Good Layman's guide to the financial crisis

[Entropy]

Surferbeetle,

I wonder if the UN got their nukes from Lichtenstein?

[slapout9]

Good Post Entropy, here is one on how the Monetary System was designed to work per our Constitution.

http://www.youtube.com/watch?v=3qica...c-HM-fresh+div

[Entropy]

Thanks slap, that looks really good. I'll see if I can watch the whole series this weekend.

[Surferbeetle]

Dr. Mankiw, of the Harvard Economics Department, has an interesting blog (and his textbook Macroeconomics is a good read as well...)

I don't pretend to be enough of an expert, or to be close enough to the facts, or to have a large enough staff, to know what should be done with the banking system, which is at the center of our current economic turmoil. But I am confident that fixing it should be the main focus of policy efforts.

In this regard, I found this tidbit thought-provoking:

"The word 'nationalization' scares the hell out of people," Rep. Maxine Waters, D-Calif., said on "This Week." To combat that, some clever advocates of nationalization have come up with alternative names, including "government receivership" and "pre-privatization." (Source.)

The search for alternative names can be amusing at first, but I think there is more here than mere semantics.

From a Wired article by Felix Salmon: Recipe for Disaster: The Formula That Killed Wall Street

For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril.

A viewpoint from Asia

The U.S. struggle for bailouts is actually a struggle between two factions. Those who support the bailout believe that the government should be able to iron out the economic cycle and that measures to counteract the cycle can help the overall market get through this crisis. Trust the government, they say. However, people from a different school of thought hate this. They believe that without economic cycles, there would not be a free economy. From the founding of the country until today, the U.S. has been tested countless times by economic cycles. As long as people have faith in the market’s strength, they can tough it out. Although a price must be paid, it is necessary. It is not easy for any single economic structure to achieve a transformation.

The U.S. government is standing at a crossroads. Should it temporarily squash the spirit of the free market in order to let the economy get through the crisis, or should it protect the free market and let the economy suffer the pain? The scariest thought is that even after squashing the free market spirit, it will still suffer pain. Relatively speaking, nationalization is really the riskiest choice.

[Schmedlap]

In an instant gratification society, why should we expect people to stop and think about whether they can afford the home that they are buying? Shouldn't it suffice that they want it, and they want it right now?

Why should we expect mortgage brokers to engage in fair play if it's not legally required to do so? Especially if there were investment banks creating incentives for them to dole out loans without regard to risk. Their behavior was (sometimes) legal and there were incentives. Shouldn't that suffice? Most of us expect no higher standard of behavior from any house-broken dog, and it still earns the title of Man's Best Friend.

Has anyone had the nerve to suggest that perhaps our nation is closer to moral bankruptcy than our banks are to financial bankruptcy?

I've got three nieces under the age of 12 who know that it's wrong to take something that you can't pay for, know it's foolish to buy something even if you aren't sure if you can pay for it (or to take the other side of that transaction), know it's wrong to lie to, or deceive, people who are vulnerable and relying upon your advice, and know it's wrong to encourage others to do any of those things. And, now that I think about it, could the three of them have done a better job of running Citigroup, Bear Stearns, Lehman Brothers, or Merrill Lynch than the people who ran them into the ground over the past 10 years? Losing damn near everything seems like an easy benchmark to surpass.

"Once something has been approved by the government, it's no longer immoral." - Reverend Lovejoy, from The Simpsons

[Surferbeetle]

From Bloomberg, by Erik Holm and Andrew Frye: Buffett Says Economy ‘In Shambles,’ Promises Recovery

March 2 (Bloomberg) -- Billionaire Warren Buffett said the economy will be “in shambles” this year, and perhaps longer, before recovering from the reckless lending that caused the worst “freefall” he ever saw in the financial system.

The economy and stocks will rebound, and the best days for the U.S. are ahead, said Buffett, chairman of Berkshire Hathaway Inc., in his annual letter to shareholders Feb. 28. Buffett said he’ll spend the recession shopping for new investments for Omaha, Nebraska-based Berkshire.

“The economy will be in shambles throughout 2009 -- and, for that matter, probably well beyond,” said Buffett. “Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so.”

