September11
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Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 7:38 pm

I think I am little disoriented after reading numerous publications on declining economy. I can't quite put my finger on what caused current world economic woes. Can you?
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Klaus
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 8:15 pm

Lack of proper state oversight (primarily in the USA and Britain, but to some extent elsewhere as well) allowing basically a gigantic pyramid scheme being created primarily by banks which promised illusionary returns on "investments" which were actually just wasted and consumed for the most part. Everything else followed from there.

Unregulated capitalism on the loose running into the usual greed-induced feeding frenzy and as usual in such cases leading to a major crash.

Basically the financial equivalent of a drinking binge with a temporary high, resulting in a prolonged recovery with probably some permanent damage.
 
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ER757
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 8:49 pm



Quoting Klaus (Reply 1):
Basically the financial equivalent of a drinking binge with a temporary high, resulting in a prolonged recovery with probably some permanent damage.

Nice analogy  drunk   fever 

What I've been thinking about lately is - for the U.S. at least, things seem to have collapsed disproportionately to the true state of affairs. Unemployement is about 8 - 9% which means more than 90% of people still have jobs. Mortgage defaults are less than 10% which means 90% of people are still paying on time. So, why are the banks all bleeding red ink when only 10% of their loans are toxic? I am no economist (obviously) so I hope someone can explain it.
 
PPVRA
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 8:52 pm

Our flawed central-banking system and a monetary policy called "Quantitative easing".
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par13del
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 8:58 pm

Here's another one, a new way to define success. Company loose 1 billion dollars with a projected loss the following year of 1.5 billion. Fire CEO, hire new CEO, company looses 1.2 billion and not 1.5, pay the CEO a huge bonus for the success of the company.

Millenia ago, bonus's were paid by companies making money, not loosing it, new financial times lead to new workers whose focus is not in the ultimate success of the company, but the numbers required to be regarded as a success.
 
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Dreadnought
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 8:59 pm



Quoting Klaus (Reply 1):
Lack of proper state oversight (primarily in the USA and Britain, but to some extent elsewhere as well) allowing basically a gigantic pyramid scheme being created primarily by banks which promised illusionary returns on "investments" which were actually just wasted and consumed for the most part. Everything else followed from there.

Unregulated capitalism on the loose running into the usual greed-induced feeding frenzy and as usual in such cases leading to a major crash.

Thanks for the anti-capitalist talking points, but I think he was looking for real information.

Ever since the arrival of the credit card in the 60s, we've become a nation that puts everything on credit.

Buying a house on mortgage is understandable and valid - it's been done that way for centuries, it's a long term investment and as long as the buyer has skin in the game (i.e. assumption of risk by putting some of your own money) it makes sense. Cars too, with the same caveats.

But now you have millions of people who buy cars and house on credit with no money down. You buy furniture on credit. Go to Best Buy and buy TVs, DVD players, stereos and kitchen appliances on credit. You can even get a credit card for buying stuff at Target, for pete's sake. It fueled our economy for a while, but now everyone (broadly speaking of course) is overleveraged.

Here is the painful part. Our government in Washington is telling banks that they should start lending again to consumers. NO! That's not what we need. That's what got us in trouble, guys - lending to people who could not afford what they were buying. It's got to stop. Credit card limits should be capped at 10% of your annual salary (in total - whether you have 1 or 5 cards). Credit purchases for furniture, stereos etc. should be shut down. Houses and cars should not be sold on credit unless you can put at least 20% down.

That means no more ARMs, no more sub-prime mortgages. If you can't afford to put in the 20% down payment, and you can't apply your 401k or IRA towards it, sorry, you'll just have to rent. A nice home in the suburbs is not a right - it's something you have to earn.

That will necessarily mean a market contraction, maybe by as much as 20 or 30%, all in one year. The good news is that the correction will happen quickly, and within a year demand should be back to normal, I should think. But no question, in the short term it would be a hard knock, and no politician will accept it (none of our current bunch anyway).

Another thing to do is to revise mark-to-market rules, which forced otherwise profitable banks to take huge losses on unrealized market fluctuations. All the banks and mortgage-holders which had a lot of property in markets where the housing prices have dropped were forced to rewrite the asset values by up to 40-50%, even if the homeowners were doing fine and paying on time. The law should be rewritten to not force a revaluation unless the homeowner is more than a month in arrears.

But of course, I have not heard any politician talk about these steps. They just want the banks to "start lending again", so that we can put ourselves from the fire right back into the frying pan where we started, instead of turning down the heat.
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Klaus
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 9:00 pm



Quoting ER757 (Reply 2):
Unemployement is about 8 - 9%

The numbers reduced to only those people getting unemployment benefits are deceptive.

Quoting ER757 (Reply 2):
So, why are the banks all bleeding red ink when only 10% of their loans are toxic?

Because the actually failed or failing loans are just the tiny tip of the iceberg (or the pyramid, in keeping the image). The huge bulk of the problem is the mass of speculative derivatives hooked to the original loans which — without proper oversight — have become a much larger problem by themselves. Without the derivatives neither the extent of lending nor the extent of financial consequences for the entire system would have happened.

Quoting PPVRA (Reply 3):
Our flawed central-banking system and a monetary policy called "Quantitative easing".

Not the cause. Just a marginal influence on the side.
 
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Dreadnought
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 9:00 pm



Quoting ER757 (Reply 2):
So, why are the banks all bleeding red ink when only 10% of their loans are toxic? I am no economist (obviously) so I hope someone can explain it.

That relates to mark-to-market. I explain it briefly above.
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AirframeAS
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 9:06 pm



Quoting September11 (Thread starter):
Exactly What Caused Current World Economic Woes?

The media.
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Klaus
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RE: Exactly What Caused Current World Economic Woe

Tue Mar 10, 2009 9:07 pm



Quoting Dreadnought (Reply 5):
Thanks for the anti-capitalist talking points, but I think he was looking for real information.

Ever since the arrival of the credit card in the 60s, we've become a nation that puts everything on credit.

Sorry, but unregulated capitalism is the clearly verifiable cause of the problem here.

The lack of oversight of the derivatives market in the US and Britain have been the root cause for both the defaulting "investments" which now paralyze the financial system and for the much smaller problem of actually defaulting loans. Without the leverage introduced through derivatives this would be a much smaller problem, if it would exist at all.

The fuel for the overextended credit lines was the unregulated derivatives market. Without that there would not have been the credit volume available you're (justifiably) critical of.
 
Mir
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 9:18 pm



Quoting September11 (Thread starter):
Exactly What Caused Current World Economic Woes?

Very simply, the perfect storm union of:

A) People who buy things with money they don't have
B) People who sell to people without regard to whether they will be able to get paid or not.

