Because you can't keep beating a dead pitbull

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Because you can't keep beating a dead pitbull

Postby avak » Wed Oct 01, 2008 6:32 pm

Yeah, I'm curious to see Lathander explain how we can get out of this by cutting taxes for the rich and deregulating big business some more.


I run two Main Street businesses in the Midwest and I can say with absolute certainty that the Wall St mess affects me directly. I think it really f$&*%^ hysterical to see these loud mouths calling for market "correction" and consequences for Wall Street because I can't absorb the fallout. You know the 95k layoffs last month? Those are real people, not just some abstract metric that economists made up.

When the NYSE drops 780 points people start restricting their discretional spending and that means a noticeable drop in my sales which means I lay off people or go out of business, which just makes it all even worse. Sure, its all originally due to unfit borrowers and we can argue about that all day long (kind of like we argue about going to Iraq), but this is not some esoteric discussion for market philosophers to have a field day with.

So, thanks to the people that are actually working on a solution and I really do hope this is used as an opportunity for real change.
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Re: Because you can't keep beating a dead pitbull

Postby Sarvis » Wed Oct 01, 2008 8:22 pm

avak wrote:

When the NYSE drops 780 points people start restricting their discretional spending



If it helps any, I don't plan on doing so. Going on vacation tomorrow, actually!
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Wed Oct 01, 2008 9:36 pm

The only thing that this bailout will ensure is another bailout sometime down the line... and possibly the destruction of people's life savings through inflation. The message being sent is that its a good idea for banks and other players in the free market to take outsized risks. If it works out you make a fortune. If it doesn't, the government will make you whole at the expense of the taxpayer. The insane incentives created by such a system will ensure the ultimate destruction of the system. Its not some esoteric subject. Either you have a free market with all the risks and rewards inherent in that system, or you structure a socialized system and hopefully regulate everyone in a manner that will keep things running more or less smoothly. But to have socialism for the rich and free market capitalism for everyone else.. that can't end well.

I'm sorry if times are tough for you. I am a business owner and employer as well, and while I won't go into specifics, I will say that I am feeling the pinch. However, trying to reinflate a credit bubble is not only ill advised, its also probably impossible. Individuals, businesses, and even government will have to adjust to the post credit bubble economy where you buy what you can afford, not what you can make payments on. It won't be easy, but there actually isn't any other option.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth

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Re: Because you can't keep beating a dead pitbull

Postby Corth » Wed Oct 01, 2008 9:42 pm

Oh, and by the way.. its not like this was just some surprise unpredictable event. I've been telling anyone who would listen to me for years now that this is what would happen. Ask Lathander about how I was calling for a credit crunch well over a year ago. Anyone who really followed the real estate bubble and did a little bit of research knew that it would end poorly. The scary thing is that its going to get a LOT worse. Welcome to the great depression, again. The next step in this process will be lots of unemployment.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Ragorn » Wed Oct 01, 2008 10:20 pm

Yeah, I'm against the bailout.

Yes, there is a practical downside to allowing these companies to fail. Credit will be hard to come by for a while. The housing market will tank. The securities market will sink. And in a few years, all of these problems will go away as new companies rise to fill the holes created.

The problem with a bailout is that it injects money into a system we can't take money back out of. We put $700 billion into the system now, and what happens in 10 years when these businesses prosper again? How do we recoup that money? Do we tax it out of those corporations? No of course not, the Republicans would never allow that. That's why we have to make this a loan and not a gift.
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Re: Because you can't keep beating a dead pitbull

Postby Gormal » Thu Oct 02, 2008 4:41 am

I thought that the bailout was intended as a loan from the start, or was I just hearing someone inject their ideas into reality?
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Re: Because you can't keep beating a dead pitbull

Postby Xisiqomelir » Thu Oct 02, 2008 4:54 am

Thus spake Shevarash: "Invokers are not going to be removed"

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Re: Because you can't keep beating a dead pitbull

Postby Corth » Thu Oct 02, 2008 5:50 am

Gormal wrote:I thought that the bailout was intended as a loan from the start, or was I just hearing someone inject their ideas into reality?


It was never meant as a loan. Just charity for wall street.

The issue here is not liquidity.. rather its solvency. Liquidity can be provided with loans. The goal here is to inject money into the books of the banks.. to recapitalize them and make them solvent.

The banks own securities that are backed by mortgages. If the mortgages perform well, then the banks make a nice return. Especially if they use leverage to buy a lot more of these securities than they might otherwise be able to afford. For a while it was a huge party. Think millions of dollars in bonuses for joe six pack investment bankers. Unfortunately, the mortgages behind these securities are now not performing well. If offered for sale on the market, many of them would attract no bids at all, or perhaps bids of only a few cents on the dollar.

Because of the leverage, a small decline in the value of these securities can wipe out all shareholder equity and cause the bank to become insolvent. Broke. Thats where pretty much the entire banking system is at now. A loan might put off the inevitable bankruptcy, but it does not make the bank solvent. After all, it has to be paid back.

