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My take on the current financial situation

is below... It is very long; was a reply to my sister looking for material to help trump her boyfriend in a little ongoing debate they have regarding the need for the fed (and it needs to be read in that context). Question is: am I correct? Is there anything major left out?

Yes, I understand what is being said. It seems quite logical. The fed does not cause boom and bust; it tries to mitigate great swings by using monetary policy to stunt or encourage growth-the lower the interest rate, the cheaper money is, which leads to capital expenditure (purchasing of productive assets by companies) and new production, jobs, etc (the converse is true when rates are made to go up in order to prevent over heating of the economy). Boom and bust would happen anyway, and there is a very good chance that they would be more severe (although some would argue otherwise, and I don't have any empirical data with which to refute the claims). The cycle goes something like this: overinvestment is caused by a perceived opportunity (think late 90's tech) drawing in a great deal of capital/investment, this capital is used to invest in productive assets, these assets produce goods/services, the market generally overshoots (too much product/service into supply-this is a human sociological/psychological reaction to perceived opportunity-, not enough demand to absorb the new massive supply), the price of the good/service falls (too much supply results in lower equilibrium price), uncompetitive firms fail (can't make a profit), job losses, slowing economy, end of cycle. The cycle begins again once it appears that there is some opportunity (demand is greater than supply), thus triggering new investment. That is a basic overview, but it captures the gist of it.

As for the second part about the current situation, it is very complex and to be honest, I'm not 100% sure I understand it perfectly. Basically, the fed made money cheap (lowered interest rates) to stave off recession after the tech bust. This massive infusion of capital (that is what the fed is doing when it "lowers" rates-printing money and handing it out to banks, basically) was then lent by banks to people who wanted to buy homes. The trouble was, the government failed to enforce some rules that required banks to confirm that a person made sufficient income to pay for the mortgage that they took out. So, money was cheap and there were no rules governing who could get it.

Now, since money was so cheap (low interest rate) banks could make risky investments because they thought the risk was justified by the cheap cost of funds/capital/money. Think about it this way: if you borrow $100 and have to pay back $110, then you are more likely to risk the money on what might be a break even proposition-since you will only "lose" the $10 that you have to pay back in interest-than to risk it on the same break even investment if you have to pay back $150. The potential "loss" of $50 is greater than the $10 one. So, you have to be more careful about what you invest in. Now, money is cheap and lending standards are completely nonexistent. Banks are all about lending money for homes. So, they do. As more and more money begins to chase the homes on the market, the market responds.

Houses are build all over the place to take advantage of the rising demand for them. The builders cannot keep up with the demand, so the price of homes rises, and it keeps rising. The fed keeps the interest rate low for a long time-most people say too long. So, banks keep lending, home prices keep rising ("who cares if the house price went up 20% last year-it is only like $50 a month more on the person's mortgage since rates are so low. Any one can handle that...").

There is one even more troubling aspect to what is going on. The banks aren't the ones lending the money to buy the houses. It is loan origination companies like Countrywide. These people lend money without bothering to check whether it will ever be paid back (since this is now "allowed" under the federal rules), and then they sell the loan to a giant wall street bank-all the while telling the big wall street guy that these loans are actually being made to people who can pay them back, which they cannot. What do the mortgage originators care if the money is ever paid back? They make their money from the initial sale of the loan to the consumer (origination fees) and the subsequent transfer to the big bank. Now you have all of these shit loans being held by the big wall street banks. In their infinite wisdom, they package pools of loans and sell "shares" in the loan pool to their fellow wall street banks, insurance companies, international entities, etc-basically everyone. Everything is fine and dandy until the bankers start to realize "shit, these people are not going to be able to pay back the loans!!!!". Chaos ensues. Foreclosures are everywhere, since these people could never afford their mortgage once they actually had to pay what it would've cost under normal circumstances (you see, these loans were made with adjustable rates that rose along with the fed rate-making the payment much higher-, or even worse, they were made with "teaser" rates that ballooned after a year or two-not to mention you didn't need a job to get the loan in the first place).

Ok, so what? We have a few big wall street banks that bought all these mortgages. NO! Remember I said that these banks packaged the debt (mortgages) and sold shares in it? Well, now everyone that bought these "shares" is fucked, not just the big banks. How do you think AIG failed? They are an insurance company for God's sake, but they bought and/or insured a bunch of this junk debt. And we are not talking about a few billion dollars here. The system is out trillions. Yea, thats right, trillions.

Next step-and where we are right now-no bank will lend to another bank for fear that the other bank will fail/go bankrupt. There is a "lack of liquidity" meaning there is no cash available to lend. This is a major problem in itself, because our system is built on credit availability. Businesses and others have to pay a much higher interest rate to induce a bank to lend to them. I am forgetting/leaving out some things, like the the failure of the credit ratings agencies to correctly value debt default risk (mortgage backed securities) and the SEC's foolish decision to drop the uptick rule for short sellers, among others things, but this provides a basic overview.