Both are going to have to stop.

-Mir
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AirframeAS
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 9:20 pm



Quoting Mir (Reply 10):
A) People who buy things with money they don't have
B) People who sell to people without regard to whether they will be able to get paid or not.

Add:
C) The media who speculates that something might happen that will produce more fears into citizens.
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Dreadnought
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 9:45 pm



Quoting Klaus (Reply 9):
The fuel for the overextended credit lines was the unregulated derivatives market. Without that there would not have been the credit volume available you're (justifiably) critical of.

If the government had not stuck it's nose in the business in an attempt to do social engineering, there would not be any such things as "sub-prime" mortgages to go bad in the first place. Only the government could pressure the industry into offering excellent credit terms with no money down, and little in the way of creditworthiness or revenue checks. Without government involvement, all mortgages would have a reasonable percentage of money down as a requirement, and banks would have ensured that the applicant had a solid credit history and sufficient revenue. The only reason they relaxed on those rules were that 1) govenment told them to, and 2) government created Fannie and Freddie to help liquidate and resell them.

It's the law of unintended consequences - government tries to make housing cheaper, and ends up blowing up the industry.
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Flighty
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RE: Exactly What Caused Current World Economic Woe

Tue Mar 10, 2009 9:52 pm

First, things really aren't that bad. The world is a little screwed up but it will unscrew itself. There is more wealth-creating material lying around than ever before. Happily, a lot of it is environmentally friendly too.


I would say the media was hyping a "coming recession" way back early in 2007, when all was well. It started when gas prices rose. Traditionally, some say "oil shocks" can cause economic crises. It might have done that through the mortgage market.

But, no need to blame anyone outright. The US government, as voters commanded, supported unsustainable bubble home buyers and had a mandate to hold up prices on them. Low interest rates result in home prices spiking, which voters just love. Tax benefits to mortgages also cause home prices to spike, which voters also love. So the voters wanted this campfire.

The "crisis" has also made some things clear about executive compensation. They were compensated asymmetrically when gambles paid off (i.e., for $100 million extra, the executive could pocket $10 million). Yet, when the gambles lost, did the company charge the executive for the loss? Did they send them to a torture chamber? Unfortunately not. The point is, asymmetric executive rewards for risk-taking put them out of step with shareholders. This caused for example, the shareholders of AIG or Citi to lose all their wealth. Oops! But the executives got paid anyway. Of course, that strategy was disastrous for shareholders and the financial system. Ideally, an executive will be just like a shareholder (say, locking their shares up for 6-8 years after they leave). Shareholders absolutely hate losing all their money. This is a good safety mechanism, or it should be.

Here is how the gambling went in Vegas terms. An executive can go to Vegas with a $1 billion bankroll, and play hands of poker. 99 times out of 100, he can walk away with $10 million profit. He looks so smart! But it was easy, because he had such a big bankroll, he never ran dry on losing streaks! So he almost always won. The other 1 time out of 100, he loses the whole $1 billion. Oh dear! Maybe it is time to "pursue other interests" at the ski home in Aspen for Mr. Executive. Can't win 'em all, he tells cleaned out shareholders.

So in reality, he was not creating value, he was simply gambling, with zero value creation. By risking the entire bankroll, he put the entire company at risk, which resulted in some good years, always with a risk of disaster. The problem is, the executive will pursue the "disaster" strategy unless his incentives are created otherwise. They are paid well to take inappropriate risks, so that is what they do.
 
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STT757
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RE: Exactly What Caused Current World Economic Woe

Tue Mar 10, 2009 9:57 pm



Quoting September11 (Thread starter):
I think I am little disoriented after reading numerous publications on declining economy. I can't quite put my finger on what caused current world economic woes. Can you?

What started everything was the outrageous spike in the price of oil, it was being manipulated by speculators and no one in power (particularly oil friendly Bush administration) wanted to try and reign that in. The spike in oil prices meant big businesses started to stop growing which lead to suppliers and other smaller businesses to start laying people off which meant some individuals who were living pay check to pay check started to default on their mortgages, which caused a glut of foreclosed homes which tanked existing home prices which in turn lead to home builders not being able to sell new homes and that popped the housing bubble which had been building to absurd levels in some parts of the Country.

The mortgage crisis then sparked the financial crisis, banks and investors quickly realized they were up to their necks in bad loans and mortgages they should not have approved. Not only that but these banks were allowing investors to come in and invest in these bad assets, which caused the investment community to tank.

And now we are where we're at.
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Klaus
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RE: Exactly What Caused Current World Economic Woe

Tue Mar 10, 2009 9:58 pm



Quoting Dreadnought (Reply 12):
If the government had not stuck it's nose in the business in an attempt to do social engineering, there would not be any such things as "sub-prime" mortgages to go bad in the first place.

There wouldn't have been many if any sub-prime mortgages if derivatives hadn't allowed the banks to inflate their lending without actually having the capital to back them up.

The mortgages are not the root cause of the problem, nor the cause of its massive extent which by far exceeds the volume of the mortgages themselves.

Without the artificial (and illusionary) leverage through derivatives lending would have remained constrained and even the same number of defaults would have been just a nuisance. The massive crash and financial market paralysis we're seeing now has been caused by unregulated (and largely fraudulent) speculation.

It's almost a textbook example of why proper regulation is essential to keep capitalism stable and viable in the long run. If greed and egoism run free, the market will end up in wild oscillations which can lead to self-destruction of the entire system. Pretty much like any self-reinforcing system without proper damping.
 
757gb
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 10:00 pm



Quoting Dreadnought (Reply 5):

Thanks for that post. It explains a few things I've been trying to understand.

Regards,
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Dreadnought
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 10:15 pm



Quoting Klaus (Reply 15):
There wouldn't have been many if any sub-prime mortgages if derivatives hadn't allowed the banks to inflate their lending without actually having the capital to back them up.

The mortgage-based derivatives were a reaction to having to sell these mortgages in the first place. You are putting the chicken in front of the egg.

Housing prices rose steadily for the past 100 years, accelerating a little with the first CRA and then skyrocketed in the 90s when Clinton really stepped on the gas. If housing prices fell across the board around 50%, we should be about back where we should be according to the 100 year trend.

Ironically, doing the reforms I recommended and allowing the markets to fall would result in far more affordable housing than the government was ever able to accomplish  Smile
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prebennorholm
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 10:26 pm



Quoting September11 (Thread starter):
I can't quite put my finger on what caused current world economic woes. Can you?

It is three different things.

3 x G

Governance, greed and Greenspan.
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Flighty
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RE: Exactly What Caused Current World Economic Woes?

Tue Mar 10, 2009 11:38 pm



Quoting STT757 (Reply 14):
What started everything was the outrageous spike in the price of oil, it was being manipulated by speculators and no one in power (particularly oil friendly Bush administration) wanted to try and reign that in.