The bailout bill allows the federal government to buy these mortgage backed securities from the bank. The problem though is one of value. If the government offers to buy the securities at fair market value, the banks will recognize a huge loss and remain undercapitalized. The bailout wouldn't accomplish anything under those circumstances other than accelerate the inevitable depression. Rather, the only way for this plan to recapitalize the banks is for the government to OVERPAY for the securities. Pay more then they are worth. Bernanke alluded to this by testifying that they would be paying 'hold to maturity' value for the securities rather than the 'fire sale' value which the market is currently placing on these securities. Paying more than market value is nothing more than a HANDOUT to wall street.

Some pundits are trying to spin this as a potentially profit making venture by the government. Unfortunately, its complete bullshit. The only way that happens is if home prices becoming reinflated, which simply will not happen. They are currently in the process of reverting back to their historical ratio of approximately 3.5 to 1 between median home prices and median household income. Home prices will probably fall another 20-30% nationwide, possibly even more if they overshoot, which usually happens in a crash. This implies an increase in foreclosures, and a decrease in value of these securities that the government plans to buy. There will be no profit made here.

The cost of the bailout is ENORMOUS. Approximately $2,500 or so for every man woman and child in the country. Your typical family of 4 is on the hook for $10k to make sure wall street doesn't suffer. Realistically this is the burden of the middle class. The rich will not feel the pinch, the poor don't pay taxes.. the middle class will end up paying a lot more than $10k per family. Get ready to work hard to make wall street whole.

This cost does not even take into account the other costly ramifications of the bailout. Inflation being the costliest. People who have saved their whole life will see that nest egg seriously devalued as a result of these inflationary policies. Where do you think this 700 billion dollars is coming from?

Or, for instance, the government will likely see increased borrowing costs as foreign investors lose their appetite for US treasuries due to a perceived inflationary bias in Washington. Since adjustable rate mortgages are tied to the 10 year treasury note, mortgage rates will rise. Uh oh.. more foreclosures!

And if by some miracle the bailout actually managed to reinflate the credit bubble, which I seriously doubt could happen at this point but I'm not prepared to completely rule out.. well that would actually be the worst outcome in the long run. The message to Wall Street would be that you cannot die. You can take the largest risks, which allow you to make the biggest bonuses, but when the shit finally hits the fan and reality returns... well, you'll do fine because the taxpayer will be blackmailed into bailing you out. This is called moral hazard, and it would result in a bigger bubble and eventually a bigger and more painful bailout.

Imagine how you would live your life if you knew that you couldn't die. Saying that banks are too big to fail is essentially telling a business it can't die. If you can't die, why not take huge risks?

The problem that none of the politicians want to publically recognize, is that this recession is normal and in the long run beneficial. Housing prices ARE too expensive, even now. Why would they want to prop them up further? Enormous amounts of mal-investment occurred as a result of artificially cheap credit. These mal-investments are being liquidated and revalued, as they should be. A recession is painful, but its also a healing process. You cannot indefinitely pause the market cycles. We should have felt more pain when the stock market bubble burst, but rather another bubble was inflated and now the day of reckoning will be exponentially more painful. If they could figure out a way to inflate some other bubble, it would just make things even that much worse in the future.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Corth » Thu Oct 02, 2008 6:12 am

Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Vaprak » Thu Oct 02, 2008 12:03 pm

I agree with almost everything Corth said above except,
Because of the leverage, a small decline in the value of these securities can wipe out all shareholder equity and cause the bank to become insolvent. Broke. Thats where pretty much the entire banking system is at now. A loan might put off the inevitable bankruptcy, but it does not make the bank solvent. After all, it has to be paid back.


I would modify "That's where pretty much the entire banking system is at now" to read "That's pretty much where every wall street bank or firm, enormous bank, or regional bank is at now." Small banks such as community banks and/or most credit unions are still highly capitalized and solvent. Small banks never became over leveraged because they can only loan out to the limits of their funding from deposits. Once you get up into banks that are publicly traded or run by assclowns then you see the greed and 30 times leveraged situation. Sure it's a little harder for small banks in this economic enviroment, but that's mostly due to upside-down rate curves than it is to mortgage backed securities.
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Re: Because you can't keep beating a dead pitbull

Postby avak » Thu Oct 02, 2008 1:40 pm

One of the problems with this situation is that it is extremely complicated, at least from the stand point of your average citizen. I appreciate that post, Corth, but I've heard equally compelling arguments from various other positions. Supposedly, this bailout has been under discussion for a significant amount of time and then it was dropped in Congress completely out of nowhere and demands made for it to be passed. I was actually impressed by the House Republicans and some talk from the Dems about stalling the passage of the plan so it could be looked at more closely.

So, Soros and others are proposing something very similar to what Sweden did to get themselves out of a supposedly similar crisis. He wants the gov't to get equity in exchange for recapitalizing these banks. I imagine that Corth would say that will just promote bad lending practices and delay the inevitable. Will it? Is there really no course of action to slowly ratchet down the crisis instead of this sacrosanct natural correction process?

