Is the American Dream in Jeopardy?

[LowlyPion]

You miss the point. No GSEs, no nationwide crisis requiring a bailout, at least very, very unlikely. Instead we'd have an Enron, or an AOL size bust. Big deal. Without GSEs, the Mozillo's in this story would have been section 2 news in the business section.

It doesn't miss the point. The lax regulation is what failed the system. Merely because Fannie and Freddie were so big doesn't absolve the regulation from preventing it. "The let the market determine" attitude inevitably devolves into "whatever they can get away with" without adequate regulation.

 

[Astronuc]

Besides the GSEs and entities like Countrywide, it appears many financial institutions failed with respect to due diligence, and passed along bad/faulty instruments as fast as possible. Then the question becomes - was this simply negligence or was there criminal intent.

There was also a lot of people taking out home equity loans, who then couldn't afford to repay two mortgages and the other living expenses.


When I bought a house and took a mortgage, I bought what I could afford at the time, with the expectation that my salary would increase while the monthly payment stayed constant (except for the gradual increase in local/school taxes). Then when I expanded the house, I took out a home equity loan, which I could also afford, but it went into expanding the house and not buying a car or other stuff. Subsequently, I was able to consolidate and refinance at a lower interest rate, which brought down my monthly payment to less than both mortgages separately. Meanwhile the property appreciated and we don't have to pay a PMI.

 

[Ivan Seeking]

Yes, the key point is that the free market now effectively requires socialism to save it; so we are told. One couldn't ask for a better example of a failed philosophy.

Profits are privatized. Risk is nationalized.

 

[chemisttree]

What's next? http://www.time.com/time/business/article/0,8599,1723152,00.html"

Subprime mortages are small potatoes. http://marketplace.publicradio.org/display/web/2008/04/01/credit_default_swaps_q/" are valued at 45 trillion dollars last year. The size of the entire mortgage market is only 7 trillion, and the subprime market is a small subset of that.

RYSSDAL: So I take it what we're about to hear is another thing that we knew nothing about, but yet somehow now we need to be really, really concerned about?

MOON: I'm afraid so. In this case, what you don't know can hurt you. I'm going to try to mention this term only once, Kai. We're talking about something called "credit default swaps."

RYSSDAL: And they are?

MOON: They were invented a few years back so banks and bondholders -- the investors -- could make sure that they got paid back when companies failed to pay their loans. So in a way, you could call this insurance.

RYSSDAL: You could call it that, but we don't -- we call it something else. How do these things work?

MOON: Well, this is where it gets tough, Kai, because a lot of people on Wall Street, even some of the leading economists in the academic world, don't really understand exactly how these things work. A lot of them are whipped up with some computer wizardry, some advanced math -- think of those fancy Greek letters turned on their sides. And there's a lot of guesswork to this, too, about how much they're really worth.

Sounds chillingly familiar...

MOON: OK, I'm about to unload some numbers on you here, so I'll speak slowly so you can follow this.

The value of the entire U.S. Treasuries market: $4.5 trillion.

The value of the entire mortgage market: $7 trillion.

The size of the U.S. stock market: $22 trillion.

OK, you ready?

The size of the credit default swap market last year: $45 trillion.

RYSSDAL: That's a lot of money, Bob.

MOON: It is, and the great unknown here is that these things get traded, or swapped, between the banks and hedge funds and other investors, and there's really no one who oversees or regulates these trades to guarantee that the buyer actually is going to be able to make good on these if they have to. And these things end up being so interconnected that it's not just like single line of dominoes falling, if one fails. Imagine one falling domino taking down two more, and those taking down four more, and eight, and so on.

RYSSDAL: OK, I'm with you, but let me ask you this. We just had the secretary of the Treasury yesterday with a big policy announcement. If these things are so bad, what's being done about it?

MOON: The irony here is that the former Fed Chairman Alan Greenspan, a couple of years ago he called credit default swaps "probably the most important instrument in finance," because they were supposed to spread risk around and stabilize the market. Well, critics now say that they've had exactly the opposite effect. One of the leading critics of these things is Christopher Whalen. He's an expert on financial risk at Institutional Risk Analytics. And he told me that this is nothing more than government-guaranteed gambling:

CHRISTOPHER WHALEN: They are the most hideous kind of speculation. To have a federally insured bank like JPMorgan as the largest dealer in this market, to me says we don't know what we're doing anymore, and we don't understand the difference between real work -- real economic activity -- and something that's essentially wasting.

MOON: And Whalen points out that Bear Stearns had more than $2.5 trillion in credit default swaps. He suspects that that's why JPMorgan came to the rescue, so it didn't get pulled down.