I would love to say you're wrong. But oil was such a big drag on us at the moment when we had no cash to spare. We should not have been so vulnerable to it. We had a big huge problem that the oil spike may have helped uncover.

The "crisis" happened because of the law of large numbers. The crisis COULD happen so eventually it did. It was destined to happen. The policies and laws we had locked us into this result. We had no safety mechanisms to prevent these diseases from happening. But we are learning, hopefully.
 
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Tugger
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 1:10 am



Quoting Dreadnought (Reply 12):
Without government involvement, all mortgages would have a reasonable percentage of money down as a requirement, and banks would have ensured that the applicant had a solid credit history and sufficient revenue. The only reason they relaxed on those rules were that 1) govenment told them to, and 2) government created Fannie and Freddie to help liquidate and resell them.

It's the law of unintended consequences - government tries to make housing cheaper, and ends up blowing up the industry.


You are being far too simplistic in your placing of blame, the government does share some of the blame but so does business since it did not regulate itself and find a balance point as both the administration and Greenspan thought it would. The crisis is due to a combination of factors, and party and administration errors that lead us to where we are today. As an example of a counter argument:

The requirements were still there, the banks didn't have to make the loans if they did not operate in the area. And when they did make loans that conformed to the CRA they were very careful about the applicants and the stats show the default rate on these loans were not worse than the industry average.... until CDO's came along and disconnected risk from the loans. Then the banks didn't care about anything but the fees they could make off the loans since they would just sell them quickly to the market.

Also the congress, as a whole, put new requirements on Fannie and Freddie which opened the price escalation even more when they passed requirements that Fannie (or Freddie) use third party property value estimators. Republicans liked it because it placed more of the process into private business hands, Democrats liked it because it allowed more loans to be processed. Prior to this Fannie used their own estimators who did far more research and at a much slower pace, with the third part estimation banks influenced them and could get "an estimate to justify the loan". This helped lead to the insane home price escalation.

Quoting Dreadnought (Reply 17):
The mortgage-based derivatives were a reaction to having to sell these mortgages in the first place. You are putting the chicken in front of the egg.

Remember the whole "chicken or the egg" thing is about "which came first" since you need one to have the other. And the derivatives were not a reaction CRA mortgages, they were around a long time before and their use for sub-prime loans was a reaction to the loosening of lending standards the business friendly Bush administration encouraged. You can see this by the fact that it wasn't until the Bush era changes in regulations came about that CDO's became vehicle for sub-prime loan offloading. I am not saying that loosening standards is the wrong thing to do but that to do so and also decreasing regulatory oversight is not wise.

Quote:
From 2003 to 2006, new issues of CDOs backed by asset-backed and mortgage-backed securities had increasing exposure to subprime mortgage bonds. Mezzanine ABS CDOs are mainly backed by the BBB or lower-rated tranches of mortgage bonds, and in 2006, $200 billion in mezzanine ABS CDOs were issued with an average exposure to subprime bonds of 70%.

http://en.wikipedia.org/wiki/Collate...bligation#Subprime_mortgage_crisis

Quoting Dreadnought (Reply 17):
Housing prices rose steadily for the past 100 years, accelerating a little with the first CRA and then skyrocketed in the 90s when Clinton really stepped on the gas. If housing prices fell across the board around 50%, we should be about back where we should be according to the 100 year trend.

The CRA was not the reason for the failures, the banks offloading of all risk and the reduction in regulatory oversight was. That in conjunction with the enabling of Greenspan opened up a can of home price escalation the ran on for almost two decades.
The CRA itself was first implemented in 1977 and the Bush administration and congressional Republicans has a chance to change it and address the concerns in 2005 but did not do anything. If the CRA was to blame why did it not have any effect until the last eight or so years? Once you uncouple risk from the loans that the banks make you can guess what happens. And did.

Quote:
Fresh off the false and politicized attack on Fannie Mae and Freddie Mac, today we’re hearing the know-nothings blame the subprime crisis on the Community Reinvestment Act — a 30-year-old law that was actually weakened by the Bush administration just as the worst lending wave began. This is even more ridiculous than blaming Freddie and Fannie.

The Community Reinvestment Act, passed in 1977, requires banks to lend in the low-income neighborhoods where they take deposits. Just the idea that a lending crisis created from 2004 to 2007 was caused by a 1977 law is silly. But it’s even more ridiculous when you consider that most subprime loans were made by firms that aren’t subject to the CRA. University of Michigan law professor Michael Barr testified back in February before the House Committee on Financial Services that 50% of subprime loans were made by mortgage service companies not subject comprehensive federal supervision and another 30% were made by affiliates of banks or thrifts which are not subject to routine supervision or examinations. As former Fed Governor Ned Gramlich said in an August, 2007, speech shortly before he passed away: “In the subprime market where we badly need supervision, a majority of loans are made with very little supervision. It is like a city with a murder law, but no cops on the beat.”

http://www.businessweek.com/investin...hives/2008/09/community_reinv.html
( What's really fun is to read the 'opinions' section that follows this blog article, they get into it almost as well as we do here! Almost...  Smile )

This crisis is as much Capitalist based as it is social engineering but the primary actor was what is normally in between those two ends of the spectrum: Rules, Regulation, Requirements. All of which must be imposed by and controlled by the government to ensure that all players in a market play be the same rules (would you really want to fly on a plane that was not designed to FAA regulations and requirements? EAA is one thing, but for a commercial airliner?). The real problems is separating good government regulation from bad or overly burdensome regulation. And I can't think of anyway to actually change that.

Tugg
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DfwRevolution
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 1:30 am



Quoting Klaus (Reply 1):
Lack of proper state oversight (primarily in the USA and Britain, but to some extent elsewhere as well) allowing basically a gigantic pyramid scheme being created primarily by banks which promised illusionary returns on "investments" which were actually just wasted and consumed for the most part.

The U.S. subprime mortgage crisis may have been the tipping point, but Europe's lending practices are looking significantly worse than the America's problems. And it isn't fair to put Europe's woes on the UK either.

Quoting Klaus (Reply 9):
Sorry, but unregulated capitalism is the clearly verifiable cause of the problem here.

You cannot state this as fact. It may be a well informed opinion, but that is all.

I disagree that unregulated capitalism was the "clear cause" of this mess because the government was massively involved in the economy before things went to hell. You are going to say that we didn't have the right kinds of regulation, which aside from being the most obvious statement imaginable, fails to address the conflict in interests spawned when the government meddles with the financial services of a $14 trillion dollar economy.

