The Fundamentals are Sound?
The Fundamentals are Sound?
Who plundered the economy? What happened to all the wealth? Should Americans feel shame at having recklessly squandered their children’s future with imprudent borrowing?
Not long ago, as our
Not long ago, as our
Who plundered the economy? What happened to all the wealth? Should Americans feel shame at having recklessly squandered their children's future with imprudent borrowing?
Not long ago, as our wise leaders were dishing out the economic stimulus package - about $600 per taxpayer - we were assured that the "fundamentals" of our economy were sound.
They don't look so sound today.
Today, every man, woman and child in America has been scheduled to pony up almost $3,000 to bail out a flagging economy. And that money will be borrowed, likely doubling the total commitment after interest.
Whether or not it will actually open the gates for a flood of fresh credit is seriously in doubt. Well, not in that much doubt. Most knowledgeable economists believe the era of easy credit has irrevocably passed. Whether or not it will do anything to solve the credit crunch is more seriously in doubt.
Credit? What's that? It's what most of America lives on! It's what employers use to cover purchases and payroll around their cash flow. It's the lifeblood of our modern economy.
Credit originates with your savings deposits. With deposits safely stowed in their vault, banks lend many times their total amount, betting that fractional reserves will cover any current cash requirements. In theory, the cash flow from debt repayment produces funds sufficient to keep the ball rolling. In practice, these debts, especially mortgages, are packaged into securities and marketed to investors interested in the long-term revenue stream. Cash from these sales create additional reserves, making more loans possible.
But investors not only want to know that their investments are long-term and relatively high-yield. They also want to know they are low-risk and actually secured with something of value. That's why Mortgage Backed Securities (MBS) were so popular. People are surely going to continue paying on their homes!
Even so, investors are savvy folk. They want insurance! So clever financial engineers devised an instrument called Credit Default Swaps (CDS). Investors earmark a small percentage of their returns for premiums on these insurance instruments, so that if payments on the debt underlying their investment falters, they can cash in and stay out of trouble.
Of course, no one likes to shell out actual cash, so the folks supplying the CDS go out to the market and buy another one to guarantee against their loss, again paring off a couple percent for premiums. And whoever supplies that guarantee goes out for another, etc.
You may sense a little problem emerging. Everyone is raking in commissions and premiums in a circular tail chase of phantom coverage, but where is the actual collateral to guarantee a specific loss? Oops! There isn't any.
You see, CDSs were completely unregulated, specifically exempted under the Commodity Futures Modernization Act of 2000. Unlike more conventional insurance - or even the banks originating the debt - there was no requirement to set aside adequate reserves. In addition, the debt bundles are hard to unravel, making a few bad debts capable of souring many good loans. Finally, the trail of coverage, like translucent layers of an onion, add up, swap upon swap, into total opacity. It is impossible to actually understand the risk, except through esoteric probabilistic models - until the crap hits the fan.
Then the mark-to-market principle - hinged to what people will actually pay - pegs the value, not at the worth of the fan, but as crap. Oops again.
Smart speculators soon discovered that they could snap up risk from jittery investors at deep discounts with leveraged purchases and make tidy profits with little investment. Smarter speculators, knowing the market was unregulated, would bet on relatively good risks, underwriting their debt and simply collecting the premiums. Free money!
This was such good business that the value of these outstanding debt derivatives in the US has grown larger than our annual Gross Domestic Product. Globally, the amount is estimated at over $60 trillion. Lots of commissions, lots of premium payments, but nothing in the bank to back up the coverage. Nothing in the mix as an actual bulwark against default. Oops again, again!
Now deposits are down, shrinking as burgeoning war debt and fuel costs gobble up our productivity. Property values have dropped in an inescapable but somehow unforeseen downturn of the business cycle. Defaults have grown, making investors more and more nervous as specific "credit events" trigger payment on swaps that are backed up with nothing more than additional swaps plagued by the same toxic uncertainty, opacity and the gooey adhesion of bad and sound debt.
So shame on American excess? Not so fast! What's wrong with borrowing money to buy a home to shelter your family? Have some faith in the sound fundamentals of the economy! We need places to live and are willing to work and make the payments. So what if Joe Blow borrowed more than he could repay on a fancy, schmancy mortgage with adjustable rates, betting he could refinance his appreciated value and get on steady terms. Hey, the loan was made institutionally available, approved, packaged, sold, insured and reinsured. Joe Blow may have tried to borrow too much - maybe $300,000 - but guess what? He is going to lose everything if he fails to make his payments. There is no bail-out on the horizon for him.
There are far more culpable culprits in the mix: Those that banked the commissions and premiums with no where-with-all to meet their obligations; Those who, seeing the fan start whirling, packed their knapsacks with plunder on their way out the door; Those who originally pushed the policies and wrote the laws that left America in a murky financial alley surrounded by hold-up thugs in three piece suits.
When managers at Lehman Brothers were warned in January that they faced an impending liquidity crisis, they raced to package more than $5 billion in compensation for executives before filing for bankruptcy - including $72 million for the outgoing CEO - meanwhile begging the US Treasury for a bail-out! And they are just one example of many.
Now, their retirements and pensions having evaporated, taxpayers are told that, over their objections, they will be footing the bill for an attempt at restoring the shortfall. They can no longer qualify for a home loan, but they can borrow the money for a massive bail-out and be trusted to pay it back - with interest.
Last month the fundamentals were sound. This month, the President asks us to (quick) put $700 billion in small, unmarked bills in a plain, brown paper bag and leave it on the corner of Wall Street and...