RYSSDAL: Yeah, not too big to fail, but too interconnected to fail, right?

MOON: That's right.

Time to buy some gold...

 

[edward]

FBI Began Investigating AIG in March

On Feb. 28, AIG posted its largest quarterly loss ever, blaming complex financial instruments known as derivatives for write-downs of more than $11 billion. Martin J. Sullivan, the insurer's chief executive at the time, resigned in June after AIG suffered another multibillion-dollar quarterly loss on its derivatives connected to defaulting home mortgages.

The company's near-death is largely being blamed on its heavy involvement in a kind of unregulated derivative called credit default swaps, whereby AIG earned hefty premiums in exchange for guaranteeing another company's mortgage investments if the mortgages defaulted. AIG bet that many of the mortgages would never fail, but an unusually high percentage did

http://www.washingtonpost.com/wp-dyn/content/article/2008/09/24/AR2008092403589.html

 

[edward]

It appears that there is now a big rush to regulate credit default sawps..

On Tuesday, SEC Chairman Christopher Cox called for giving the agency the authority to regulate credit default swaps. Testifying before the Senate Banking Committee on the turmoil in U.S. credit markets, Cox told Congress “the $58 trillion notional market in credit default swaps— double the amount outstanding in 2006 – is regulated by no one.”

http://www.advancedtrading.com/blog/archives/2008/09/the_rush_to_reg.html

Too little too late

 

[Ivan Seeking]

One point of note that provides an interesting perspective: A one-time $700 Billion bailout is considered a crisis.

We now spend $700 Billion every year on foreign oil.

 

[russ_watters]

Also, I did not know banks trade mortgages between themselves. How does that work? The person taking out the loan obviously pays the bank the got the loan from. I guess at the end of the month that bank then gives that loan payments to the bank it traded the mortgage to?

No, you pay the owner of the loan. I took out my mortage through a subsidiary of LendingTree and a month later got a notice saying to start sending my checks to Citibank.

Man, $700 billion is $28k per citizen.

Please note: what the government is doing is buying loans, just like these banks bought and sold the loans. The difference? The packages of loans have crashed in value and/because the banks are desperate to get rid of them. That means that the government will be getting them for far less than face value (40-60%, iirc). If this works and home prices stabilize and delinquencies drop back to normal levels, the government gets that money back the same way the banks do: people pay their mortgages.

Initially, there will be a huge outlay of cash, but it is near certain that the government will get most of that money back. And since they are buying the loans in a firesale, there is a small but real possibility that the government could profit from this venture. Some hypothetical numbers as an example:

If you have $700 billion in loans and you expect 5% of them to default without ever paying a dime back, they are really only worth $665 billion. So you strucutre them to ensure that with a 5% failure rate, you'll still turn a profit. If the failure rate doubles (it has), then you stand to lose an additional $35 billion. But if your comopany needs cash badly and so sells the loan for 80% of its value, the buyer stands to make a profit of $70 billion even if the market doesn't improve.

IMO, the best thing that the government can do here after buying the loans is to re-negotiate the terms with people who are at risk of defaulting, at least long enough for the real estate market to recover and the value of the houses to go back up (say, 3-5 years). That way if the govt does need to sieze and sell the houses, they stand a good chance of selling them for a good amount. And if all they do is decrease the number of defaults, those loans will "merely" return their face value to the government (who bought them for far less than face value). Fannie and Freddy are big companies, but they can't beat the federal government in ability to ride out a storm. And that's the key to being able to profit from picking up the pieces of a shattered company.

Here's an article on the subject:

Once it collects all that trash, the government is expected to hold the world's largest garage sale of distressed securities and bad mortgages and business loans. Years from now, when the dust clears, the U.S. might even make money on the deal.

http://www.chicagotribune.com/business/chi-sat-how-it-works-sep20,0,5185626.story

It would be a pretty sweet irony: banks screw up and fail and the government picks up the pieces, profits, and gives the money to the people (via reduced national debt).

 

[LowlyPion]

Please note: what the government is doing is buying loans, just like these banks bought and sold the loans. ... If this works and home prices stabilize and delinquencies drop back to normal levels, the government gets that money back the same way the banks do: people pay their mortgages.

Doesn't this argument sound eerily like the assurances before the Iraq war that once liberated all their oil would be available to pay for our being there?

And now we're shelling out $10B a month and have carted back 4,000 body bags?