Naturally, the purpose of regulation is to establish rules that shape the allowable conduct for those in the financial services sector. That sounds all well and good, but government is totally and completely incapable of stopping there. Two examples are particularly relevant today:

1. The federal government bailed-out the poorly managed Long Term Capital Management fund in 1998

2. Fannie Mae and Freddie Mac, both chartered by the government to alter the financial services market, directly contributed to the crisis by purchasing hundreds of billions of dollars in securities backed by subprime loans

Both actions were taken for short-term gain and gave both spoken/unspoken assurance to the commercial financial institutions that the subprime market was safe. If worse came to worse, the government would intervene. Regulation led to participation which led to a loss of accountability. IMO, I don't think it's possible for the government to simply regulate without getting involved.

Finally, there are successful industries that essentially police themselves and create their own set of standards. How active is the federal government in regulating engineering practices in comparison with financial services? What is the rate of building failures to bank failures? Engineering disciplines have created meticulous building and testing standards because they are completely liable and accountable for their work. When failure is an option, you tend to do so more often.
 
Flighty
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 2:00 am



Quoting DfwRevolution (Reply 21):
You are going to say that we didn't have the right kinds of regulation, which aside from being the most obvious statement imaginable, fails to address the conflict in interests spawned when the government meddles with the financial services of a $14 trillion dollar economy.

About regulation, one thing is antitrust. If we didn't let banks get so big and so connected, (which they wanted), then nothing would have been too big to fail. No financial bailouts would have been necessary (nor should they be!)

That's one kind of regulation we can talk about.
 
cannibalz3
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 2:22 am

This thread is a good one - people all over are asking themselves the same question. Many of the reasons have been highlighted here.
Check out Frontline's show on the economic meltdown for the blow-by-blow. They do a good job of using simple ideas to explain complex happenings without dumbing it down.
http://www.pbs.org/wgbh/pages/frontline/meltdown/view/
 
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WarRI1
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 2:24 am

I cannot say what caused the problem, but here are some ideas how to prevent another finanicial collapse.



http://www.nytimes.com/2009/03/11/business/economy/11fed.html?em
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Pyrex
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 2:32 am



Quoting STT757 (Reply 14):

I would bother posting a picture with the evolution of the default rate in mortgages vs unemployment and oil price but we wouldn't want facts to get in the way of a populist ranting by someone who feels essentially free oil is a god-given right, now would we?

As for the argument about derivatives, Klaus, the true thing is no-one really knows what the NET value of derivatives outstanding really is, so we have no idea how they compare with the value of actual mortgages, other debt, interest rates, commodities, etc. Yes, there are tens of trillions of NOTIONAL value outstanding, but since there is no central clearing house for derivatives no-one really knows the true exposure out there. The reason is simple - if I buy a derivatives contract (face value $1000) from party A for X dollars and then sell it to party B for Y dollars, my net exposure is 0 and the systemic exposure is $1000 (in essence owed by party A to party B, or vice-versa depending on the side of the contract you are in). However, these contracts get counted as two different contracts and so the GROSS exposure is $2000. Repeat this a few times and you suddenly get grossly inflated values for the amount of derivatives out there. No-one really knows what the net exposure is, but since even in the best of t
imes anyone selling (or buying, in the case of futures) a derivative contract needed to post at least some collateral, even if they then traded out of their positions, the actual value of derivatives will be significantly less than 50+ trillion.

That is why letting Lehman fail proved, in hindsight, to be a mistake. Lehman acted in essence as a clearing house - yes they had hundreds of billions of dollars of derivatives in their balance sheet but most of them were netted out internally. When Lehman went under, all their counterparties ran to liquidate their collateral and exacerbated the problem.

Quoting DfwRevolution (Reply 21):
1. The federal government bailed-out the poorly managed Long Term Capital Management fund in 1998

Actually it didn't. The Federal Government promoted a market solution for LTCM, and that was having a group of banks (creditors) pitch in to fund an orderly wind-down of their positions. The partners at LTCM made out with next to nothing (besides what they had already taken out of the business) and the group of creditors actually ended up making money on it. There was no Federal money involved, some banks that chose not to participate did not participate (I am looking at you, Bear Stearns...) and no-one got bailed out.

BTW, LTCM's problems were similar to the ones that faced Lehman - they essentiallyn acted as a clearing house for all their derivative contracts as well.
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PPVRA
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 2:33 am



Quoting Klaus (Reply 6):

Not the cause. Just a marginal influence on the side.

It's the very cause. Nothing marginal about it, those policies have very big impacts.

Quoting Klaus (Reply 15):
There wouldn't have been many if any sub-prime mortgages if derivatives hadn't allowed the banks to inflate their lending without actually having the capital to back them up.

Unfortunately the banks don't have the capital to back much of anything up even if derivatives didn't exist. It's the nature of fractional-reserve banking.

Now if bank failures weren't automatically bailed out or granted cheap credit to cover up their blunders, they might actually pay closer attention to the risks they are taking up. If not they'd be forced to by their creditors.
"If goods do not cross borders, soldiers will" - Frederic Bastiat
 
MOBflyer
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 3:15 am

My understanding is that Bush did it.  Smile
 
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stasisLAX
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 3:18 am

Executive greed - banking industry greed - political greed....

Human greed.
"Those who would give up essential liberty to purchase temporary safety deserve neither liberty nor safety!" B.Franklin
 
Arrow
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RE: Exactly What Caused Current World Economic Woe

Wed Mar 11, 2009 5:30 am



Quoting Dreadnought (Reply 5):
Ever since the arrival of the credit card in the 60s, we've become a nation that puts everything on credit.

I thought the following item was the best explanation I've heard on how we got into this mess:

Subject: Bank Crisis in Terms I Understand

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she decides to allow her loyal customers, most of whom are unemployed alcoholics - to drink now but pay later.
She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around and as a result increasing numbers of customers flood into Heidi's bar.
Taking advantage of her customers' freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit.
He sees no reason for undue concern since he has the debts of the
alcoholics as collateral.

At the bank's corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling  items.

One day, although the prices are still climbing, a risk manager (of course subsequently fired due his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Heidi's bar. However they cannot pay back the debts. Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95%. PUKEBOND performs better,
stabilizing in price after dropping by 80%. The suppliers of Heidi's bar, having granted her generous payment duedates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.

The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties. The funds required for this purpose are obtained by a tax levied on the non-drinkers.

Finally an explanation I understand.
Never let the facts get in the way of a good story.
 
MadameConcorde
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 8:43 am

I hear a lot of talking about derivatives being a critical element amidst this financial crisis.
Can somebody explain derivatives?
How about the central banks printing money and turning it into bonds?

Thank you very much in advance.  cheerful 
There was a better way to fly it was called Concorde
 
redflyer
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 3:30 pm



Quoting Klaus (Reply 9):
Sorry, but unregulated capitalism is the clearly verifiable cause of the problem here.