As for my businesses, we're like the small banks...we have no leverage with which to manipulate the system. Therefore we have always operated under 'normal' capitalistic principles that leave us solvent and resilient. We'll see how the rest of the world around us responds to the crisis though....that is what worries me.
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Re: Because you can't keep beating a dead pitbull

Postby teflor the ranger » Thu Oct 02, 2008 2:32 pm

When things are going badly, often times the last thing people consider is freedom. We are so willing to trade freedom for security on so many levels, even with things we don't think of as being freedom at all. Freedom is what got us into this mess, never mind that all the good it has done for us far outweighs the current downturn or crisis. It's not individual freedom now that we need to be concerned about, but capital freedom.

What does that mean? Capital freedom? One of the major reasons for the massive economic success of the United States is that money can move about relatively freely, for the most part unburdened by regulation and politics.

It means a guy with so-so credit can get a loan to house his family, or a business that doesn't yet have any customers can raise the money it requires to purchase equipment. I hate to use terms like "main street" and "wall street," because in America, it's the same damned street. Some people toss around the terms as if no one sells hot dogs on wall street and no one on main street has a 401k. Is it possible to isolate one from the other? Absolutely not. Is it possible to dampen the up and down swings to insulate one from the other - yes, and it is in fact recommendable when you're in a downswing.

But the problem with most dampening equations is that they're usually from both sides. If you dampen too much, main street won't feel the benefit of a rising wall street.

Regulation of capital and other markets should exist for the purpose of protecting people from the ups and downs of a free market. Something about unbridled capitalism being the worst enemy of capitalism. But rarely do people consider the effects of over-regulation.

Say the government tells banks they can only loan money to people who are at virtually no risk to lend to. This means that the top 10% most credit worthy can get a loan, and the 90% of the rest of us can't. What does this mean to the rest of the economy? No growth. Nobody buying cars and nobody buying houses.

But here's the secret: if nobody is buying, nobody is building. If there's no money, there's no work. This is what happens when money lacks the freedom to move around. You want people to invest money - you want people to lend money - you want there to be a risk that the money doesn't get paid back!

One of the reasons that America has been more successful than the rest of the world economically (even if we lost half of everything, we'd still have more than just about anybody else), is that money has a great deal of freedom in the United States, as well as a system of regulation that has been fairly market-oriented and administered by reason rather than panic/politics. We should be very careful when we consider what steps need to be taken going forward. We do not want to unduly burden our capital to the point where its freedom has been destroyed.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Thu Oct 02, 2008 4:10 pm

Avak,

I am against the bailout in principle, but you know what? If we MUST have a bailout, Soros' plan makes a hell of a lot more sense. Thats one of the infuriating things about Paulson's plan. There are so many better ways to do it if you are so inclined.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby amena wolfsnarl » Thu Oct 02, 2008 4:40 pm

Just heard that theres a meeting goin on in europe now about a 500 billion dollar bailout for the banks there too. Wonder if we can blame that one on bush too? hehe :)
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Re: Because you can't keep beating a dead pitbull

Postby teflor the ranger » Fri Oct 03, 2008 2:00 am

amena wolfsnarl wrote:Just heard that theres a meeting goin on in europe now about a 500 billion dollar bailout for the banks there too. Wonder if we can blame that one on bush too? hehe :)


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Re: Because you can't keep beating a dead pitbull

Postby kiryan » Fri Oct 03, 2008 3:49 am

The only way out of this is through inflation. IE the houses are worth what the loans were made for.

I think we should seriously consider letting the whole world financial system fall apart. The confidence has been shattered so I don't see it going back to the way it used to be (other countries financing our spending). We might as well bankrupt them all now (foreign countries) instead of bailing them out (by bailing out the firms they are invested in Fannie/Freddie, investment banks).

Get some good protectionism going again and bringing those manufacturing and tech jobs home.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Fri Oct 03, 2008 12:55 pm

http://www.msnbc.msn.com/id/27006906/

California is begging Paulson for a bailout now. Who's next?
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby shalath » Fri Oct 03, 2008 5:39 pm

Oh cool. Americans will now pay to fix the american money crisis.

http://news.bbc.co.uk/1/hi/business/7651060.stm
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Re: Because you can't keep beating a dead pitbull

Postby teflor the ranger » Fri Oct 03, 2008 11:54 pm

Corth wrote:http://www.msnbc.msn.com/id/27006906/

California is begging Paulson for a bailout now. Who's next?


Just start listing off the blue states.
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Re: Because you can't keep beating a dead pitbull

Postby Gormal » Sat Oct 04, 2008 7:46 am

I'm so glad that the job I just got hired to isn't going anywhere regardless of the economy really. It might not be ideal but at least I know it'll be there for next year.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Sat Oct 04, 2008 2:08 pm

Yeah job security is going to be real important going forward. Unemployment is going to increase significantly. When that happens, you have no leverage in the job market. You either take whatever they are offering you, or they'll hire any one of the thousand other people who want your job.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Corth » Sat Oct 04, 2008 2:23 pm

James Grant has the best take on this I've seen yet.

http://www.washingtonpost.com/wp-dyn/content/article/2008/10/03/AR2008100303309.html

Money quote:

Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes. The unifying theme of the new bailout bill, all 451 pages of it, is the hair of the dog that bit you.

The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are "upside down," as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards.

Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby avak » Sat Oct 04, 2008 6:04 pm

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Re: Because you can't keep beating a dead pitbull

Postby Kifle » Sun Oct 05, 2008 9:09 am

kiryan wrote:The only way out of this is through inflation. IE the houses are worth what the loans were made for.

I think we should seriously consider letting the whole world financial system fall apart. The confidence has been shattered so I don't see it going back to the way it used to be (other countries financing our spending). We might as well bankrupt them all now (foreign countries) instead of bailing them out (by bailing out the firms they are invested in Fannie/Freddie, investment banks).

Get some good protectionism going again and bringing those manufacturing and tech jobs home.


I think I almost puked in my mouth, but I agree with Neo on this one. I think Corth was dead on as well. Letting the system implode upon itself seems the only logical choice. This bailout is a duct tape fix to something that needs replaced. In the long run, I'd much rather feel the hit of the economic collapse now rather than waste tax money on a bailout that is doomed to the same collapse down the road. It's understandable, as Kiryan pointed out, that this also affects the global economy as well, but, unless this is just my ignorance of economics speaking, it would be better to go through this as a world problem rather than something that only affects this country.

Also, Corth, could you explain how this bailout (if it were given as a loan) would affect liquidity. How I understand the terms (solvency/liquidity), a loan would help neither (unless you're saying the gov. is buying the debt securities and in turn meaning the banks are liquidating those securities as such). Its been a while since I've felt the need to pay attention to more than a general framework of economics...
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Re: Because you can't keep beating a dead pitbull

Postby avak » Sun Oct 05, 2008 1:51 pm

The most recent This American Life episode does the best job of explaining this crisis of anything I have heard or seen. In fact, I thought I had a decent understanding of some of the financial mechanisms in play here until I heard them explained. There are also associated podcasts from the team of journalists that worked on the story.

Two key things I pulled out of the TAL show. One, this is not just due to people mortgaging more than they could afford. The financial engineering in place is staggering. And two, the bailout plan that was passed has provisions for the Treasurer (I think, should double check that) to shift the plan in a significant way. The language would allow purchasing of equity stakes in the bailed out companies, instead of purchasing the toxic paper that has almost no chance of returning value. This equity stake plan is something I mentioned before, something that was done successfully in Sweden and something that many lawmakers and economists are calling for.

No matter how much you do or do not understand about this plan and these markets I would highly, highly recommend listening to the rerun show of This American Life today or find a copy online.
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Re: Because you can't keep beating a dead pitbull

Postby teflor the ranger » Sun Oct 05, 2008 8:30 pm

Kifle wrote:I think I almost puked in my mouth, but I agree with Neo on this one. I think Corth was dead on as well. Letting the system implode upon itself seems the only logical choice. This bailout is a duct tape fix to something that needs replaced.


Clearly, the American financial and economic system that made us the largest and most wealthy in the world needs to be replaced. Yes. This... Is... SARCASM.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Mon Oct 06, 2008 12:33 am

Kifle,

I'm not an accountant and really i'm kind of shooting from the cuff here but I'll give it a try. Perhaps someone else can make a clearer example than me.

An example of a corporation with a liquidity issue might be one where assets exceed liabilities but it is unable to meet short term expenses. Like for instance, perhaps they have a lot of equity in their factory but little cash in the bank to meet payroll. Such a corporation might want to borrow money against its assets for its cash needs.

An example of a solvency problem is where liabilities exceed assets. There is no equity in the corporation. A loan might allow it to meet its cash obligations, but that loan also becomes a liability, so it does nothing to cure the underlying problem that the company is less than worthless.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby amena wolfsnarl » Mon Oct 06, 2008 2:19 am

corth we were talking about this the other day in accounting class and u summed it up pretty good some corporations have too many long term assets that they are unable to liquidate and taking out another loan to save a sinking ship is nothing but a patch job
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Re: Because you can't keep beating a dead pitbull

Postby Ragorn » Mon Oct 06, 2008 3:03 am

Ok, plain examples.

Let's say a bank opens up, and customers deposit a million dollars into it. The bank, wanting to invest these deposits, starts making loans. They loan out $700,000 of their original million, and after the interest accrues, they plan to get a $950,000 return on their investment.

On paper, our bank is worth $1.25 million. They have $300k cash on hand, and $950k worth of investments.

Now the market crashes and the original depositors want to withdraw their million dollars. Uh-oh. Our bank only has $300k cash on hand, and their $950k asset is not liquid... they can't "cash it in" to pay out their depositors. In this case, if our bank can get a $700k loan from the government for a lower interest rate than they charge their customers, everything is cool. They can use the loan to pay off their depositors, and they'll still make SOME money off the cash they loaned out.

Keep in mind, that's still annoying, because the bank would have to request an interest rate FAR less than what they're charging their own customers in order to stay afloat. It's still, in some ways, a free handout.

That's scenario #1. That's a situation in which a loan would solve the problem.

Now, let's switch things up a little for scenario #2. Same bank, but instead of loaning $700k, the bank offers $700k worth of mortgages to familes with bad credit. After interest, the mortgages are valued at $950k on paper, and the bank prospers as long as people make their mortgage payments.