Buffett, an informal adviser to President Barack Obama, said the consequences of the U.S. housing bubble are now “reverberating through every corner of our economy.” Gross domestic product shrank at a 6.2 percent annual pace from October through December, the most since 1982, the Commerce Department said last week.

“Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown,” Buffett said. “Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.”

[Schmedlap]

Maybe some have done it, but I haven't seen any media sources publish the entire sentence that the "economy will be in shambles" quote was pulled from.

"We're certain, for example, that the economy will be in shambles throughout 2009 - and, for that matter, probably well beyond - but that conclusion does not tell us whether the stock market will rise or fall."
- from the top of page 4 (3rd page of the pdf file) of the letter to shareholders, available here

As someone who trades (and owns Berkshire B shares) I wish the full context were given more often (the Bloomberg quote above does a decent job). Many have come to associate the market with the economy and vice versa, and invest accordingly.

[bourbon]

Maybe some have done it, but I haven't seen any media sources publish the entire sentence that the "economy will be in shambles" quote was pulled from.

Excellent point Schmed, you are not the only one to notice that. It seems

And the Beat Goes On…. (Jim Cramer, Joe Nocera, & Doug Kass), by Patrick Byrne. Deep Capture, March 1st, 2009.

Then February 28, the New York Times published a lie. In his annual shareholders’ letter released that morning Buffett had written:
.....
...but that conclusion does not tell us whether the stock market will rise or fall” (page 3).

That evening, New York Times journalist David Segal published an article which states in the third paragraph:

“But he [Buffett] also needled regulators and an assortment of unnamed chief executives as he predicted that fallout from the credit crisis would leave the stock market a shambles through 2009.”

Regarding a figure whose every utterance is scrutinized for meaning that can rock markets, such sloppiness is at best careless editing......But the consistent direction of such little liberties with the truth must give one pause.

[bourbon]

Harry Markopolos, who I mentioned earlier in the thread, gave his only interview to 60 Minutes last night.

The Man Who Knew, 60 Minutes, March 1, 2009. (Video)
Harry Markopolos blew the whistle to the Securities and Exchange Commission about Bernard Madoff as early as 2000. Why were his warnings ignored? Steve Kroft has the interview.Transcript

"It took me five minutes to know that it was a fraud. It took me another almost four hours of mathematical modeling to prove that it was a fraud. "

This guy is great.

[Ski]

It's going to get far worse. I think the DOW has a real chance of hitting 5000 and perhaps even lower than that.

All the indicators are out there. I'm still amazed that the DOW took so long to break the 7000 mark. And gold prices make zero sense right now.

[Sergeant T]

Watched a Frontline a few weeks ago entitled Inside the Meltdown. The thing that amazed me were all of the giants of Wall Street essentially coming to the same conclusion (we've screwed the pooch) at about the same time. Like some convoy of drivers that's been staring at the speedometer, only to look up and realize the road is about to run out. How is it that nobody looked up?

Has anybody out there seen anything reasonable or rational that outlines how this plays out? Not We're All Gonna Die or Everything Sucks but the course this will run. It's no longer astute to observe that things are broken, which the media will probably figure out in a year or two. Everything has a bottom. I can't find anyone, aside from Strauss & Howe, that's defined what it might look like. I've taken to calling it the Barney Clark Economy: Old heart's dead, don't have a new donor so we're just getting by on this bypass machine.

[slapout9]

Watched a Frontline a few weeks ago entitled Inside the Meltdown. The thing that amazed me were all of the giants of Wall Street essentially coming to the same conclusion (we've screwed the pooch) at about the same time. Like some convoy of drivers that's been staring at the speedometer, only to look up and realize the road is about to run out. How is it that nobody looked up?

Has anybody out there seen anything reasonable or rational that outlines how this plays out? Not We're All Gonna Die or Everything Sucks but the course this will run. It's no longer astute to observe that things are broken, which the media will probably figure out in a year or two. Everything has a bottom. I can't find anyone, aside from Strauss & Howe, that's defined what it might look like. I've taken to calling it the Barney Clark Economy: Old heart's dead, don't have a new donor so we're just getting by on this bypass machine.

Some guy on Larry King just said the DOW could drop to 6,000 before it stops.