 

[mheslep]

What's next? http://www.time.com/time/business/article/0,8599,1723152,00.html"

Subprime mortages are small potatoes. http://marketplace.publicradio.org/display/web/2008/04/01/credit_default_swaps_q/" are valued at 45 trillion dollars last year. The size of the entire mortgage market is only 7 trillion, and the subprime market is a small subset of that.

Well I can't fathom that Time piece, it reads like hype. First, the Fed lists the mortgage debt is $14 trillion as of '08 1st qtr, not $7t
http://www.federalreserve.gov/pubs/supplement/2008/05/table1_54.htm
Ok, perhaps they're referring to market volume, not value? Well they mentioned a $22 trillion US stock market - that's value. US stock market volume is several $hundred billion every day. The $4 trillion treasury - value. Second, the CDS market numbers - $45 trillion/ 2007 from the International SD Assoc. That is a world wide market number, not just US, and again its an activity number. The actual underlying value is a small percentage of that. Finally, both Moon (who?) and Time cite the CDS numbers as if they're a problem on top of but separate from the mortgage securities problem. That's double counting, as much of the US CDS's are instruments based on the underlying mortgage securities.

 

[russ_watters]

Yes, the key point is that the free market now effectively requires socialism to save it; so we are told. One couldn't ask for a better example of a failed philosophy.

You have got to be kidding. That's an utterly rediculous post. The free market isn't going away because an already pseudo-government company becomes more government run. And you can't call a philosophy a failure after an economy levels off (without even dropping) after two centuries and thousands of percent of gains.

Profits are privatized. Risk is nationalized.

Try telling that to the shareholders.

 

[russ_watters]

One point of note that provides an interesting perspective: A one-time $700 Billion bailout is considered a crisis.

We now spend $700 Billion every year on foreign oil.

Social security is also about $700 billion a year. So what? I don't see how that's relevant, much less interesting, much less interesting.

 

[Gokul43201]

You have got to be kidding. That's an utterly rediculous post. The free market isn't going away because an already pseudo-government company becomes more government run.

AIG was a "pseudo-government company"?

 

[russ_watters]

Doesn't this argument sound eerily like the assurances before the Iraq war that once liberated all their oil would be available to pay for our being there?

And now we're shelling out $10B a month and have carted back 4,000 body bags?

No, you're wrong twice in one sentence! I gave no assurances, nor did the government ever say that Iraqis would pay for their own reconstruction. For us to take their oil profit for the reconstruction would be the very imperialism people like to accuse us of. It wouldn't be ethical and maybe wouldn't be legal either.

 

[Gokul43201]

No, you're wrong twice in one sentence! I gave no assurances, nor did the government ever say that Iraqis would pay for their own reconstruction.

Deputy Defense Secretary Paul Wolfowitz, speaking to the House Appropriations Committee on March 27, 2003, estimated the figure in the tens of billions of dollars if Iraq's oil fields were not destroyed.

"We're dealing with a country that can really finance its own reconstruction, and relatively soon," he said.

For us to take their oil profit for the reconstruction would be the very imperialism people like to accuse us of. It wouldn't be ethical and probably wouldn't be

Wouldn't be what? Legal?

 

[fuzzyfelt]

Well I can't fathom that Time piece, it reads like hype. First, the Fed lists the mortgage debt is $14 trillion as of '08 1st qtr, not $7t
http://www.federalreserve.gov/pubs/supplement/2008/05/table1_54.htm
Ok, perhaps they're referring to market volume, not value? Well they mentioned a $22 trillion US stock market - that's value. US stock market volume is several $hundred billion every day. The $4 trillion treasury - value. Second, the CDS market numbers - $45 trillion/ 2007 from the International SD Assoc. That is a world wide market number, not just US, and again its an activity number. The actual underlying value is a small percentage of that. Finally, both Moon (who?) and Time cite the CDS numbers as if they're a problem on top of but separate from the mortgage securities problem. That's double counting, as much of the US CDS's are instruments based on the underlying mortgage securities.

Yes, and the Time piece was published back in March, prior to what happened to AIG, which held many CDSs and prior to Lehmans defaulting.

 

[russ_watters]

AIG was a "pseudo-government company"?

Who said anything about AIG? The $700 billion bailout is of fannie mae and freddie mac.

 

[russ_watters]

Wouldn't be what? Legal?

Heh. I think I was trying to decide between "legal" and "ethical", didn't finish the thought. Certainly it would be inethical. I'm not as sure about it being illegal. Wording fixed now.

 

[russ_watters]

The only reason the economy has grown in the last several years is because the US government has been deficit spending.

That's interesting: When Clinton left office, we were in a recession. So then the only reason Clinton's recession isn't still with us is deficit spending from Republicans?