But oops... now people start defaulting on their mortgages. Now the bank has $300k cash on hand, and they own a dozen shitty houses they can't sell. So when the depositors try to withdraw their million dollars... well, fuck, what do we do? The bank mortgaged out $700k, expecting to make $950k back. The bank can't sell the houses for $950k, because they aren't worth that much. Those houses were only worth $700k at the peak of the housing bubble (the bank was hoping to make $250k profit on interest payments), and now the market is crashing. Even if the bank could sell those houses, they're only worth $500k now, which isn't enough to cover the original million dollar deposit that the bank needs to pay out.

The bank, as the kids say, is RIGHT FUCK'D.

The banks won't try to unload their houses for what they're ACTUALLY worth, because doing so "devaules the asset." The bank itself is only worth the $300k they have on hand plus the value of the houses they own. So if the bank suddenly says "these houses aren't worth the $950k we thought they were, we're going to try to sell them for $500k," the total value of the bank drops from $1.25M to $800k. And then the stock price plummets, and the CEO's stock options deflate in value. So you understand, we CAN'T do that.

A loan won't help, because the bank has no way to pay it back. Those houses aren't a liquid asset, and the bank has no guaranteed income in its future with which to repay the government loan. A loan would simply delay the inevitable... the bank would pay its depositors, but it would eventually default on the loan and go bankrupt.

And if a hundred banks like this one all take out loans from the government, and they all default... what then? The government is stuck with thousands of unsold houses that are worth far less in reality ($500k) than they are on paper ($950k).

The only thing that will save our little bank is a huge government bailout... a shovelful of free money that will allow them to pay off their debts while retaining their non-liquid assets. That's what just happened. The government just wrote our bank a million dollar check.

So the real question isn't loan vs. bailout. It's which is the lesser evil: writing these banks a free, blank check? Or letting hundreds of banks and businesses fail and seeing what happens to the economy afterwards?

And then... how do we prevent this from just happening all over again in ten years?
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Re: Because you can't keep beating a dead pitbull

Postby Kifle » Mon Oct 06, 2008 10:20 am

Corth wrote:Kifle,

I'm not an accountant and really i'm kind of shooting from the cuff here but I'll give it a try. Perhaps someone else can make a clearer example than me.

An example of a corporation with a liquidity issue might be one where assets exceed liabilities but it is unable to meet short term expenses. Like for instance, perhaps they have a lot of equity in their factory but little cash in the bank to meet payroll. Such a corporation might want to borrow money against its assets for its cash needs.

An example of a solvency problem is where liabilities exceed assets. There is no equity in the corporation. A loan might allow it to meet its cash obligations, but that loan also becomes a liability, so it does nothing to cure the underlying problem that the company is less than worthless.


Ahh, thanks Corth. I wasn't thinking about short-term liabilities. I understood the solvency issue in respect to the loan idea though -- which is why I think this bailout is practically useless.
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Re: Because you can't keep beating a dead pitbull

Postby Sarvis » Mon Oct 06, 2008 12:58 pm

Ragorn wrote:Ok, plain examples.

Let's say a bank opens up, and customers deposit a million dollars into it. The bank, wanting to invest these deposits, starts making loans. They loan out $700,000 of their original million, and after the interest accrues, they plan to get a $950,000 return on their investment.

On paper, our bank is worth $1.25 million. They have $300k cash on hand, and $950k worth of investments.

Now the market crashes and the original depositors want to withdraw their million dollars. Uh-oh. Our bank only has $300k cash on hand, and their $950k asset is not liquid... they can't "cash it in" to pay out their depositors. In this case, if our bank can get a $700k loan from the government for a lower interest rate than they charge their customers, everything is cool. They can use the loan to pay off their depositors, and they'll still make SOME money off the cash they loaned out.

Keep in mind, that's still annoying, because the bank would have to request an interest rate FAR less than what they're charging their own customers in order to stay afloat. It's still, in some ways, a free handout.

That's scenario #1. That's a situation in which a loan would solve the problem.

Now, let's switch things up a little for scenario #2. Same bank, but instead of loaning $700k, the bank offers $700k worth of mortgages to familes with bad credit. After interest, the mortgages are valued at $950k on paper, and the bank prospers as long as people make their mortgage payments.

But oops... now people start defaulting on their mortgages. Now the bank has $300k cash on hand, and they own a dozen shitty houses they can't sell. So when the depositors try to withdraw their million dollars... well, fuck, what do we do? The bank mortgaged out $700k, expecting to make $950k back. The bank can't sell the houses for $950k, because they aren't worth that much. Those houses were only worth $700k at the peak of the housing bubble (the bank was hoping to make $250k profit on interest payments), and now the market is crashing. Even if the bank could sell those houses, they're only worth $500k now, which isn't enough to cover the original million dollar deposit that the bank needs to pay out.

The bank, as the kids say, is RIGHT FUCK'D.

The banks won't try to unload their houses for what they're ACTUALLY worth, because doing so "devaules the asset." The bank itself is only worth the $300k they have on hand plus the value of the houses they own. So if the bank suddenly says "these houses aren't worth the $950k we thought they were, we're going to try to sell them for $500k," the total value of the bank drops from $1.25M to $800k. And then the stock price plummets, and the CEO's stock options deflate in value. So you understand, we CAN'T do that.