Some other place I read an article (and can not remember where it was), but he said some countries were trying to figure out how to really use this situation to their advantage against the US in way that hurts us permantley without going to War.

[Schmedlap]

Some other place I read an article (and can not remember where it was), but he said some countries were trying to figure out how to really use this situation to their advantage against the US in way that hurts us permantley without going to War.

Unless they invest in our economy at this opportune time, I suspect that other countries are going to emerge from this more battered than we will. We're the folks who buy their stuff, borrow their money, deter people from invading them, and provide a useful bogeyman to distract their people. Suddenly OPEC countries have had their petrol-dollar spigot turned off. China is trying to get their own people to buy their stuff because we're not able to anymore and they're snatching up our low-interest treasuries (thanks for the cheap loans, Hu). Europe is enduring the same pain that we are and their less dynamic economy will not likely recover as quickly.

If I were a country with a large sovereign wealth fund, I'd being going long on the US economy now, taking advantage of this moment to be the hero who rides into town with a sack full of money and buys everything up at historical lows and then, ten years from now, cashes out at a hefty profit. I don't think people are going to be concerned about SWF's if they are injecting a lot of badly needed capital into our system and it has a stabilizing effect. If they want to play some other game (what are they going to do - destabilize the economy even more?), there will be a large opportunity cost that will probably pale in comparison to any benefit that they enjoy or pain that we suffer as a result of it. But I'm all ears if someone can think of something.

[ODB]

If you could buy now with everything bottoming out, what do you buy?

[bourbon]

Has anybody out there seen anything reasonable or rational that outlines how this plays out?

David Rosenberg is Merrill Lynch's North American economist. This analysis of his is very well thought out, and his work is held in high opinion by people who I consider very sharp. Apparently Merrill Lynch thought this article was too gloomy and tried to pull it.

[Schmedlap]

If you could buy now with everything bottoming out, what do you buy?

Depends on what kind of investor you are. For an individual, like me, I've been accumulating Berkshire B shares. Warren Buffet has some deep pockets and I don't share the concern that many have about his derivative plays. If he needs to pay more than what he's already written down on those derivatives, then the economy will be the least of our worries. We'll be more concerned with accumulating ammo and spam. But, it remains to be seen how smart my investment is.

For a bigtime investor, like an SWF, their investment, if large enough, can be the financial equivalent of a self-licking ice cream cone. If they announce that they're both confident in, and investing buckets of money into, a company like GE, which is now trading below book value, but still has a AAA credit rating, still pays a dividend, and is not in nearly as much trouble as the likes of Citigroup and BoA - I think that such a move would be welcomed by GE and pay off handsomely for the white knight.

But I'm neither a savvy finance guy, nor do I play one on TV.

[lamont]

If you could buy now with everything bottoming out, what do you buy?

Wind turbines, solar photovoltaic and generic drug manufacturing are my thoughts. Now is also probably a good time to start the automatic contributions to retirement accounts again although that is just for *new* savings and should be a dollar-cost averaging strategy. I wouldn't throw all the kids college money back into the market just yet.

Not all the data is bad news either:

http://www.forbes.com/2009/03/02/inc...turing_18.html

The rate of PCE decline slowing, low inventories and the manufacturing decline slowing would be signs that the worst of it are over and are leading indicators. 6-12 months later newscasters should start to use the phrase 'jobless recovery' in a worried fashion while wall street is solidly rallying.

I wouldn't call a bottom right now, though. Although I would bet heavily against the DOW violating 4,000 to the downside -- there's extremely long term support there from the lows in the 1930s to the lows in the 1970s.

We've also clearly violated the Nov 2008 lows, so if we're near a bottom the market will still probably rally off this point then move sideways for months before re-testing these levels again and then convincingly finding a bottom -- so best case calling a bottom is still 3+ months out. There's no hurry to buy.

Look for stocks right now which are still above their Nov 2008 lows -- they're outperforming the broader market and probably trying to put in a Nov 2008 low on an individual basis. Good time to cautiously put some money into those (again, not all the kids college funds all at once).

YMMV a *lot*.

[George L. Singleton]

...you guys are doing a very good job of covering the waterfront of articles and opinions in our current turbulent economic and financial collapse and upsets, at home and worldwide.

