The Achilles heel of the economy

[TheodoreLogan]

Investments have risk. Money deposited in a bank are considered safer and protected by the FDIC to a limit. The rule of thumb is the greater the risk - the greater the reward.

There is nothing (other than a lack of sufficient capital) to prevent any person from loaning money directly to a company or another person with the hope of a return. If a person wanted to conduct an ongoing business of loaning money to a variety of people - that might require Government approval and regulation (adds cost).

Ok... I am not sure whether you are agreeing or disagreeing with me though?

What specifically are you commenting on, or what specifically do you agree/disagree with?

Thanks.

 

[WhoWee]

Ok... I am not sure whether you are agreeing or disagreeing with me though?

What specifically are you commenting on, or what specifically do you agree/disagree with?

Thanks.

The banks serve many purposes. For depositors, it's a safe place to store cash and earn a small amount of interest. Also for clients, a way to write checks or make electronic payments. Also for clients, a way to finance large purchases.

If earning a fee for these services makes the bank a "parasite" - then I disagree. On the other hand, I would describe check cashing businesses as "parasites".

 

[TheodoreLogan]

The banks serve many purposes. For depositors, it's a safe place to store cash and earn a small amount of interest. Also for clients, a way to write checks or make electronic payments. Also for clients, a way to finance large purchases.

If earning a fee for these services makes the bank a "parasite" - then I disagree. On the other hand, I would describe check cashing businesses as "parasites".

Well it's not the fees that make them (banks) a parasite. It is that they are loaning out their depositor's money, with interest, at no risk of their own. That is the problem. If a large bank goes bankrupt because of massive defaults they lose their depositor's money, not their own money. This is obviously a problem seeing as all the accounts that the bank holds will be wiped out. The savings of many people are wiped out. This has a major negative effect on the rest of the economy. If a bank is 'too big to fail' they will be bailed out by the taxpayers.
This bailout will create inflation, devaluing the money in all savings accounts. So in this instance the depositor and the rest of the taxpayers lose money through inflation and taxes. What does the bank lose? Imagine if you could invest in the market and never lose. Imagine if you could invest other people's money in the market, make a profit and never lose your money, even if you lose everyone else's! Sweet deal!

 

[WhoWee]

Well it's not the fees that make them (banks) a parasite. It is that they are loaning out their depositor's money, with interest, at no risk of their own. That is the problem. If a large bank goes bankrupt because of massive defaults they lose their depositor's money, not their own money. This is obviously a problem seeing as all the accounts that the bank holds will be wiped out. The savings of many people are wiped out. This has a major negative effect on the rest of the economy. If a bank is 'too big to fail' they will be bailed out by the taxpayers.
This bailout will create inflation, devaluing the money in all savings accounts. So in this instance the depositor and the rest of the taxpayers lose money through inflation and taxes. What does the bank lose? Imagine if you could invest in the market and never lose. Imagine if you could invest other people's money in the market, make a profit and never lose your money, even if you lose everyone else's! Sweet deal!

Individuals and businesses default on loans quite often - the Government doesn't typically assume the risk without a prior agreement. The bank bailout is not the norm.

 

[TheodoreLogan]

Individuals and businesses default on loans quite often - the Government doesn't typically assume the risk without a prior agreement. The bank bailout is not the norm.

The bank bailout is not the norm

This site seems to prove otherwise.http://www.propublica.org/special/government-bailouts"

Defining what the 'norm' is can be a little tricky. If you say "bailouts don't happen everyday" then I would agree. If you say that "bank bailouts are not the norm", well that leads to a need to define what the 'norm' really is.

the Government doesn't typically assume the risk without a prior agreement

The FDIC was created to assume this risk. The FDIC insures deposits up to $250,000 currently. Before the FDIC, bank runs could cripple a bank and the economy if the bank was large enough. Because of the FDIC you no longer have to worry about losing all your money in bank runs, instead you have to worry about the tax dollars needed to supply this fund since only about 1.15% of the deposits insured by the FDIC are held in a fund created by insurance premiums payed by all member banks. So, the government (taxpayers) does actually assume all the risk on all deposits up to $250,000. Therefore the government/taxpayers do assume the risks taken by the banks themselves.