A loan won't help, because the bank has no way to pay it back. Those houses aren't a liquid asset, and the bank has no guaranteed income in its future with which to repay the government loan. A loan would simply delay the inevitable... the bank would pay its depositors, but it would eventually default on the loan and go bankrupt.

And if a hundred banks like this one all take out loans from the government, and they all default... what then? The government is stuck with thousands of unsold houses that are worth far less in reality ($500k) than they are on paper ($950k).

The only thing that will save our little bank is a huge government bailout... a shovelful of free money that will allow them to pay off their debts while retaining their non-liquid assets. That's what just happened. The government just wrote our bank a million dollar check.

So the real question isn't loan vs. bailout. It's which is the lesser evil: writing these banks a free, blank check? Or letting hundreds of banks and businesses fail and seeing what happens to the economy afterwards?

And then... how do we prevent this from just happening all over again in ten years?



I watched 20/20 last night, and there's apparently one step you missed. The banks actually sold each other insurance on those mortgages, which is the big reason why they were willing to loan money to families with no income and bad credit. Only it wasn't "insurance" which is regulated, it was a "credit swap" which is NOT regulated. The problem there is: The banks selling these "credit swaps" didn't keep enough money on hand to pay out the credit swap... which they could do because it wasn't called "insurance" and therefore wasn't regulated.

So not only do you have banks lending to people who can't pay, you have banks promising money to each other that they'll never have in order to make that look like a good idea.

Personally, and I know this is probably unrealistic/illegal, I think we should just seize the assets of everyone involved with approving these mortgages and selling these "credit swaps" and give that cash back to the banks as the bailout. The taxpayers can fund the rest if it's still needed, but it should still be a loan. If we can't expect the banks to eventually become solvent and pay the money back, then a bailout isn't worthwhile either!
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Re: Because you can't keep beating a dead pitbull

Postby Vaprak » Mon Oct 06, 2008 2:55 pm

Comment on Ragorn's comments:

Scenario A is pretty accurate and is the reason why the FDIC and other regulatory bodies attempt to make sure that credit quality is good-excellent at banks, credit unions, and savings institutions. If the loans are all good quality then theoretically the FDIC will not have to payout deposit insurance. The problem with this scenario is that for a small $155 million dollar bank it's relatively easy for the FDIC to come in with a team of 10 people, look over the Bank's books and determine whether the bank has quality loans in relation to its assets. For a $55 billion dollar bank or any huge bank it's almost impossible for the FDIC, OTS, OCC, FED, etc to determine the quality of the loans in relation to assets held. These large banking institutions like WaMu, Wachovia, Wells Fargo, BoA, Citi, JPMorgan Chase, etc are simply too big to regulate properly. Not to mention that investment banks like Bear Stears, Lehman Brothers, etc were never regulated in this manner in the first place as they aren't deposit holders. Small institutions with liquidity problems can be helped by short term loans and are forced by regulators to maintain proper liquidity. Large institutions get away with bloody murder.

Scenario B is also fairly accurate and is what happens when the FDIC comes in with a bank liquidation team and siezes the assets of the insolvent bank and invokes FDIC insurance on the deposits. Again, this system works fine for a small community bank or small regional bank, but for a huge bank it places too much of a burden on the FDIC fund and a buyer must be found immediately. A buyer was found immediately for the WaMu failure, no problems there. Wachovia isn't quite insolvent yet so wasn't liquidated or seized by the FDIC, and this deal isn't over yet. IndyMac was a terrible failure because the FDCI still holds the assets and is running the bank after a few months simply because nobody wants to touch IndyMac's toxic credit portfolio of subprime mortgages, option ARMS, and nodoc mortgages. This causes the FDIC's insurance fund to get hit BAD. Also consider that large institutions loan out considerably more than what they hold in deposits, sometimes as much as 30 times leveraged. Hell, investment banks weren't even required to maintain an adequate capital ratio in the first place. Small banks and institutions don't do this as it's not an acceptable risk to take. Most tiny banks (under $50M in assets) don't even loan out 50% of their deposits. These tiny banks take very few risks and are very financially sound. Unfortunately they rarely have succession plans and generally get gobbled up by larger banks over time.

As bad as the Wachovia, WaMU, and IndyMac failures were, just think if a bank like Bank of America were to become insolvent and fail. BoA holds just shy of 10% of all US deposits (they're at their threshold as no bank can hold more than 10% of all available deposits, but they're lobbying hard to get that threshold bumped up for their benefit).

My personal opinion is that a) no bank/creditunion/thrift/savings/investmentbank should be allowed to get so large that it becomes impossible to keep an eye on, b) nobody should be able to get 30x leveraged (too high of a risk ratio), c) Clinton-era Community Reinvestment Act additions from 1999 should be repealed, d) FDIC insurance should be no higher than $200K adjusted for inflation starting in 2010 and should be risk-based insurance that coorelates with the degree of risk the institution takes in terms of capital ratios and asset classifications with a floor of $50K (this will cause people to put their deposits where there is less risk and make banks not be so stupid risky), e) give the 2 GSEs authority to restructure ARM loans that are going to reset into 30 year fixed mortgages and also purchase some of the better loans from other institutions and do the same (don't buy complete garbage), and f) let banks that bet wrong on subprime and option arms fail
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Re: Because you can't keep beating a dead pitbull

Postby teflor the ranger » Mon Oct 06, 2008 5:45 pm

avak wrote:Image


Newsflash: Liberal arts majors prefer Obama.