Instead of quoting others here are a few grassroots observations from the "old coot", me, who did his time in NYC as Special Assistant to the Vice Chairman of the Board of the old Manufacturers Hanover Trust Co., 1968-1971, then the fourth largest bank in the world, which is dated in time but not in practical experience. [*I was doing my MBA at bank expense, which I appreciate to this day, in the night division of New York University Sterne Graduate Business School, with such professors as Dr. Peter Drucker (author of the business book THE PETER PRINCIPLE) with a classmate who was 12 or more years older than me, Alan Greenspan, who with one honors degree in economics from Princeton was for 8 years as a young man chairman of President Eisenhower's White House Council of Economic Advisors, and later you knew him as Chairman of the Federal Reserve System...and he turned out to have made bad financial and economic decisions to favor the mortgage, housing and commercial real estate industry, which materially contributed to today's economic "chaos" as well.]

1. MHTCo. (Manufacturers Hanover Trust Co.) became over exposed in the International Department making wholesale loans to governments who were poorly performing financially, then and now, such as the Philippines (which lives even today on revolving loans and lines of credits from commercial banks, the Export Import Bank, the International Monetary Fund) and Japan, which we all know today has been upside down financially speaking in recent years, on and off. MHTCo. was making a huge volume of loans to Japan who we thought we were on top of economically, which in short order Japan turned around and used to "eat our lunch" especially in their auto manufacturing and export business. We likewise were pushing into the newly opening mainland China market, where they likewise have developed at our greedy short term profit expense a favorable balance of payments internationally in China today such that they, China, are one of our major buyers of US Treasury debt to keep our economy afloat! Astounding if you think this all has happened since 1970!

2. As a result of poor decisions making International loans, MHTCo. merged with Chemical Bank (Chemical in effect took over, MHTCo. which on paper was broke, even sold off their HQ building at 350 Park Ave.); then Chemical, too, [technically] failed and merged/was taken over by Chase Manhatten, which in turn merged/was taken over/failed by JP Morgan. *This whole concept today of mergers to create economies of scale scares me as if you are not doing sound business and growing your credit base honestly and soundly, size does not matter...to wit, AIG, CITI, et al.

3. That gets you to today's JP Morgan Chase Bank [JP Morgan buys out/merges with Chase to save Chase]...and so today JP Morgan Chase Bank is a heavy user of gifted billions of taxpayer and Federal Reserve Bank dollars under the new "save the banks" TARP program which stared end of 2008 under President Bush and continues today under President Obama, no change except in the name of the President.

Today while I am retired from banking [a mini career designed around getting an MBA at night at bank expense], from US Civil Service (old system, not FERS), from the Air Force (6 active and 25 reserve years), I am since USCS retirement at age 55 [today I am going on age 70] a real estate Broker, selling, not owning nor managing, I avoided those roles as had enough of running things responsibility in my earlier careers. Technically I newly, only, do buyer or seller referrals within my realty firm, the pace of which currently is pretty flat!

Here is what I observed that directly contributed to the mortgage and real estate collapse we are now in, which you can now see is preceded by years and years of bad wholesale international loan making to both governmetns and commercial/financial institutions both overseas and at home which do business overseas (MHTCo. was "a" banker to the top 100 US corporations in my day, including Chrysler Corporation)...which we all know is near it's financial death for the umpteenth time:

a) Mega relocation firms like USAA got too greedy (I am a 47 year member) and opened it's financially and economically sound conservative membership to all ranks. This action brought in your worst credit scores and credit risks in the history of credit scoring and credit management. *Do you remember, you older troopers, when an enlisted man below the pay grade of E-5 had to have his commander's permission to get married? When today's AAFES had no credit cards, you had to pay cash? Etc.

b) USAA's mortgage side has guided borrowers to 80/20 mortgage loans instead of doing VA morgages (which formerly were almost no money down, fixed 30 year interest rates and assumable to a qualifed buyer when you have to resell due to miliary moves, etc.) but never used FHA mortgages even though FHA criteria parallels VA guaranteed mortgages and both are the safest style of mortgage for a USAA member-buyer and the safest style of mortage, as VA and FHA are federally insured mortages, to USAA mortgage company as the lender.

c) Credit scores were more and more ignored by folks like USAA, as well as big mortgage makers in general like Wells Fargo, CITI, they all went bezerk over making an ever increasing "buck" when sanity and proper credit evaluations on the mortgage lender side should have either avoided making many of the mortgages now in foreclosure or these should have been only made unless when/if buyers improved over a period of years their credit history, not some hokus pokus smoke and mirrors as was done to "clean up instantly" bad credit buyers.

d) The allegation that the mortgage companies created today's housing and economic collapse, which has spread worldwide, is true, no point in blaming other things for our plight.