 

[WhoWee]

The FDIC was created to assume this risk. The FDIC insures deposits up to $250,000 currently. Before the FDIC, bank runs could cripple a bank and the economy if the bank was large enough. Because of the FDIC you no longer have to worry about losing all your money in bank runs, instead you have to worry about the tax dollars needed to supply this fund since only about 1.15% of the deposits insured by the FDIC are held in a fund created by insurance premiums payed by all member banks. So, the government (taxpayers) does actually assume all the risk on all deposits up to $250,000. Therefore the government/taxpayers do assume the risks taken by the banks themselves.

The FDIC insures deposits - collateral typically guarantees loans - behind promises to pay.

 

[WhoWee]

Defining what the 'norm' is can be a little tricky. If you say "bailouts don't happen everyday" then I would agree. If you say that "bank bailouts are not the norm", well that leads to a need to define what the 'norm' really is.

If you look closely at the list, you'll see the Savings and Loan bailout in the 1980's. IMO - it was the precursor of today's banking and derivatives problems. Again IMO as I don't want to rehash - although well intentioned (as they often are) Congress unleashed Wall Street onto small S&L's at great consequence to tax payers. We'll label this IMO also - when the regulators looked at S&L's, they took a peak at pension funds and were scared senseless.

More opinion - the interest rates dropped and the stock market took off - pensions funds were salvaged and the housing bubble swelled. If you want to blame someone for bad banking practices - start with Congress (again IMO). ...nothing like a Friday afternoon rant.

 

[TheodoreLogan]

The FDIC insures deposits - collateral typically guarantees loans - behind promises to pay.

What happens when the collateral loses it's value? Like in the case of the U.S. housing bubble where from 2005-2009 home prices dropped nearly $100,000 dollars. This is one example. Do you support the banking system as is? It seems you are defending the lack of accountability for banks that become insolvent.

edit: I thought I should include this graph http://mysite.verizon.net/vzeqrguz/housingbubble/"

 

[TheodoreLogan]

If you look closely at the list, you'll see the Savings and Loan bailout in the 1980's. IMO - it was the precursor of today's banking and derivatives problems. Again IMO as I don't want to rehash - although well intentioned (as they often are) Congress unleashed Wall Street onto small S&L's at great consequence to tax payers. We'll label this IMO also - when the regulators looked at S&L's, they took a peak at pension funds and were scared senseless.

More opinion - the interest rates dropped and the stock market took off - pensions funds were salvaged and the housing bubble swelled. If you want to blame someone for bad banking practices - start with Congress (again IMO). ...nothing like a Friday afternoon rant.

Of course. Congress gave the power to the banks in the first place. Congress makes it possible for this to continue as well. If Congress makes the laws, and we vote for congress members, than it is really our fault for not paying more attention!:tongue:

 

[WhoWee]

What happens when the collateral loses it's value? Like in the case of the U.S. housing bubble where from 2005-2009 home prices dropped nearly $100,000 dollars. This is one example. Do you support the banking system as is? It seems you are defending the lack of accountability for banks that become insolvent.

Let's consider some loan dynamics.

Who was the loan originator? Was the loan economically feasible? Was the mortgage bundled and sold?

How much downpayment was required? What percentage?
Next, what was the interest rate and was the it fixed or variable? How many years on the note 10, 20, 30, or other? Was the loan written "interest only" with a re-finance requirement or other hybrid?

Were the payments based upon the borrowers ability to re-pay - what percentage of income? Were income levels verified? What was credit history of borrower? How many payments were made before foreclosure?

Did the depreciation of the asset exceed the original downpayment requirement? Did the depreciation of the asset exceed the combined value of the original downpayment and the actual payments made on the loan?

There are a lot of factors to consider.

 

[TheodoreLogan]

Let's consider some loan dynamics.

Who was the loan originator? Was the loan economically feasible? Was the mortgage bundled and sold?

How much downpayment was required? What percentage?
Next, what was the interest rate and was the it fixed or variable? How many years on the note 10, 20, 30, or other? Was the loan written "interest only" with a re-finance requirement or other hybrid?