There's actually quite a bit of regulation in all capitalist systems, including here in the U.S. Some would even say too much. But more to your point, the problem is the very government that should have provided some regulatory oversight turned a blind eye towards what was - in hindsight - a very weak link in an otherwise robust system. Indeed, the government itself not only turned a blind eye, but also meddled in an otherwise stable system.

In the final analysis, and despite our current woes, let's not forget that this robust system has created more wealth and raised the standard of living across much of the globe in the past 2 decades more than at any other time in the history of mankind. And, unfortunately, any economy is going to go through periods of contraction - growth cannot be sustained indefinitely. The key is to keep an eye on the overall system so that when it does contract, it doesn't do so in a crash-and-burn way.

Quoting Dreadnought (Reply 12):

 checkmark 

Excellent post.
My other home is in the sky inside my Piper Cherokee 180.
 
AverageUser
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 4:34 pm

Here's a little something from a rather famous 19th C. theorist:

As a matter of fact, since 1825, when the first general crisis broke out, the whole industrial and commercial world, production and exchange among all civilised peoples and their more or less barbaric hangers-on, are thrown out of joint about once every ten years. Commerce is at a standstill, the markets are glutted, products accumulate, as multitudinous as they are unsaleable, hard cash disappears, credit vanishes, factories are closed, the mass of the workers are in want of the means of subsistence, because they have produced too much of the means of subsistence; bankruptcy follows upon bankruptcy, execution upon execution. The stagnation lasts for years; productive forces and products are wasted and destroyed wholesale, until the accumulated mass of commodities finally filters off, more or less depreciated in value, until production and exchange gradually begin to move again. Little by little the pace quickens. It becomes a trot. The industrial trot breaks into a canter, the canter in turn grows into the headlong gallop of a perfect steeplechase of industry, commercial credit, and speculation, which finally, after break-neck leaps, ends where it began — in the ditch of a crisis. And so over and over again. We have now, since the year 1825, gone through this five times, and at the present moment (1877) we are going through it for the sixth time.
 
baroque
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 5:41 pm



Quoting Mir (Reply 10):
Very simply, the perfect storm union of:

A) People who buy things with money they don't have
B) People who sell to people without regard to whether they will be able to get paid or not.

But you do need to add:

Quoting Klaus (Reply 15):
There wouldn't have been many if any sub-prime mortgages if derivatives hadn't allowed the banks to inflate their lending without actually having the capital to back them up.

to get the full flavour of the disaster. And arguably, even then, the sub-primes might not have gone as well if there had not been criminality involved in those doling out the mortgages. See Miami Herald and earlier threads on the thousands of mortgage salesmen with criminal records.

Quoting Tugger (Reply 20):
Remember the whole "chicken or the egg" thing is about "which came first" since you need one to have the other. And the derivatives were not a reaction CRA mortgages, they were around a long time before and their use for sub-prime loans was a reaction to the loosening of lending standards the business friendly Bush administration encouraged. You can see this by the fact that it wasn't until the Bush era changes in regulations came about that CDO's became vehicle for sub-prime loan offloading. I am not saying that loosening standards is the wrong thing to do but that to do so and also decreasing regulatory oversight is not wise.

Also not mentioned so far is giving the bonds high ratings when they were in fact worse than junk. Anyone still in doubt should watch the Bird and Fortune video on the unemployed man in a string vest.
http://www.wikio.co.uk/video/351257
Add sentiment and appreciation of the market rigorous analysis to other factors mentioned. Mortgages salesman whose salary depends entirely upon selling mortgages ........... dodgy debts ....... structured investment vehicle ....... onsold ......what is in it?..... that is the market. The worst part is that 90% of what Bird says is true including, "It is not us that will suffer it is your pension fund".

Quoting Arrow (Reply 29):
Finally an explanation I understand.

Excellent but you just missed one aspect, Heidi had a number of dishonest bartenders selling the drinks.

Quoting AverageUser (Reply 32):
at the present moment (1877) we are going through it for the sixth time

Shhhh. Mention not his name AU!!!
 
Dougloid
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 6:20 pm

If I had to take a stab at it, I'd list the following.

1. Little regulation and oversight in the financial industry, which led to lax lending practices.

2. The same, which led to the development and widespread off-exchange trade in derivative products.

Parenthetically, I might add, Klaus, that although you're doing a good job playing the victim card for non English speaking financial institutions, those don't speaka de english guys were right in there hip deep wallowing with the rest of the hogs.

So you gotta ask yourself: Who bears the greater moral blame-the bartender who sells booze to a lush, or the lush who uses his rent money to buy the sauce and will not be denied? They're equally blameworthy, and even if you're successful in pinning the tail on this or that donkey, what's it going to do here and now?

And that's if you assume-incorrectly, I think-that finance has a nationality or loyalty.

3. I think that this is the most important factor. The expectation of everyman that it was his right to grow rich and profit regardless of whether he'd done anything to deserve it or had the intelligence to. There's a parallel to the get rich quick mentality of the 1920s that common people had. They'd taken leave of their senses and hocked the farm to play the stock market on margins. Functionally, playing the market on margin money is about the same as using the alleged appreciation of real estate as leverage to finance other things-they're both houses of cards.

In the present era it was the common expectation of everyman that property values would rise 15 or 20 per cent per annum, world without end, amen. Rising tides and all that, leading to leveraged purchases of luxuries. In hindsight it was as unsustainable as it was in the late eighties and early nineties in southern California real estate.

I'm in mind of a story about Bernard Baruch. One day in the spring of 1929, as was his wont, he walked to his office and stopped at the same place every day to get his shoes shined. The shoeshine man gave him what he promised was the hottest of hot stock tips.

Baruch thought about this, and that day he started quietly liquidating his holdings.

The smart money-well, most of it- moved out of the market before it crashed in October of 1929.

I suspect that the same will be shown to be true when the story of this bust is written.
If you believe in coincidence, you haven't looked close enough-Joe Leaphorn
 
us330
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 6:42 pm



Quoting Dreadnought (Reply 5):
Our government in Washington is telling banks that they should start lending again to consumers. NO! That's not what we need. That's what got us in trouble, guys - lending to people who could not afford what they were buying. It's got to stop. Credit card limits should be capped at 10% of your annual salary (in total - whether you have 1 or 5 cards). Credit purchases for furniture, stereos etc. should be shut down. Houses and cars should not be sold on credit unless you can put at least 20% down.

Basically agree with the intent and logic of the argument--don't buy things you cannot afford, and don't make it possible for consumers to do so--but I disagree with some of the individual points. Setting credit limits as a percentage of salary should be looked at on a case by case basis, as well as credit purchases for furniture and stereos. Employing blanket standards could lead to unintended consequences.

