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The Bailout... are you watching?


MichaelSaulnier
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Markets will almost always self correct if left alone.

 

I find it interesting that the Fed was created in 1913 to manage monetary policy. Seventeen years later a recession was turned into the Great Depression, largely due to mismanaged monetary policy. More mismanaged government policies and tinkering by the FDR administration probably did more to prolong the depression than had they minimized their relief efforts.

Fast forward to the past three decades: government decided to try to implement social engineering by managing the mortgage industry, which it had no business doing, by dictating lending standards and demographic quotas. It then decided to get into the lending business by propping up and 'guaranteeing' a sure-to-fail system through Fannie Mae and Freddie Mac. And here we are....

 

I'm not saying we don't need regulation or oversight. But what we have here is meddling, and no matter how well intentioned it is, the results are unmistakable.

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A traditional mortgage is collateralized by the house. These re-packaged default swaps and mortgage-backed securities were a step removed from any tangible asset. They were also clearly over-valued. Now, the houses that underly these defaulted loans were overvalued too. The market is declining to a level that more closely reflects what things are worth in dollar terms. And really, is that McMansion worth $750,000? Is a Mercedes worth $80,000?

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I wish we had a presidential candidate who would articulate exactly what you have just said.

 

We are probably going to elect Barack Obama because all many people know is that there is a crisis and he represents "change". Well, when Mr. Obama is elected, we will get change. Unfortunately, his change is massive amounts of new governmental regulation and lots more taxes.

This is despite the fact that he has duped most Americans into believing they will get a tax cut and it is the evil corporations and wealthy people who will shoulder their burden.

 

Everybody wants something for nothing. Everyone wants new government programs as long as somebody else pays for it. This attitude is precisely what got us into this mess, and more of the same has little chance of getting us out of it.

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A traditional mortgage is collateralized by the house. These re-packaged default swaps and mortgage-backed securities were a step removed from any tangible asset. They were also clearly over-valued. Now, the houses that underly these defaulted loans were overvalued too. The market is declining to a level that more closely reflects what things are worth in dollar terms. And really, is that McMansion worth $750,000? Is a Mercedes worth $80,000?



Bill, I find myself reading many of your posts, and nodding my head in agreement, but I have a different point of view on this one.

It's not that the derivatives were "overvalued", as you put it. It's that they were "overleveraged". At 40:1 ratios, when things go even a little bad, they go a LOT bad. a 2.5% negative means your underlying equity is gone. A mere 5% decline means you've lost double your equity. And when things go a LOT bad... where there's uncertainty that drives the price to pennies on the dollar... you get to where we are today.

As far as the value of something... well, it's what someone is willing to pay. There's no "real" way of deciding the value except for this. As long as there are buyers willing and able to buy McMansions for $750,000 it's an accurate reflection of the "value".

Many factors impact both the "willing" and the "able" aspects of my statement. Willing has more to do with wants and needs, as well as "faith" in the future. Able is the ability to have cash or credit to buy.

Sadly, in a market like we're in now, both the willing and able are in trouble.

M

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I think "willing" is going through a serious crisis. I think "able" will come around first, but consumers will be more conservative once the lending thing get straightened out. I think there will be a big drop in people moving from a "starter home" to larger digs, and people will be closely watching their wants vs. needs decisions.

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I think "willing" is going through a serious crisis. I think "able" will come around first, but consumers will be more conservative once the lending thing get straightened out. I think there will be a big drop in people moving from a "starter home" to larger digs, and people will be closely watching their wants vs. needs decisions.

 

That is an optimistic idea.

The very fact of the bailout means that the government is encouraging people NOT to closely watch their wants vs. needs! And guess who gets to pay for it: Those of us who DID watch our wants vs. needs!

 

Even though I am still supporting John McCain as the way lesser of two evils, McCain's plan to buy up mortgages makes me want to puke.

 

It's way past 1984, but BIG BROTHER is on the way unless we as citizens will do something to stop it.

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A couple o thoughts , without getting too political.

 

First off, I'm as guilty as anyone else for borrowing money......3 cars and a house, but for the past 2 years I've been able to afford it.

 

Secondly, whether you are conservative or liberal, it is a bit naeve to think that the U.S. alone can stop this mess with $700 billion. The entire WORLD is in panic now. Iceland went bankrupt. The EU is in panic.