Were the payments based upon the borrowers ability to re-pay - what percentage of income? Were income levels verified? What was credit history of borrower? How many payments were made before foreclosure?

Did the depreciation of the asset exceed the original downpayment requirement? Did the depreciation of the asset exceed the combined value of the original downpayment and the actual payments made on the loan?

There are a lot of factors to consider.

Well, that is really besides the point. We already know how much it costs the taxpayers to bailout these companies as provided by the link I posted. So my question "What happens when the collateral loses it's value?" is really more of a rhetorical question since we already know what happens. It is in black and white. It will be interesting to see what happens in the future once the inflation brought on my massive bailout spending is realized. This will cause home prices to rise rather dramatically I would imagine.
They will only rise as much as people are willing to pay for them, I know that. I will have to close my eyes to avoid the carnage! So, do you support the banking system as is? You never really answered that one. You still seem to be a 'defender of current banking principles'. You are losing the battle for the majority though, I must warn you. On second thought... the American people have a terrible memory!

 

[WhoWee]

Well, that is really besides the point. We already know how much it costs the taxpayers to bailout these companies as provided by the link I posted. So my question "What happens when the collateral loses it's value?" is really more of a rhetorical question since we already know what happens. It is in black and white. It will be interesting to see what happens in the future once the inflation brought on my massive bailout spending is realized. This will cause home prices to rise rather dramatically I would imagine.
They will only rise as much as people are willing to pay for them, I know that. I will have to close my eyes to avoid the carnage! So, do you support the banking system as is? You never really answered that one. You still seem to be a 'defender of current banking principles'. You are losing the battle for the majority though, I must warn you. On second thought... the American people have a terrible memory!

No, I went through the process for a reason.

If a house has a value of $100,000 and a loan is written with $0 downpayment, with no credit check-no doc, with a variable interest rate on an interest only loan requiring re-financing in 10 years, the income is not verified (possibly inflated to get a bigger house), and the payments represent 50% of the income - the loan will probably default if anyone of many variables trigger.

The "borrower" will make variable rate interest only payments (they build $0 equity and the loan equals the value of the house) for years 1 - 10. If they are able to make the payments, they will either refinance or the loan might convert to some form of conventional mortgage. We'll assume the borrower that makes 120 payments will not be a problem. They consider the first 10 years to have been (tax deductible) "rent" and they continue to pay for 30 more years.

The problem loan is the one that defaults after 6 months because of a fluctuating interest payment, or loss of part of the income, maybe a new baby, a different car payment, the realization that furniture is needed in a house - who knows?

Now the bank has a problem - but not the borrower - remember there is $0 invested and only a few interest only (tax deductible rent) payments. The bank must go through a costly foreclosure process and recover the property. The bank may also be faced with repairs and a cost to re-market and re-sell. If the property maintains a valuation of $100,000, the bank might breakeven upon resale. However, if the property lost 25% of it's value when the market dropped - the bank absorbs the entire loss.

On the other hand, if the borrower was required to make a 10% to 30% downpayment - on a conventional 30 year fixed mortgage the end result might be different. First, the borrower would have an investment and probably would have made a greater effort to make sure the property was affordable. Second, the downpayment reduces the risk to the bank. If the borrower loses income - a restructuring of the loan might be possible.

Here's the "problem". The downpayment requirement would slow the real estate market and basically eliminate Wall Street and the mortgage brokers from the mix. It would also be declared "not fair" to low income people - force them to buy something they can afford (we'll label that my opinion).

 

[TheodoreLogan]

Here's the "problem". The downpayment requirement would slow the real estate market and basically eliminate Wall Street and the mortgage brokers from the mix. It would also be declared "not fair" to low income people - force them to buy something they can afford (we'll label that my opinion).

I knew what you were getting at. This is the lack of accountability I am referring to.
I don't disagree with your last post. What I originally posted, that you disagreed with, has become confused.

The banks serve many purposes. For depositors, it's a safe place to store cash and earn a small amount of interest. Also for clients, a way to write checks or make electronic payments. Also for clients, a way to finance large purchases. If earning a fee for these services makes the bank a "parasite" - then I disagree. On the other hand, I would describe check cashing businesses as "parasites".