I will take the bail-out a lot more seriously when someone goes after the disappearing sacks of money, starts putting it back into the banks and, swapping three-piece for jump suits, frog marches the crooks into jail. That is a sound fundamental that could really benefit our economy.
Not long ago, as our wise leaders were dishing out the economic stimulus package - about $600 per taxpayer - we were assured that the "fundamentals" of our economy were sound.
They don't look so sound today.
Today, every man, woman and child in America has been scheduled to pony up almost $3,000 to bail out a flagging economy. And that money will be borrowed, likely doubling the total commitment after interest.
Whether or not it will actually open the gates for a flood of fresh credit is seriously in doubt. Well, not in that much doubt. Most knowledgeable economists believe the era of easy credit has irrevocably passed. Whether or not it will do anything to solve the credit crunch is more seriously in doubt.
Credit? What's that? It's what most of America lives on! It's what employers use to cover purchases and payroll around their cash flow. It's the lifeblood of our modern economy.
Credit originates with your savings deposits. With deposits safely stowed in their vault, banks lend many times their total amount, betting that fractional reserves will cover any current cash requirements. In theory, the cash flow from debt repayment produces funds sufficient to keep the ball rolling. In practice, these debts, especially mortgages, are packaged into securities and marketed to investors interested in the long-term revenue stream. Cash from these sales create additional reserves, making more loans possible.
But investors not only want to know that their investments are long-term and relatively high-yield. They also want to know they are low-risk and actually secured with something of value. That's why Mortgage Backed Securities (MBS) were so popular. People are surely going to continue paying on their homes!
Even so, investors are savvy folk. They want insurance! So clever financial engineers devised an instrument called Credit Default Swaps (CDS). Investors earmark a small percentage of their returns for premiums on these insurance instruments, so that if payments on the debt underlying their investment falters, they can cash in and stay out of trouble.
Of course, no one likes to shell out actual cash, so the folks supplying the CDS go out to the market and buy another one to guarantee against their loss, again paring off a couple percent for premiums. And whoever supplies that guarantee goes out for another, etc.
You may sense a little problem emerging. Everyone is raking in commissions and premiums in a circular tail chase of phantom coverage, but where is the actual collateral to guarantee a specific loss? Oops! There isn't any.
You see, CDSs were completely unregulated, specifically exempted under the Commodity Futures Modernization Act of 2000. Unlike more conventional insurance - or even the banks originating the debt - there was no requirement to set aside adequate reserves. In addition, the debt bundles are hard to unravel, making a few bad debts capable of souring many good loans. Finally, the trail of coverage, like translucent layers of an onion, add up, swap upon swap, into total opacity. It is impossible to actually understand the risk, except through esoteric probabilistic models - until the crap hits the fan.
Then the mark-to-market principle - hinged to what people will actually pay - pegs the value, not at the worth of the fan, but as crap. Oops again.
Smart speculators soon discovered that they could snap up risk from jittery investors at deep discounts with leveraged purchases and make tidy profits with little investment. Smarter speculators, knowing the market was unregulated, would bet on relatively good risks, underwriting their debt and simply collecting the premiums. Free money!
This was such good business that the value of these outstanding debt derivatives in the US has grown larger than our annual Gross Domestic Product. Globally, the amount is estimated at over $60 trillion. Lots of commissions, lots of premium payments, but nothing in the bank to back up the coverage. Nothing in the mix as an actual bulwark against default. Oops again, again!
Now deposits are down, shrinking as burgeoning war debt and fuel costs gobble up our productivity. Property values have dropped in an inescapable but somehow unforeseen downturn of the business cycle. Defaults have grown, making investors more and more nervous as specific "credit events" trigger payment on swaps that are backed up with nothing more than additional swaps plagued by the same toxic uncertainty, opacity and the gooey adhesion of bad and sound debt.
So shame on American excess? Not so fast! What's wrong with borrowing money to buy a home to shelter your family? Have some faith in the sound fundamentals of the economy! We need places to live and are willing to work and make the payments. So what if Joe Blow borrowed more than he could repay on a fancy, schmancy mortgage with adjustable rates, betting he could refinance his appreciated value and get on steady terms. Hey, the loan was made institutionally available, approved, packaged, sold, insured and reinsured. Joe Blow may have tried to borrow too much - maybe $300,000 - but guess what? He is going to lose everything if he fails to make his payments. There is no bail-out on the horizon for him.
There are far more culpable culprits in the mix: Those that banked the commissions and premiums with no where-with-all to meet their obligations; Those who, seeing the fan start whirling, packed their knapsacks with plunder on their way out the door; Those who originally pushed the policies and wrote the laws that left America in a murky financial alley surrounded by hold-up thugs in three piece suits.
When managers at Lehman Brothers were warned in January that they faced an impending liquidity crisis, they raced to package more than $5 billion in compensation for executives before filing for bankruptcy - including $72 million for the outgoing CEO - meanwhile begging the US Treasury for a bail-out! And they are just one example of many.
Now, their retirements and pensions having evaporated, taxpayers are told that, over their objections, they will be footing the bill for an attempt at restoring the shortfall. They can no longer qualify for a home loan, but they can borrow the money for a massive bail-out and be trusted to pay it back - with interest.
Last month the fundamentals were sound. This month, the President asks us to (quick) put $700 billion in small, unmarked bills in a plain, brown paper bag and leave it on the corner of Wall Street and...
I will take the bail-out a lot more seriously when someone goes after the disappearing sacks of money, starts putting it back into the banks and, swapping three-piece for jump suits, frog marches the crooks into jail. That is a sound fundamental that could really benefit our economy.
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