 

Personal greed is the cause of this mess. Perhaps giving to the REAL POOR would help the world right now.

 

A more positive attitude would also help. Saying that the DJIA is going to crash every 10 minutes doesn't help either. Some will turn it around and make money by buying cheap shares in GM and Ford etc.

 

Do you still have a home over your head? Be thankful. There are still many with much less.

 

Dan

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I'm seeing some very possitive things in all of this.

One, oil prices are falling, so are the prices consumers pay for fuel.

Second, interest rates are on the way down again.

Third, and I know this hurts a lot of us with 401K's and houses that we count on for value, but the market is adjusting. I always had a feeling that housing had to make a correction sooner or later. I did not quite realize why, but I felt it was growing at a crazy rate. I look at it this way. Everything I put into my 401K is buying a lot more stock than it used to, so "if" and when the market rebounds, I stand to make more. I can afford my house so I can live with a lower value thinking that over the next 10-15 years it will rebound some.
Obviously, I am not retired yet. My feelings on that issue would surely be different if I were drawing retirement money now and finding that I just don't have enough anymore. But, for me, what's happening right now is not sending me into a panic. I worry more about everyone else getting scared. Fear is the number one enemy in economic downtimes.

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As someone said, we now have everything to fear from fear itself. People are lemmings when the poo hits the rotating air foil. They will screw themselves in the process of trying to get out with everything they can before someone else does.

It kind of makes one look more kindly on those people who said that allowing individuals to invest in the stock market is a bad idea because they have no idea how it works and will make it too volatile.

It seems to me that at some point here before too much longer people and institutions with the means are going to wake up and see that, even if it goes down further it's purely a short term, panic driven issue, and start buying stuff up. Someone with the bucks to load up right now I bet would probably make a killing four or five years out.

But, anyway, I guess this is one advantage to being dirt poor. I have almost nothing to lose.

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It kind of makes one look more kindly on those people who said that allowing individuals to invest in the stock market is a bad idea because they have no idea how it works and will make it too volatile.




Of course it's a bad idea. But if people want a free market, this is what they get.

Just let it be a free market when it fails.

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It's kind or hard to see how this could go much further without those people and institutions with the means to come to the conclusion that there are deals of a lifetime out there and starting to buy up stocks in a pretty significant way. Given that the current drop is probably way beyond anything related to fundamentals and is purely fear driven, even if it goes down some more, it seems like those folks with the means to load up right now would make a killing four or five years out.

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Of course it's a bad idea. But if people want a free market, this is what they get.


Just let it be a free market when it fails.

 

Now if they'd just let it remain a free market to correct itself. But no, this is an election year, so all kinds of idiotic and expensive things are going to be foisted on us in the name of "doing something" and "fixing the problem" that will remain with us long, long after they've forgotten about it and are onto something else.

 

 

Ironically, had the governments the world over stopped propping up this house of cards years ago and let corrections occur normally, we wouldn't see the magnitude of the crisis we see now. Kinda like government "managing' forests by putting out every burn that happens. Then when one huge lightning storm comes along that can't be managed, there is so much fuel laying around that should have been burned long ago incrementally that the whole thing goes up for weeks.

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Now if they'd just let it remain a free market to correct itself. But no, this is an election year, so all kinds of idiotic and expensive things are going to be foisted on us in the name of "doing something" and "fixing the problem" that will remain with us long, long after they've forgotten about it and are onto something else.



Ironically, had the governments the world over stopped propping up this house of cards years ago and let corrections occur normally, we wouldn't see the magnitude of the crisis we see now. Kinda like government "managing' forests by putting out every burn that happens. Then when one huge lightning storm comes along that can't be managed, there is so much fuel laying around that should have been burned long ago incrementally that the whole thing goes up for weeks.



Yep. +1

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Back in the late 80s I sold mortgages for a time. I was just starting to understand how it all worked ( I still don't completely; I don't think anyone really does anymore).

 

Anyway one of the oldtimers there explained it like this:

 

Say I ask you to loan me a dollar. And you say sure, but I don't have it on me right now. I'll write you an IOU. And that dollar is going to cost you $1.10.