Individuals and businesses default on loans quite often - the Government doesn't typically assume the risk without a prior agreement. The bank bailout is not the norm.

The FDIC insures deposits - collateral typically guarantees loans - behind promises to pay.

Your last post does not support your previous posts here. If what you're saying is that a down payment requirement is necessary to stabilize the housing market and help to stabilize the banking industry, then I would agree, but that is only one part of a much larger problem. What you pointed out as being the problem is only one of the many consequences of a banking system that won't be allowed to fail. Bailouts are also not limited to housing bubbles. So it is not sufficient to say, "Here's the "problem". The downpayment requirement would slow the real estate market and basically eliminate Wall Street and the mortgage brokers from the mix". It is 'a' problem, but not 'the' problem, 'the' problem if fixed would solve this one and many others. But again it is the lack of accountability that makes this possible. That is the problem. That is what makes $0 down loans possible, that is what creates an incentive to make such risky loans, and as many as allowed by law.

 

[Nev]

Further to my earlier comments about capitalism in general, it seems to me we should never allow investors to sell on a whim for profit or from a sense of concern or panic, even if inviting share offers or the state of a company's finances are fraudulently engineered.

We all know how a flourishing company can be driven out of existence by the withdrawal of its working capital amid rumours of impending disaster-which is precisely what happened to many at the time of the Wall Street Crash. Of course stock exchanges, which only survive and make huge fortunes for some, by virtue of the right to sell for profit, would cease to exist in their present form.

All business is based on trust, but if companies and their employees can have no trust in the loyalty and commitment of their investors, their future can never be sure, whether or not their operations remain viable, bearing in mind, in a competitive world every company will always face risks-which its shareholders surely should share with no option to withdraw their investment. In any case, most businesses, once firmly established, go on for years-unless grave ethical issues arise or something dire takes place in the financial services sector due to the current system!

Only by radical change can we hope to obtain greater stability and greater wealth for the future.

 

[WhoWee]

Further to my earlier comments about capitalism in general, it seems to me we should never allow investors to sell on a whim for profit or from a sense of concern or panic, even if inviting share offers or the state of a company's finances are fraudulently engineered.

We all know how a flourishing company can be driven out of existence by the withdrawal of its working capital amid rumours of impending disaster-which is precisely what happened to many at the time of the Wall Street Crash. Of course stock exchanges, which only survive and make huge fortunes for some, by virtue of the right to sell for profit, would cease to exist in their present form.

All business is based on trust, but if companies and their employees can have no trust in the loyalty and commitment of their investors, their future can never be sure, whether or not their operations remain viable, bearing in mind, in a competitive world every company will always face risks-which its shareholders surely should share with no option to withdraw their investment. In any case, most businesses, once firmly established, go on for years-unless grave ethical issues arise or something dire takes place in the financial services sector due to the current system!

Only by radical change can we hope to obtain greater stability and greater wealth for the future.

my bold
You believe "we should never allow investors to sell on a whim for profit or from a sense of concern or panic"? Have you ever made an investment? Are you willing to let someone else decide whether you should take a profit or loss?

Also, your comment that "a flourishing company can be driven out of existence by the withdrawal of its working capital amid rumours of impending disaster-which is precisely what happened to many at the time of the Wall Street Crash" - are you talking about the cancellation of working lines of credit or bridge loans?

 

[Nev]

- are you talking about the cancellation of working lines of credit or bridge loans?

All I was talking about was the panic selling which triggered the Wall St Crash and the Great Depression of the 30's.

The question of credit or loans from banks is another matter altogether.

 

[WhoWee]

- are you talking about the cancellation of working lines of credit or bridge loans?

All I was talking about was the panic selling which triggered the Wall St Crash and the Great Depression of the 30's.

The question of credit or loans from banks is another matter altogether.

How does one investor selling a share of stock to another investor (regardless of price or motivation) reduce working capital?

 

[Nev]

How does one investor selling a share of stock to another investor (regardless of price or motivation) reduce working capital?

The problem with the right to sell is that a spiralling downturn in confidence as with the Wall Street Crash can lead to the point where no one is willing to buy and the whole edifice comes tumbling down.