Quoting Klaus (Reply 6):
The numbers reduced to only those people getting unemployment benefits are deceptive.

True--doesn't take into account how many people have stopped looking for jobs, or are still receiving severance.

Quoting Klaus (Reply 6):
Without the derivatives neither the extent of lending nor the extent of financial consequences for the entire system would have happened

Disagree. Can't blame derivatives for the entire thing when plenty of things went wrong that were unrelated to derivatives---CDOs and packaged loans, for example, were securities. Granted, the existence of derivatives makes figuring out who owns what and who is responsible for debt a lot more complicated, and certainly didn't help.
Either the derivatives market needs to be abolished, or the Fed needs to start regulating it.

Quoting Flighty (Reply 13):
They were compensated asymmetrically when gambles paid off (i.e., for $100 million extra, the executive could pocket $10 million). Yet, when the gambles lost, did the company charge the executive for the loss? Did they send them to a torture chamber? Unfortunately not. The point is, asymmetric executive rewards for risk-taking put them out of step with shareholders. This caused for example, the shareholders of AIG or Citi to lose all their wealth. Oops! But the executives got paid anyway

That's because the executives were smart and took advantage of the trusting board of directors and had special clauses inserted into their contracts that would cover their rear ends in case bad stuff happened. Were the executives greedy? Yes, but they were only trying to look out for themselves, which is semi-understandable.
Put the blame on the people who let the executives put all these clauses into their contracts--the board of directors and the hiring manager. They were the stupid ones.

Quoting Flighty (Reply 13):
By risking the entire bankroll, he put the entire company at risk, which resulted in some good years, always with a risk of disaster. The problem is, the executive will pursue the "disaster" strategy unless his incentives are created otherwise. They are paid well to take inappropriate risks, so that is what they do.

But how do suggest that we fix that, especially when they have contracts that cover their asses whether or not they succeed?
Setting government mandated limits isn't the answer--the only solution is for the people overseeing the hiring and the like to finally wise up, and for the shareholders to tell company boards that they won't support the hiring of an executive that insists on a golden parachute or clause laden contract.


Two things that have gone unmentioned--the failure of the SEC to prevent some of this stuff from happening.
And the ratings agencies that saw it prudent to label a package of these subprime loans AAA or something similar because they didn't think it would be possible for all of the debtors to default on their loans.
 
Alessandro
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 6:51 pm

So no one thinks population growth has anything to do with it?
It took 150 years for the population to double between 1750 to 1900, today it took 40 years
1969 to 2009. Even with the current improvement of technology it´s definitly putting a strain on things, add expensive wars and you´ll see how everybody is affected.
From New Yorqatar to Califarbia...
 
StarAC17
Posts: 3400
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 7:26 pm



Quoting RedFlyer (Reply 31):
In the final analysis, and despite our current woes, let's not forget that this robust system has created more wealth and raised the standard of living across much of the globe in the past 2 decades more than at any other time in the history of mankind. And, unfortunately, any economy is going to go through periods of contraction - growth cannot be sustained indefinitely. The key is to keep an eye on the overall system so that when it does contract, it doesn't do so in a crash-and-burn way.

It has but where has most of that wealth gone, it has gone to the wealthiest people in not just the US but the entire world. Which is what Reagan preached as president and was continued by both Bushes and even Bill Clinton. For the most part middle class wages have been stagnant if you adjust for inflation, and middle class spending is what drives an industrial economy and in fact a middle class is the biggest thing that separates a developed economy from a developing one. The large wealth gap is also one of the big reasons the great depression lasted so long.

Article about it here:
http://www.usatoday.com/money/perfi/...2006-11-24-luxury-homes-usat_x.htm

The two main reasons that this mess has spread so deeply beyond the banking sector is that middle class people are being smart and not spending frivolously (they are using the "Do I need it mantra") and the facts the banks aren't lending. Also giving money to the top will not work because they are hoarding it and not lending it out which was the point of the bank bailouts in October which many of the banks abused without any guilt what so ever. What has a better chance of working is giving money to people in the middle class and poor who have legitimate debts to pay off where most people are well intentioned.

Now you may say why should be pay for these deadbeats who can't keep up. Well I would say to that consider the circumstances that many are going through, lack of job security which is pretty much everywhere, and plenty of factors that might be out of an individual's control such as a health problem which is the number one cause of bankruptcy in the US. If they do pay off their debts that money goes to the banks and they have more capital and less troubled assets. Barack Obama I feel is doing his best to do this but its tough for him to make everyone happy because this pisses off the rich and they scream class warfare.
Engineers Rule The World!!!!!
 
Flighty
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 8:30 pm



Quoting Us330 (Reply 35):
Put the blame on the people who let the executives put all these clauses into their contracts--the board of directors and the hiring manager. They were the stupid ones.

Agree 100%. Though, sometimes executives set their OWN rules and defrauded the shareholders. But, that should have been prevented. Solution to that is unfinished business.

Quoting Us330 (Reply 35):
But how do suggest that we fix that, especially when they have contracts that cover their asses whether or not they succeed?
Setting government mandated limits isn't the answer--

Well, one answer is to scientifically investigate how those contracts result in predictable blow-ups and disasters. Once those are considered "blow-up" and/or "disaster" contracts, perhaps the mood might change. "Chuck is a good executive, so why does he want a blow-up contract? Does he want the company to blow up?" etc. The conventional wisdom was wrong, you can't let executives auto-compensate. Shareholders have to do that, otherwise capitalism DOESN'T WORK. In fact it's not really capitalism at all, just lunatics running around. IMO
 
Dougloid
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 8:37 pm



Quoting Alessandro (Reply 36):
So no one thinks population growth has anything to do with it?

It's important but tangential, Mr. Malthus. Be careful what you wish for, too. When the eugenics machine finally gets up to speed it will be the weakest (read smallest) to the wall.
If you believe in coincidence, you haven't looked close enough-Joe Leaphorn
 
hawaii12
Posts: 83
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RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 8:45 pm

frankly, i like to blame my old boss, joe cassano. he was the chief at AIG Financial Products. He was allowed to insure mortgage backed securities (via credit default swaps) when his risk guru, gary gorton, omitted one key piece of information in his risk analysis.... what would happen if the prices of homes began to decrease.

i know, this did not set off the decline we see the global economy in right now, but it surely contributed to the entire mess.

well done joe and gary

btw, gary now a prof at yale.
 
Alessandro
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Joined: Wed Sep 12, 2001 3:13 am

RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 8:45 pm

My name isn´t Malthus. Nor do I wish to do a Roman "reduction" after battles lost.
From New Yorqatar to Califarbia...
 