 

Now let's say I take that IOU and think hey, I can issue my own IOU and so I find someone else to borrow that $1.10 for $1.20. And then that guy decided to get in the game and he loans that IOU dollar for $1.50. And on it goes, that dollar being constantly re-loaned at ever higher profit margins. In fact, someone gets the idea that if I count the IOU as an asset to be used for collateral, I can borrow more IOUs and sell them, too. And on it goes everyone buying and selling IOUs. It hums along nicely, until--

 

the last guy wants to cash in. Or someone along the chain needs liquid assets in a hurry. So a chain reaction starts happening-until it gets to the original dollar lender who, as it turns out, had to spend his dollar elsewhere and now no longer has access to it. So the whole thing starts to unravel:

 

That is until your uncle Sam steps in and says "I'll guarantee your loan". So the whole house of cards remains standing and buying and selling resumes it's same intensity.

 

This in a nutshell is a simplistic illustration of how we got into this mess. Except that up until the crash, those IOUs were trading at 80 to one or more: 80 dollars in credit being sold for every actual dollar in the well. You don't have to be a financial genius to see where that was headed and how damaging government (uncle Sam's) interference could ultimately be. Not only was the house of cards allowed to stand and expand, but the guys who allowed greed to cloud their judgment remained unpunished by the consequences of their actions. Which means that as soon as the market "recovers", it's all going to start up again.

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So now, it looks like the Treasury is planning to purchase preferred stock in financial institutions in addition to or instead of purchasing the toxic assets.

I wonder how the list of contributors to the political parties will correlate with the list of financial institutions that get federal capital infusions.

Also, it's a little sad for tiny Iceland.

They got smacked in the face by this crisis, and it looks like they're gonna have to leave the european depositors holding the bag.

I think it's gonna be a great time to travel to Iceland soon... their currency has been destroyed and the exchange rate with the dollar and euro has gone through the roof.

M

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Back in the late 80s I sold mortgages for a time. I was just starting to understand how it all worked ( I still don't completely; I don't think anyone really does anymore).


Anyway one of the oldtimers there explained it like this:


Say I ask you to loan me a dollar. And you say sure, but I don't have it on me right now. I'll write you an IOU. And that dollar is going to cost you $1.10.


Now let's say I take that IOU and think
hey, I can issue my own IOU
and so I find someone else to borrow that $1.10 for $1.20. And then that guy decided to get in the game and he loans that IOU dollar for $1.50. And on it goes, that dollar being constantly re-loaned at ever higher profit margins. In fact, someone gets the idea that if I count the IOU as an asset to be used for collateral, I can borrow more IOUs and sell them, too. And on it goes everyone buying and selling IOUs. It hums along nicely, until--


the last guy wants to cash in. Or someone along the chain needs liquid assets in a hurry. So a chain reaction starts happening-until it gets to the original dollar lender who, as it turns out, had to spend his dollar elsewhere and now no longer has access to it. So the whole thing starts to unravel:


That is until your uncle Sam steps in and says "I'll guarantee your loan". So the whole house of cards remains standing and buying and selling resumes it's same intensity.


This in a nutshell is a simplistic illustration of how we got into this mess. Except that up until the crash, those IOUs were trading at 80 to one or more: 80 dollars in credit being sold for every actual dollar in the well. You don't have to be a financial genius to see where that was headed and how damaging government (uncle Sam's) interference could ultimately be. Not only was the house of cards allowed to stand and expand, but the guys who allowed greed to cloud their judgment remained unpunished by the consequences of their actions. Which means that as soon as the market "recovers", it's all going to start up again.



Of course all banking is based on the concept of multiplication of assets to loans. I believe that any normal bank is allowed to loan 9 dollars for every dollar of deposit and equity they have. This is a fixed required number by the Federal Reserve, and is considered "conservative".

One of the reasons for today's problem, as you mention, is that many of the derivatives were created by non-bank entities, often as insurance instruments, that were outside the bank rules, so the 9:1 ratio was completely out the window.

In fact, the unwinding of Lehman Bros is hurting a lot, because LB had insured so many derivatives against a decline, and now they may only be able to pay out about 10 cents on the dollar of the claims for those insurance policies. In the coming days and weeks we may see a significant number of other financial institutions be forced to record big losses as the numbers hit their balance sheets, which had previously been marked to reflect the insured amounts.

M

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