Now, today, as a USAA Member, those of us who are currently USAA Members are faced with USAA overnight deciding to keep the higher profit from Federal Reserve discount window loans at .5% per annum interest... and USAA has artificially self created a floor of 6% interest as their benchmark to which they have applied a 2% add on...guys and gals...this takes your USAA credit card interest, overnight, in disregard to all prior written covenants with you and me, from a January 2009 credit card interest rate of 5.75% up to a February 7.75%, at a cost to USAA of money of half of one percent, making a gouging profit of 7.25%, which profit formerly was strong already for USAA at net 5.25% credit card profit.

If you have followed me to this point, I am stopping now.

Our real estate firm here locally was failing last fall. Our ownership merged with a larger firm, but both firms did and still do relocations from USAA via a large umbrella holding company of our company's brand name (national brand name.)

USAA is a prime example of what is compounding and killing clean, honest credit restarts in our economy by overreacting to the financial collapse and gouging good, high credit score members like you and me in collateral areas such as their credit card division to try to offset losses in their mortgage division (company). Thanks to dumb, greedy decision making by these mortgage making giants a first time buyer today faces even with a VA guaranteed mortgage a compound cost of about 10% to buy and close a home...and conventional mortgages are still being pushed which means 20% down today, plus closing costs. These standards are applied to good credit history and scores innocent buyers when less greedy mortgage making sprees through 2007 and the first half of 2008 would have averted the collapse we now are deeply in. Too many years, 15-20 years of heavy greed by all major mortgage makers got us in the mess we are in today. Greed, just one word, and sloppy or even dishonest among some mortgage makers documentation to qualify weak borrowers who had no business being loaned to.

Do you think our men and women in uniform deserve to have their credit cards, USAA, jacked up to robber profits when their credit scores are good and they have not defaulted on card payments, mortgage, car, or any other financial obligation paymens? How about the robber baron increased interest rates on almost all bank credit cards, to include CITI and JP Morgan Chase Bank?

I sure think we all in the military community deserve honest banking without gouging profit all over again, this time with the effect of killing off honest credit growth that would be sustainable to help revive our economy...as a corporate fright reaction to years of bad credit decisions in their own mortgage company where they knew many then new mortgages should not have been made as the people in many instances they "pushed" and enabled to borrow were proven lousy credit score risks. Greed, greed, greed.

[Ski]

The economy is not bottoming out right now. Please do not get deluded into thinking this is the bottom.

There is still a lot of room to fall. The Europeans are in real trouble minus the French and a lesser extent the Germans. Housing is dead in the US. Credit is very hard to get for anything. The consumer confidence index dropped by 30%. Unemployment numbers are still rising.

The first indicator is to identify where and when unemployment bottoms out at. That means three quarters of static performance. Then add 2 additional quarters after that to start seeing any kind of growth at all.

Unemployment is going over 10% this year - using the offical government numbers which are badly calculated and often revised two or three times every month. Also does not count underemployed or those off the dole.


I wouldn't buy anything right now - other than whatever you are dollar cost averaging at the moment - and wait another 3-6 months. The global economy is going to get far worse as well, with ripple effects hitting us sooner than later.

I can't believe a company like General Electric is trading at $8 a share.

[George L. Singleton]

Ski, and I think the 10% unemployment figure nationally will be occur before mid-summer, if not sooner.

Yes, this is a long term depression, not a silly recession, as some keep trying to fool us into believing.

In short, when the US catches a cold, then the rest of the world's economies get pneumonia.

So, since the US economy now has pneumonia, what can you then expect in overseas economies?

Ireland is one I am watching closely right now, it is in awful shape.

Hate to reinforce such negative info but that is the way it is.