MD-90
Posts: 7835
Joined: Mon Jan 17, 2000 12:45 pm

RE: Exactly What Caused Current World Economic Woes?

Wed Mar 11, 2009 8:50 pm

The Federal Reserve: Devaluing our currency and making the world poorer since 1913.

Thanks a lot Alan "I Love To Inflate" Greenspan.
 
baroque
Posts: 12302
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RE: Exactly What Caused Current World Economic Woes?

Thu Mar 12, 2009 2:33 am



Quoting Dougloid (Reply 34):
The smart money-well, most of it- moved out of the market before it crashed in October of 1929.

I suspect that the same will be shown to be true when the story of this bust is written.

In theory the large presence of super funds in the markets would prevent this, and it probably played its part in keeping the mountain stable long before it should have collapsed.

Quoting Alessandro (Reply 36):
So no one thinks population growth has anything to do with it?

Probably does, but maybe in the opposite sense in this short interval. Eventually Mr Malthus will have his way! I rather doubt it will be as Dougloid supposes but rather weaker nations that will have "a spot of bother".

Quoting Flighty (Reply 38):
In fact it's not really capitalism at all, just lunatics running around.

Lunatics yes, but we are probably also lunatics to have let this lot loose. It is not capitalism but it is managerialism red in tooth and claw. The many pleas for the free market and capitalism boil down to special pleading to keep managers sacrosanct and secure from nasty things like market forces and shareholders opinions. I must read AUs source again to see what role KM supposed managers would have in the fall of capitalism.
 
us330
Posts: 3413
Joined: Tue Aug 08, 2000 7:00 am

RE: Exactly What Caused Current World Economic Woes?

Thu Mar 12, 2009 3:28 am



Quoting Alessandro (Reply 36):
So no one thinks population growth has anything to do with it?
It took 150 years for the population to double between 1750 to 1900, today it took 40 years
1969 to 2009. Even with the current improvement of technology it´s definitly putting a strain on things, add expensive wars and you´ll see how everybody is affected.

I don't see how population growth has anything to do with this. Yes it has grown so much. But more people are also better off now in 2009 than they were in 1750.
Population growth might have other negative side effects--see increased pollution for one--but it cannot be blamed for this crisis.
What is your reasoning behind this?
 
N174UA
Posts: 860
Joined: Thu Jun 01, 2006 4:17 pm

RE: Exactly What Caused Current World Economic Woes?

Thu Mar 12, 2009 6:48 am



Quoting MadameConcorde (Reply 30):
Can somebody explain derivatives?

Sure - derivatives are "derived" from the value of the underlying asset. There are four general categories of derivatives.

1. Options (there are "American" and "European" versions)

Call - the option (not a right) to buy a security at a certain "strike" price. For a $100 stock, the option might cost me $10. If the stock price hits a strike price of $40, I have the option to buy the stock at that price.

Put - the option (but not a right) to sell a security at a certain "strike" price.

2. Forwards (contracts) - between two parties to exchange an asset in the future for a price that's determined today. Typically, forward contracts involve currencies as well as commodities, such as oil, gold, etc.

3. Futures - Very similar to forwards, but the difference is that futures are standard-sized contracts for currencies and commodities that are traded on exchanges. Instead of buying the asset, you're only buying a contract to buy that asset.

4. Swaps - Basically an agreement between two parties to exchange a set of cash flows at a future date. The most common is an interest rate swap. There are also swaps for commodities and currencies as well.

As for what I think caused the current woes:

1. The false assumption that the value of assets would only continue to rise, specifically real-estate. Homeowners, Lenders, and the government each made this false assumption. Anyone who knows anything about economics knows that everything (especially real estate values) are highly cyclical. It amazes me that so many people made this assumption anyway.

2. Lack of transparency in the regulation and valuation of securities based on the underlying asset (asset-backed securities) as well as the quality of the debt behind other securites, like collateralized mortgage obligations and collateralized debt obligations. These securites were bought and sold many times over, and are nearly impossible to assign any meaningful value.

3. Unscrupulous/loose lending/borrowing standards. While some lenders held back, others (like WaMu, IndyMac, Countrywide) originated loans that meant high profits for them after they sold them to other instiutions. The flip side of this is the borrower who had no idea what their budget was and didn't understand the mechanics of an adjustable rate mortgage and the future implications of what that would mean to them.

The three reasons above eventually collided, and there is little confidence in the valuation of securities held by banks, and why we have seen big increases in their loan-loss provisions (allowance for bad debt) on their income statements. Banks who engaged in this activity lost the confidence of their deposit base, and when they pulled their funds, their liquidity dried up. That in turn froze credit markets, for both corporations and individuals. Companies can't borrow short-term funds to cover operating expenses and payroll, and voila - losses and layoffs.

Whew. Time for bed.
 
Yellowstone
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RE: Exactly What Caused Current World Economic Woes?

Thu Mar 12, 2009 7:32 am

Copied and pasted from a post on DailyKos:

The Evolution of the Credit Default Swap

Stage 1 (Perturbo mutans)
You have just made a loan to someone, and now you're nervous that this scoundrel might not pay. What to do, what to do? Ah, but you need not worry! I happen to have assets on hand that can easily cover your petty loan. What's more, for a small monthly fee, I'll be happy to provide you with insurance of a sort. Should the person to whom you've extended a loan prove unreliable, I'll shoulder the burden -- so long as you keep up the payments. Let's call this insurance a... credit default swap.

In 1999, these credit default swaps already existed, but they were a niche product. Only a fraction of banks employed them and then only on a fraction of loans. Without some knock to the system, swaps would probably have remained a relatively small player.

Stage 2 (Perturbo furtiva)
Knock, knock. In 2000 Republican economic hero, Phil Gramm, with the assistance of a small legion of lobbyists, created the Commodity Futures Modernization Act. Along with ushering in the Enron disaster, this bill provided the one thing that credit default swaps needed to grow and mutate -- invisibility. Thanks to the CFMA, not only were credit default swaps unregulated, they were impossible to observe directly. Like black holes in deep space, you could only spot swaps by looking at how other things acted nearby.

So, now you've made a loan to someone, and you're worried about it. I want to offer you a credit default swap so I can collect the fee. Trouble is, I don't have the assets to cover your loan. So how can I... hold on, credit default swaps are so unregulated that no one says I actually have to be able to deliver on my promise. Hey, over here! Have I got a swap for you, and it's a bargain.

So now the CDS is a means of moving the risk, but the risk is still as high (or higher, since the original lender might have been better able to cover the loss). In fact, credit default swaps have gone from being a risk mitigator, to a risk magnifier.