The expectation is that business will slow, and they will start to lay people off (currently happening). Since rates are already very low (2%), the fed can't just cut rates to try and stimulate the economy. Adding to these woes, we have major inflationary concerns. Everyone fears that the economy may go into a long term recession. The system is super complex , and the system is on the verge of collapse.

The bottom line? If the government did not decide to spend 700 Billion to "bail out" these fools on Wall Street, the entire economy would be at risk for collapse. This means DEPRESSION, not your ordinary garden variety recession. Alan Greenspan called the current crisis a once in a century financial meltdown, and I agree that that is what it is. And lets be honest, where are we going to get this 700 Billion dollars (not that we should end up needing 700 Billion, but by the time everything is over we might)? You are gonna have a hard time borrowing that much, although people feel like treasuries are the only safe area right now... In any event, assuming you can fund the bailout with debt, you still have to pay it back. The cost of the bailout could be larger than the cost of the Iraq war. This is no trivial amount-~$2,500 per person (assuming that we actually do have to spend 700B). Worse yet, the bailout might not go through-politics-and even if it does it may not be enough to stop the chaos.

So, are we done for? Well, I think I have painted a pretty alarmist picture here, but to be honest this is DEFINITELY within the realm of possibilities. Maybe everything will work out, but its hard to tell right now. I'll finish with a little wisdom a finance professor once gave me. In 2004 he said, "I'm very afraid of the current situation and your generation in general. You are too highly leveraged. Everything is bought on credit and without any way to pay it back. This cannot continue, and when the shit hits the fan its gonna be ugly. You'll find me with gold and a shotgun heading for the hills."

Any way, Kristen, that is what I think about the current situation and the bailout. I didn't really address your points about why the downturn would be so bad-our service based economy-since I have not had the time to think it through. But I can say that it is not necessarily correct, because the global economy is integrated. If we fail, so do many other countries. Although we do produce primarily services, many of these services are as value adding and needed as goods. Overall, I think you have it pretty close to correct. Of course, I am a law student, not an economist, so don't take my word as gospel. If you wanna chat, gimmie a call.

Old 09-24-2008, 10:23 PM savage is offline  

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Old 09-24-2008, 10:48 PM mike27 is offline  


aww cmon there was real effort in my original post. i think it added to the thread
imagen a nuke hope it never come to that

Last edited by jkrowling; 09-24-2008 at 11:35 PM.. Reason: image spam
Old 09-24-2008, 11:15 PM jkrowling is offline  

So, there's really nothing there to add to the other much more comprehensive thread we already have going on. it's written in a manner which is confusing, and was responded to accurately in like 15 words.
imagen a nuke hope it never come to that
Old 09-24-2008, 11:16 PM jkrowling is offline  

3y3 4m t3h Gr4et gr4nD m0th4rfUxing mor4n! W4t<h //\y b33f kur+4nz F|4p!!# 4y4m 1e37!
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The least you can do is some editing to it's addressed to us rather than your fucking sister
09 F9
Old 09-24-2008, 11:23 PM Zangmonkey is offline  

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DOOD... the current financial situation (bailout) amounts to nothing less than a stickup.

I just heard tonight to completely pay off all mortgages would cost a billion, yet Bush is *demanding* orders of magnitude more than that and *demanding* complete criminal immunity for the people who got us into this!!!!

When the government directly has control over the infrastructure (see who built the autobahn for example), industry, and finance of a country it is called nothing less than National Socialism.... or ...

Nationalsozialistische Deutsche Arbeiterpartei[9] (NSDAP) — “National Socialist German Workers’ Party”. The Nazis were one of several historical groups that used the term National Socialism to describe themselves, and in the 1920s they became the largest such group. Nazism is generally considered by scholars to be a form of fascism. While it incorporated elements from both political wings, it formed most of its alliances on the political right.
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Old 09-24-2008, 11:46 PM Free_Willy is offline  

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Oh look, Chuck, here comes Möbius's Mystical 1d12 of Threadlocking.

You carrying any shit-thread related magic equipment that might help you on a bluffing check? I don't have anything marked down for you behind my DM screen, here.


You rolled a 2, Chuck. While not a critical failure, that's pretty fucking piss poor. In fact you can't do any worse without hurting yourself. You take a mighty swing at getting a clue and it goes completely pear-shaped. The Do Your Own Fucking Homework Lamia easily sidesteps your clumsy blow and clobbers you in the fucking noggin, spraying whatever you called "brains" against the far wall.

You have died.
I personally believe that there has to be a law that limits the power of the supreme court. -- R@$T@M@N
Old 09-24-2008, 11:51 PM möbiustrip is offline  

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