If no one is allowed to sell their shares there is less risk to a company's working capital, given the fact that a listed company currently has no control over the value of its shares and therefore its access to funding to maintain its operations.

 

[WhoWee]

The problem with the right to sell is that a spiralling downturn in confidence as with the Wall Street Crash can lead to the point where no one is willing to buy and the whole edifice comes tumbling down.

If no one is allowed to sell their shares there is less risk to a company's working capital, given the fact that a listed company currently has no control over the value of its shares and therefore its access to funding to maintain its operations.

Why would anyone ever buy a share - if they needed permission to sell it (or keep it)?

 

[Drakkith]

The problem with the right to sell is that a spiralling downturn in confidence as with the Wall Street Crash can lead to the point where no one is willing to buy and the whole edifice comes tumbling down.

If no one is allowed to sell their shares there is less risk to a company's working capital, given the fact that a listed company currently has no control over the value of its shares and therefore its access to funding to maintain its operations.

Nonsense, a company has a 100% validated way to increase the value of it's shares. BE SUCCESSFUL!

If I buy stock in a company it is exactly the same as getting together with a group of people, pooling our money together, and starting a business. If you aren't willing to risk failure, then don't do it. If you do not want to deal with the ups and downs of the stock market, DON'T use it. You always have that option when you own a company.

Also, the buying and selling of shares does NOT mean that a company has no funding. Profits from the business are the primary source of funding for companies. The owners of the company (The primary shareholders I mean) can use their shares to get more funding to expand or fund other projects by selling them, giving others a larger share of owership of the company in return for cash.

 

[russ_watters]

If no one is allowed to sell their shares there is less risk to a company's working capital, given the fact that a listed company currently has no control over the value of its shares and therefore its access to funding to maintain its operations.

Also:

You do understand that once the company sells the shares, they no longer have any impact on the company's working capital, right? All that panic buying and selling by investors changes nothing about a company's cash holdings. Outstanding shares do not provide a company with capital!

 

[Drakkith]

Also:

You do understand that once the company sells the shares, they no longer have any impact on the company's working capital, right? All that panic buying and selling by investors changes nothing about a company's cash holdings. Outstanding shares do not provide a company with capital!

Just so I am clear with what you mean, the company itself as a whole isn't gaining any money because of buying and selling shares, it is only the individuals who own the shares that make or lose money correct?

 

[WhoWee]

Just so I am clear with what you mean, the company itself as a whole isn't gaining any money because of buying and selling shares, it is only the individuals who own the shares that make or lose money correct?

When the shares are first issued by the Company - the funds are retained by the Company. All trades between investors after that (based on the value - usually determined by company performance) are separate from the company.

Another way to look at it - an artist sells a painting and keeps the proceeds. The collector/buyer takes possession and ultimately sells it to another collector. The money exchanged between the 2 collectors is not shared by the artist - but the collective work of the artist impacts the value of the piece. The difference is the artist doesn't pay dividends to the collector(investor) as the Company might.

 

[Drakkith]

I see, thanks WhoWee!

 

[WhoWee]

If trading in company capital on the open market was banned, there could be no more boom and bust cycles caused by dramatic changes in fickle confidence, while an investor could still sell his shares in a company, but only for their real, book value and not for a fictional market price. If banks were no longer run for profit, there could be no more catastrophies caused by reckless profiteering in the banking community. If interest on loans, which is a major deterrent to enterprise and produces nothing of value, was banned, business would receive a huge boost. Finally, if a common global currency was established, the benefits to international trade would be enormous.

The only barrier to such changes is the popular delusion that trading in money can somehow make more money, when in fact such a trade is a rapacious parasite which feeds on the flesh of the real wealth-creating world of work and, by its nature, resists all efforts to treat or control it.

To get us back on topic - the result of your actions would be to eliminate incentives to invest - IMO. Why would an investor take a risk?

 

[Nev]

To get us back on topic - the result of your actions would be to eliminate incentives to invest - IMO. Why would an investor take a risk?

A share in potential profits, by way of dividends, should be sufficient incentive to invest in a company or new venture, as it already is for many shrewd investors, whether or not their investment succeeds.

 

[WhoWee]

A share in potential profits, by way of dividends, should be sufficient incentive to invest in a company or new venture, as it already is for many shrewd investors, whether or not their investment succeeds.