Stage 3 (Peturbo veloxicresco)
You have a loan you're worried about. That's good, because lots of people want to offer you swaps. After all, you don't have to have any assets to issue a swap. The investment bank of First Me and The Change I Found In the Couch Cushions can offer swaps for all the debt at Morgan Stanley, and that's okay. I get free money for issuing the swaps, and the swaps have value on the books. So both me and my pal Mr. Stanley have values that are inflating faster than a tick in a blood bank.

Now you can get a swap for any loan you want, and with all the competition, the cost of these swaps is lower, and lower, and lower. Here's an idea: why not go out and make more loans, riskier loans. Why not offer anyone you can collar on the street a loan, no matter whether or not they can pay it off, not because some 30 year old law makes you do it, but because your friend the credit swap makes it perfectly safe!

So many people are offering these things that you could give a loan to Saddam while the bombs are falling without a care in the world. You can always get a swap.

Stage 4 (Fatum casus)
I have a swap. I really, really want someone to take my swap. Only even with every incentive I can offer, not enough people are loaning. Sure, there's a record amount of hypothetical money sloshing around the system thanks to me and my swaps, but it's still not enough. So what can I...

Wait a second. Swaps are unregulated. No one says I have to have enough resources to cover the swap, and even better, no one says I have to offer the swap to the person who actually made the loan! Hey buddy, see that loan over there? You may think it's iffy, but I think it'll hold up. In fact, I'm so sure it will, I'll sell you a credit default swap on it that pays off if it fails. You don't make the loan, you don't have to pay off on the loan, you don't have anything to do with the loan. You just pay me the fee. And if that guy loses his money, you collect. How sweet is that!

This mutation is enormous (see how the genera changed up there?). At this point, credit default swaps have become completely divorced from the original function. A single loan can be covered by multiple swaps. There's a complicated fiscal term for this. It's called gambling, and at this stage, that's all that remains of those little "insurance" policies. They no longer protect anyone from anything, they just offer a chance to place enormous overlapping side bets on everything.

Stage 5 (Fatum insanus)
I have swaps! Get your swaps here! Want a swap on a loan you made? Okay. Want to bet that the bozo in the next cube is making bad loans? We can do that. Want to bundle up some loans and bet on those? Buddy we can do better than that. I can give you a swap on the value of other swaps. Now we're really in business.

Who owns the original loan? Don't know, don't care. Who's actually responsible for the money if that loan should fail? Ehhh, can't really say. Has anyone noticed that a single bad loan could cause a cascade of swap calls that bounce around the system like a rocket-power pinball? Shut up.

Isn't anyone worried that this is the most massive house of cards ever constructed in human history? Lookit, what part of "we took 120 billion in bonuses out of this place in the last five years" are you missing?

Stage 6 (Fatum exicelebritas)
Hey, my loan went bad. Can I have my money from that swap, please?

Stage 7 (Fatum cerus)
Oh shit.
Hydrogen is an odorless, colorless gas which, given enough time, turns into people.
 
wardialer
Posts: 1142
Joined: Fri Sep 14, 2001 1:08 pm

RE: Exactly What Caused Current World Economic Woes?

Thu Mar 12, 2009 7:37 am

I know what caused the US to sink in the first place....I can tell you that.

And the answer is......OUTSOURCING.

Can come up of other ideas on why our nation has around 650,000 people unemployed???
Its because most companies our being sent to Eastern European countries. Thats the reason.
Thats why countries like Hungary are doing so well financially and I can you that Hungary now has its unemployement rate DROPPED around 50 percent or more. Thats why the US economy has sunk thanks to countries like these.

It makes my blood boil.
 
baroque
Posts: 12302
Joined: Thu Apr 27, 2006 2:15 pm

RE: Exactly What Caused Current World Economic Woes?

Thu Mar 12, 2009 10:22 am



Quoting N174UA (Reply 45):
Whew. Time for bed.



Quoting Yellowstone (Reply 46):
The Evolution of the Credit Default Swap

Formidable you two. First a detailed explanation of what they are and then the timing of how the bastards evolved.

News Wardialer, with no outsourcing and 150% employment what N174UA and Yellowstone describe we would all have gone down the toilet. The only thing to argue about is how much the unemployment is due to the banking problems, but it is rather like discussing the colour schemes for the deckchair just before we rearrange them on the Titanic, because the CDOs and whatever had done for us whatever. But you may well be right in that there could be two different recessions raging.

The first one started in 2007 when unemployment started ticking up and while sub-primes were realised as a problem they had not gone critical - somewhere about 4 to 5 in Y's stages. Then came Lehmans and stages 6 and 7 followed before you could say Jack, let alone Jack S***.
 
NAV20
Posts: 8453
Joined: Thu Nov 27, 2003 3:25 pm

RE: Exactly What Caused Current World Economic Woes?

Thu Mar 12, 2009 11:32 am

No-one seems to have mentioned Milton Friedman yet?

He was the guy who (once Keynes was dead and Galbraith had retired) set himself up as 'world's leading economist.' He successfully sold most world governments - and most world economists - the idea that all you needed to do to 'regulate' an economy was to fiddle around with interest rates.

The snag was, the heads of reserve banks the world over are appointed by governments. So, even though Friedman, in his dreams, envisaged 'independent' central banks, in practice they had to clear every move with their governments. And politicians like lowering interest rates, because it makes them popular - and hate raising them because it loses them elections........

Interest rates are, quite simply, the 'price of money.' If you lower them - same as if you lower the price of anything - people borrow more and save less. If you raise them........well, that's an academic question, the vast majority of central banks haven't raised rates much for the past ten years. I hope everyone remembers Greenspan, egged on by Dubya, lowering the US discount rate by a quarter-per-cent a month for about 15 months on end?

Trouble is, 'Friedmanism' is still very much with us. Governments worldwide are faced with a situation where people have borrowed and spent far too much money. The obvious (virtually the only) way to reduce excessive borrowing would be to make money more 'expensive' - that is, to raise rates.

So what are the world's central banks doing, egged on by their respective governments? Lowering discount rates practically to zero. Because Milton Friedman (the last economist they ever listened to) said that that was all you needed to do to 'revive an economy.'

In past 'downturns' all the discussion after the initial shock, in business terms, was about when the next 'upturn' would start. But that was in the context of governments having taken 'correct' - that is, deflationary - measures early on.

This time, we have governments actually trying to counter a credit-driven crash by lowering rates, and giving the banks money to cover their losses in the hope that they'll go on lending......

To me, that's like trying to to put out a fire by pouring petrol on it. But, of course, I learned my economics in the 1960s. Just put me down as 'old-fashioned'...............  Smile

[Edited 2009-03-12 04:38:01]
"Once you have flown, you will walk the earth with your eyes turned skywards.." - Leonardo da Vinci

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