Thanks.
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Re: Because you can't keep beating a dead pitbull

Postby teflor the ranger » Mon Oct 06, 2008 6:43 pm

The economy runs on bust/boom cycles, and the banking sector is no different. This has happened before and it will happen again.

The question that is always on the minds of the people when we are in a bust cycle is how we can keep this from happening again. The focus is always on this question. It is always too focused on this question when things are bad.

It's going to happen again. You cannot fully or even mostly insulate the economy from the basic cycle of growing and shrinking markets without crippling the market and forcing it to stay down. Optimism incites activity every bit as much as impending doom.

The question of freedom rarely comes up when freedom has brought us a negative result. People talk about regulation, centralization, and government equity because they don't see the bigger picture of economic efficiency. Banks and businesses must fail, not because they are weak, but to provide opportunity for another group of very intelligent people who will probably get their legs swept out from underneath them the next bust cycle. I am not fearful when hundred year old institutions go down. I see instead room to build something else.

We need that freedom to be efficient and effective. If we hamstring the economy while it's down, it is going to stay down and we'll be out of the game. America has to also compete globally. Leading globally means to have the highest economic efficiency.

While it is unfortunate that high economic efficiency is associated with large downturns and upswings, it benefits us as a nation overall to be the world's economic leader.

This means, as with all things taking the good with the bad: be prepared.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Tue Oct 07, 2008 8:12 pm

http://www.amazon.com/gp/product/0609806998/

Who wants to buy me this for my birthday?
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Vaprak » Tue Oct 07, 2008 10:32 pm

I'm waiting for Dow 72,000 to come out before I buy.
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Re: Because you can't keep beating a dead pitbull

Postby avak » Wed Oct 08, 2008 4:21 pm

Uh, the debate was boring.

McCain is a grumpy old man and I'm perversely happy about his and Palin's imminent failure.

Intrade has Obama at 73.8 and McCain at 26.5.

I reread the old thread about the Dem nomination process from the archives. Pretty interesting. archived thread

Rolling Stone blasted McCain like I have rarely seen in journalism. article

Yay
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Re: Because you can't keep beating a dead pitbull

Postby Sarvis » Wed Oct 08, 2008 5:36 pm

avak wrote:
Rolling Stone blasted McCain like I have rarely seen in journalism. article

Yay


"Both developed an uncanny social intelligence that allowed them to skate by with a minimum of mental exertion." - Avak's article

Dammit... is there a book or something to learn how to do that? Or do you have to be born rich?

Is this what Libertarians mean by "working hard to get ahead?" ;)
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Wed Oct 08, 2008 7:29 pm

Jeez, we have a thread for that crap. All things being considered, I couldn't care less about the election this year. Truth be told, I feel sorry for whomever wins.

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Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Corth » Thu Oct 09, 2008 2:41 am

Doug Noland is a fund manager at Prudent Bear. He has been documenting the credit bubble on a weekly basis for years, and continues to do so. I ran across an article he wrote in October of 2001 which is amazing insofar as it describes beforehand exactly what indeed happened with housing over the court of the next 5 years, but that it also shows that the housing bubble was a planned event in order to bring prosperity back after the stock market crash. It was written in 2001 and it was absolutely prophetic.

http://web.archive.org/web/200110250022 ... credit.htm

Scroll to the middle where he starts talking about Fannie Mae.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Kifle » Thu Oct 09, 2008 3:44 am

avak wrote:I reread the old thread about the Dem nomination process from the archives. Pretty interesting. archived thread


On a more interesting note: Where the hell did Birile run off to?
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Re: Because you can't keep beating a dead pitbull

Postby teflor the ranger » Fri Oct 10, 2008 11:37 pm

Sarvis wrote:
avak wrote:
Rolling Stone blasted McCain like I have rarely seen in journalism. article

Yay


"Both developed an uncanny social intelligence that allowed them to skate by with a minimum of mental exertion." - Avak's article

Dammit... is there a book or something to learn how to do that? Or do you have to be born rich?

Is this what Libertarians mean by "working hard to get ahead?" ;)


John McCain has a record. It is a record of sacrifice for our country so that we would not have to sacrifice for ourselves. Five years in a Vietnamese prisoner of war camp, where he was often beaten by the guards, spending much of his time in solitary confinement, managing still to give the enemy a one-fingered salute despite his debilitating injuries that he suffered making sure his mission was carried out.

I think there are a couple of books written on that.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Sat Oct 11, 2008 1:11 am

Take it to another thread. Both McCain and Obama are irrelevent (thus far) with respect to great depression 2.0 which this thread is about.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby avak » Sat Oct 11, 2008 12:48 pm

I think the fact that Paulson is looking at buying equity stakes in these banks is fascinating. First of all, I'm sort of shocked that it wasn't a more prominent part of the discussion from the very beginning, especially from the socialists, I mean dems. Secondly, now that people are talking about it, I'm surprised there isn't more of an uproar. It just goes to show that the general populace is so accustomed to being spoon-fed soundbites that until the msm starts labeling this as socialism no one is going to care.

