the Fed. All I know now is there is a loan guaranteed by AIG's assets/equity. I wonder what their liabilities are.

The 11+% interest rate is pretty stiff and that'll motivate AIG to sell off assets and retire the loan ASAP. Perhaps investors will take a wait and see tack, but the stock could be volatile until the future for AIG becomes clearer.

I'd be interested in what Hank Greenberg has to say. Back in May this year, Greenberg — still AIG's top shareholder — was very critical of management saying that AIG is overstaffed and overspends on directors and lawyers.

Seems Greenberg is interested in AIG.

Is Greenberg Making A Play For AIG?
http://www.forbes.com/business/2008/09/16/aig-insurance-greenberg-biz-wall-cx_lm_0916aigupdate3.html

 

[Greg Bernhardt]

I'd like to see the details. The common stock won't necessarily fall to $1, unless there is another class of stock being issued, which will be held by the Fed.

How does the fed get to own 80% unless AIG issues another 10.2B in stock?

 

[Astronuc]

How does the fed get to own 80% unless AIG issues another 10.2B in stock?

That's the part that is not clear to me at the moment. Perhaps they'll issue warrants or a new class of preferred stock. I'm not sure how they are calculating the equity, given that the $85 billion is backed by assets. I guess the details will eventually come out tomorrow, later this week, or perhaps by the end of the current fiscal year.

 

[russ_watters]

I'm not disputing that the United States does a bunch of borrowing and is accumulating debt. But the fact of a trade deficit, even a sustained one, is not sufficient to conclude that debt is accumulating. There are any number of ways to fund a trade deficit without borrowing money.

I'd like to clarify/emphasize this. It seems like there is a widely held belief that the "trade deficit" works the same way as the "federal budget deficit". They are not the same. One is the yearly increase in the accumulation of federeal government debt and the other is the yearly difference between imports and exports - with no accumulation of a "trade debt".

Further, it isn't even useful to speculate about how much of the trade deficit is financed by debt - the number cannot be converted by any method to give a debt number. Most certainly there is some fraction of our total imports financed by adding debt. And there is also some fraction of our total exports financed by giving credit. I suppose you could subtract the credit from the debt and find out if our foreign trade improves or hurts our debt situation overall, but I don't know that those numbers are even commonly tracked - and they have nothing to do with the "trade deficit".

 

[gravenewworld]

I'd like to clarify/emphasize this. It seems like there is a widely held belief that the "trade deficit" works the same way as the "federal budget deficit". They are not the same. One is the yearly increase in the accumulation of federeal government debt and the other is the yearly difference between imports and exports - with no accumulation of a "trade debt".

Further, it isn't even useful to speculate about how much of the trade deficit is financed by debt - the number cannot be converted by any method to give a debt number. Most certainly there is some fraction of our total imports financed by adding debt. And there is also some fraction of our total exports financed by giving credit. I suppose you could subtract the credit from the debt and find out if our foreign trade improves or hurts our debt situation overall, but I don't know that those numbers are even commonly tracked - and they have nothing to do with the "trade deficit".

Many economists believe that the federal deficit directly affects our trade deficit. This is known as the twin deficit theory.
If politicians really cared about stimulating our economy they wouldn't be arguing for more tax cuts, but they would instead be advocating for larger increases in government spending. Government spending is an endogenous component of total GDP while taxes work through exogenous methods which means tax cuts will have a weaker overall affect

 

[turbo]

The AIG bailout is proof that the neo-cons don't believe that the free market can work. AIG should have spun off the profitable insurance business so that their shareholders would still have some equity after the derivative-heavy investment segment failed. The Fed has ensured that the necessary failure/correction/healing will not happen or will happen only very slowly, and that is short-sighted, IMO. If they wanted to help our economy and improve our faith in it, they should have taken steps to back-stop the FDIC so that ordinary people don't lose their savings when large commercial banks start failing.

 

[Astronuc]

Share of Constellation Energy Group (CEG) fell 38% to $29.55 as it disclosed ties to Lehman Brothers, but closed at 35.76 yesterday. I expect they'll rebound today or if not, later this week. Constellation was built up around the old Baltimore Gas and Electric.

The company said its liquidity remains sound despite the bankruptcy of the Wall Street firm. Constellation said in a filing with regulators that Lehman Brothers' total commitment within existing credit facilities stood at $150 million. Constellation said it holds excess liquidity of approximately $2 billion, excluding the existing Lehman commitment.

 

[Astronuc]

Stock futures slip after U.S. government's AIG move

S&P 500 futures fell 6.6 points to 1,209.70 and Nasdaq 100 futures dropped 7.75 points to 1,725.25. Dow industrial futures lost 25 points.

"Due to this week's failures in the financial sector, banks, insurance firms, the fund industry, and non-regulated financial institutions will have to absorb further losses," said Tim Brunne, a strategist at UniCredit. "There is systemic pain in the financial world."

"The futures are down on disappointment the job couldn't get done privately, but this should end up being a positive," said Marc Pado, a strategist at Cantor Fitzgerald.

U.S. stocks climbed on Tuesday on speculation of an AIG rescue, which took away from an initial negative reaction to the Fed's move to keep interest rates at 2%. The Dow industrials rose 141 points, the Nasdaq Composite added 27 points and the S&P 500 rose 20 points.

AIG fell nearly 27% in pre-market trade.

As of this post, over 4 million shares of AIG have been traded in pre-market (NYSE that is).