That would eliminate start ups - wouldn't it?

 

[daveb]

Since I work for a startup, I would say it doesn't eliminate them, but it would surely reduce the number of them. For example, startups that are R&D based (such as the one I work for) would probably still be around, since the potential payoffs for the investors would be larger for successful R&D (due to lack of or negligible initial competition). The ones that might not start at all would be those trying to capitalize on a growing or established market (since effective competition makes success more difficult).

 

[WhoWee]

Since I work for a startup, I would say it doesn't eliminate them, but it would surely reduce the number of them. For example, startups that are R&D based (such as the one I work for) would probably still be around, since the potential payoffs for the investors would be larger for successful R&D (due to lack of or negligible initial competition). The ones that might not start at all would be those trying to capitalize on a growing or established market (since effective competition makes success more difficult).

I should have clarified my point - that start up and growth companies often need to re-invest profits - not pay dividends - and attract investors because of share appreciation.

 

[daveb]

Well, since we don't have a device ready for commercial distribution, I can't speak about profits, and where they'll go, but you're right in that regard.

 

[Nev]

Also, the buying and selling of shares does NOT mean that a company has no funding. Profits from the business are the primary source of funding for companies. The owners of the company (The primary shareholders I mean) can use their shares to get more funding to expand or fund other projects by selling them, giving others a larger share of owership of the company in return for cash.

If the loss of confidence in a company due to market conditions has no impact on its ability to find funding from profits to maintain its operations, why is it that widespread contagion of such loss of confidence can frequently lead to a major down-turn in economic activity, if not as serious as the Wall Street Crash?

 

[WhoWee]

If the loss of confidence in a company due to market conditions has no impact on its ability to find funding from profits to maintain its operations, why is it that widespread contagion of such loss of confidence can frequently lead to a major down-turn in economic activity, if not as serious as the Wall Street Crash?

You seem to be changing the rules/conditions?

You first posted:
"Further to my earlier comments about capitalism in general, it seems to me we should never allow investors to sell on a whim for profit or from a sense of concern or panic, even if inviting share offers or the state of a company's finances are fraudulently engineered.

We all know how a flourishing company can be driven out of existence by the withdrawal of its working capital amid rumours of impending disaster-which is precisely what happened to many at the time of the Wall Street Crash. Of course stock exchanges, which only survive and make huge fortunes for some, by virtue of the right to sell for profit, would cease to exist in their present form."

 

[Drakkith]

If the loss of confidence in a company due to market conditions has no impact on its ability to find funding from profits to maintain its operations, why is it that widespread contagion of such loss of confidence can frequently lead to a major down-turn in economic activity, if not as serious as the Wall Street Crash?

I've read a few articles online, and from what I've read it takes a combination of events to cause something like a depression from a Stock Market crash. The thing is that the stock market is directly connected to the economy and the money supply. When the economy does bad it isn't the Stock Market to blame, it is the economy. The market merely reflects the economy.

I don't know all the details, so I hope someone can explain better than I can. I've only looked around at wikipedia and a few articles such as this one: http://www.amatecon.com/gd/gdcandc.html

 

[WhoWee]

I've read a few articles online, and from what I've read it takes a combination of events to cause something like a depression from a Stock Market crash. The thing is that the stock market is directly connected to the economy and the money supply. When the economy does bad it isn't the Stock Market to blame, it is the economy. The market merely reflects the economy.

I don't know all the details, so I hope someone can explain better than I can. I've only looked around at wikipedia and a few articles such as this one: http://www.amatecon.com/gd/gdcandc.html

The 1929 Crash was fueled by speculation and credit - it was a bubble. Much like our recent real estate bubble where people bought homes of ever increasing value with nothing down - investors in the late 1920's bought stock on broker credit - or margin.

 

[Drakkith]

The 1929 Crash was fueled by speculation and credit - it was a bubble. Much like our recent real estate bubble where people bought homes of ever increasing value with nothing down - investors in the late 1920's bought stock on broker credit - or margin.

Sure, but would ONLY that cause the economic problems? Just from some quick reading it seems vastly more complex than just that. Know any good links on the issue?