It is really scary stuff. I bet conspiracy theorists are getting migraines over some of this. The government on the verge of sweeping new powers, on the verge of owning more parts of the financial system, threatening martial law...all fairly ominous. But gas is way way cheaper! Clearly world wide demand has dropped by nearly 50% in the last few months.
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Re: Because you can't keep beating a dead pitbull

Postby Vaprak » Sat Oct 11, 2008 3:36 pm

I for one welcome our new financial overloards!
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Sat Oct 11, 2008 4:00 pm

Avak,

If we need to have a bailout, I agree with you that direct injections of capital into the banks is preferable. At least the government (taxpayers) are getting something in return for its money (as opposed to worthless mortgage paper). It also more directly addresses the problem which is solvency. Buying the bad mortgage paper at a market price would address liquidity issues but thats not the problem here.

I think what happened is that Paulson and Bernanke realized that their plan to purchase bad mortgage paper was garbage, so they are broadly interpreting the statute to conclude that it allows them to simply buy equity in the banks. Nobody is complaining because, heh, they are trying to save the world.

As an aside, there is no 1:1 relationship between gas prices and demand. Thats not the way it works. Its an inelastic good. Everyone needs it. If there is even a slight shortage the price will go up very fast because everyone needs it and is willing to pay more for it. Nobody is saying that the fact that prices have halved means that demand has halved. Only a little less demand (due to slowing economy) can justify a huge decrease in price.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby Kifle » Sun Oct 12, 2008 4:58 am

Corth, gas is not necessarily a completely inelastic good. I think the recent demand/price changes will atest to that rather than refute it. As we move towards new energy, gas (oil) will lose it's inelastic properties (hybrids, e85, etc.). True, it is more inelastic than elastic, but it doesn't have quite the nature of water, electricity, etc. Which I believe is why gas is so tough to predict -- pricewise.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Sun Oct 12, 2008 10:54 pm

Lets call it a relatively inelastic good. I agree its not inelastic in the same way as necessities such as food and shelter are. On the other hand, a lot of people are willing to pay a hell of a lot more for it if necessary. I mean.. say due to some terrorist attack or something there is a severe shortage of gasoline and it spikes to $10.00 a gallon. People might not drive to the beach on the weekend, but chances are they are still going to drive to work (unless the commute is long enough and/or the wages are low enough that its cost prohibitive).

Thats an example of how markets allocate a scarce resource towards the most efficient use. There is only X amount of gasoline being produced at any given time, and its not enough for all potential uses. The more efficient and necessary uses of the resource are simply willing to pay more and the less efficient and necessary uses decide its not worth it. As the price declines you will see the less efficient uses coming back since its no longer cost prohibitive, for instance, to drive to the beach on the weekend or work far from where you live.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: Because you can't keep beating a dead pitbull

Postby kiryan » Tue Oct 14, 2008 12:14 am

One thing we have to understand is the scope of the problems. We basically can't let any bank fail because of the "guarantees" they offered on the mortgages they sold to other banks. We couldn't let Fannie/Freddie fail either because so many banks held their stock as assets. If one bank fails and the insurance or stock becomes worthless, then the assets of the next bank are now devalued which repeats the cycle.

That is why inflation is the only answer imo. I don't think its the right thing to do, but its the only way to preserve the status quo which is what we make our socialist government about... social stability. The rich stay rich, the middle class stays comfortable, the poor have foodstamps and HUD as an alternative to crime. It should be about freedom, protecting the minority from the tyranny of the majority. Personally, I'd rather let the financial system, the global economy collapse, and let everyone fend for themselves including the poor Americans dependent on our riduculous social entitlement programs.

I'm looking towards an economic war. Europe and others tried to hang us out to dry. The whole world tried really hard to believe that the world economy had gloriously "decoupled" from the US and let us fail by ourselves. The Euro central bank declined to lower rates a year ago. They wanted to strengthen their currency relative to the dollar and attract investment dollars out of the US markets (part of the reason for the run up in price of oil btw). They also hoped that their higher rates would lead to more deposits from people fleeing the US (which would shore up their bank's balance sheets). It would've worked too if Euro banks and China hadn't been so heavily invested in US markets.
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Re: Because you can't keep beating a dead pitbull

Postby Corth » Tue Oct 14, 2008 2:13 am

I agree with your middle paragraph entirely. Ultimately this will end in some serious inflation.

However, for the immediate future we are looking at the exact opposite: a deflationary spiral. Cash will be king for at least the next several months, possibly up to a couple of years. I expect to pick up some assets at pennies on the dollar with my cash. I hope to spend every penny, and even borrow money to spend if credit is available. That way I get to buy lots of assets while the money has serious purchasing power, and pay back any money I borrow in cheap inflated dollars. In particular I will be buying energy assets. Probably will concentrate on canadian oil trusts.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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