 

[russ_watters]

Yes, the key point is that the free market now effectively requires socialism to save it; so we are told. One couldn't ask for a better example of a failed philosophy.

Just so we're clear here, by calling capitalism a "failed philosophy", does that mean you are a socialist, not a capitalist?

 

[Art]

Just so we're clear here, by calling capitalism a "failed philosophy", does that mean you are a socialist, not a capitalist?

To point out the free market experiment of unregulated capitalism has lead to an unmitigated disaster does not make one a communist.

 

[Art]

Who said anything about AIG? The $700 billion bailout is of fannie mae and freddie mac.

No it is not! Fannie and Freddie have already been helped out with their own $200 billion bail out back in early September; and Russ this statement by you suggests you lack even a basic knowledge of what is happening. The $700 billion is for all of the financial houses holding so called toxic assets even including US subsidiaries of foreign banks.

 

[Art]

That's interesting: When Clinton left office, we were in a recession. So then the only reason Clinton's recession isn't still with us is deficit spending from Republicans?

Actually there is another way. You know the French whose modest economic growth you love to deride as an example of the failure of socialism? Well...

French hold out against credit crunch

Unlike Britain, the US and many other countries, France appears to be weathering the credit crunch storm in reasonable shape.
snip
Take the level of household debt. In France, it is at 47% of GDP, while in the UK it is well over twice that.

Its not that temptation does not exist in France - the lure of consumerism is just as strong as it is elsewhere.

But it is very difficult to spend money you do not have in France.

French credit cards are little more than debit cards, so there is no question of simply sticking a couple of flat screen TVs on your credit card and hoping to pay for them later - if there are insufficient funds in your account, your bank will immediately block the transaction.

http://news.bbc.co.uk/2/hi/europe/7635327.stm

So although they didn't benefit from the consumer led boom times and so had only modest growth, it seems now over the long term their policies aiming for steady growth over boom and bust have been proven to be the right ones.

 

[Astronuc]

That's interesting: When Clinton left office, we were in a recession. So then the only reason Clinton's recession isn't still with us is deficit spending from Republicans?

I should have qualified my statement - growth as measured by GDP.

The economy was certainly in recession when Clinton left office as a result of the internet bubble (a result of the 'irrational exhuberance' mentioned publicly by Greenspan - others had already mentioned it privately), and that should have been a warning right there. The Dot.coms and Telecomms were oversold, and stocks appreciated to ridiculous values, e.g. WorldCom, JDS Uniphase, Nortel, Enron, . . . . .

I strongly recommend to a friend in the beginning of 4Q 98 to get out of tech stocks and go into something more reasonable, which at the time was NS, CSX, UP, Mobil (Exxon and Mobil merged in 1999), or others. He didn't listen, he laughed at my recommendation, stayed in tech stocks - and lost 70% of the value of his retirement portfolio. If he had instead bought NS and CSX, he would have doubled his money.

The growth in the US economy has been bought on credit, and now it's time to pay and the income is not there. In addition, the value of what was bought on credit has decreased.

Capitalism is not inherently the problem. Lack of integrity, lack of discipline, and materialism are the problems.

Besides, I said government, not specifically Republicans, although they did control the executive branch and both houses of Congress from 2001 to 2006.

 

[james77]

Just so we're clear here, by calling capitalism a "failed philosophy", does that mean you are a socialist, not a capitalist?

Socialist or Capitalist. Do these terms even make sense anymore? Both systems are nothing more than systems of ideological simulacrum than are now seen in all their naked glory to be based upon want we always knew and thought they were based upon, namely, nothing much.

Both systems, but particularly the Capitalist system is based not upon traditional economic needs but rather upon promoting an endless sense of growth and false desires like the childish desire to be young, rich and famous. How childish can you get, yet think about the damage this almost banal system of happiness for all is having upon the environment of the planet?

The problem with Socialism was that it was too grown up for humanity as a result it was deemed to be un-American. I rest my case, and say, let this rotten system fall for all our sakes, economic systems can be amended, but ecological system and species cannot be replaced by a $700 Billion bail out.

 

[Gokul43201]

That's interesting: When Clinton left office, we were in a recession.

We had negative GDP growth in Q3 and Q4 of 2000? I hadn't heard.

 

[Astronuc]

FYI - http://www.bea.gov/national/nipaweb/SelectTable.asp?Popular=Y

I don't know how accurate this is, but this is supposedly a representation of the national debt (before the recent and planned bailouts).
http://zfacts.com/p/461.html

I have to wonder how the government accounts for losses or reduced wealth. Perhaps they simply ignore the negatives?