Tag Archives: debt crisis

Want Bailout Money? Fine. No More Lobbying.

New rule:   Any company that receives bailout money is forbidden now and forever from spending any money whatsoever on lobbying government officials or making campaign contributions and/or doing business with any customers, suppliers, unions, investors, lenders, associations, nations or any other entities that spend any money on lobbying government officials or make campaign contributions.

What do you think?

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Our Economic Death Spiral Explained in Bullet Points

Oh dear, what a mess we have now.  Here is a pretty ugly cycle to think about.

  1. The housing bubble peaks and home prices stop increasing.
  2. People who assumed they would be able to sell or refi before their adjustable rate mortgages adjusted… couldn’t.
  3. Many of those people, especially the least likely to be able to pay among them who had gotten “subprime” mortgage loans, defaulted on their mortgages and got foreclosed.
  4. The foreclosures hurt the value of bonds that had been sold to finance the loans.
  5. As the value of the bonds decreased, the risk exposure of bond insurers (sellers or financial instruments called credit default swaps) increased.
  6. As the risk exposure of these insurers increased, the likelihood of some of them defaulting on their insurance policies increased.
  7. Because the credit default swap market is completely unregulated (thanks to Phil Gramm and his Republican friends) it is impossible to know what the likelihood is that any of these insurers would default on their policies.
  8. Which has lowered the value of the credit default swaps that people have bought (the insurance policies).
  9. Credit default swaps are carried on banks’ balance sheets as assets.
  10. The amount of lending banks can do is dependent on their asset base.
  11. When the value of the credit default swaps went down, the value of the asset bases of the banks went down, and they became unable to lend to businesses because their asset to lending ratios were out of whack… they had become too risky.
  12. Because businesses and consumers haven’t been able to get loans, the real economy has gone into a nose dive.  Over 2 million jobs have been lost this year, including 500,000 in November alone.
  13. These newly unemployed people are beginning to default on mortgages that had never been considered risky and a new round of completely unexpected foreclosures has begun.
  14. This is going to further impact bond prices, which will increase the risk that bond insurers will default, which will further lower the value of credit default swaps, which will further lower banks’ asset base, which will further curtail their ability lend………..

Now we’re in a death spiral.  We can’t get out of it by just riding the current.  Yikes.

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Why We Get Drunk on Debt

In the world we know as consumers, debt allows us to buy things now and pay for them later, by basically agreeing to pay a lot more for those things than they actually cost.  In the world of investing, debt magnifies the profits of other investments.

It’s easy to understand how.  If you have an investment in mind that you expect a 10% return from, and you have $100,000 to invest, you expect to make a $10,000 profit.  But if you can borrow another $900,000 at 5%, you can make 10% on your initial $100,000 plus 5% on the $900,000.  You’ll earn 10% but have to pay 5% to the bank as interest.  So your profit will end up being $55,000!

The problem is that debt magnifies profit, but it also magnifies risk.  The 5% interest you owe the bank on the $900,000 has to be paid no matter what, and that comes to $45,000.  So long as your 10% estimate is accurate, life is good.  But if there is a bad year and your rate of return is actually 0%, life is terrible.  Had you only been using your own $100,000 you wouldn’t have made anything but you wouldn’t have lost anything.  But now, because of the money you borrowed, you are actually in the hole $45,000.

When times are good and profits are strong, there tends to be a pervasive tendency for both borrowers and lenders to discount the risk side of this equation.  Since the more money is borrowed, the higher profits will be, investors ask to borrow many, many times over their own actual investment money.  Lenders only make money when they are lending it, so there is also a profit motive for them to dismiss risk as unlikely.

Calamity strikes when borrowers leverage their investments so much that when their investments don’t perform as hoped, they end up unable to pay back their loans.  When this happens systemically, banks get can lose billions and billions of dollars, which limits their ability to lend, which creates a ripple effect through the entire economy.

This is how the stock market crash in 1929 evolved into a series of bank runs and then into the Great Depression.  It is also what has happened to the American economy in 2008, what happened to the Japanese economy in the early 1990’s, and what has led to nearly every major financial bloodletting in modern times, around the entire globe.

In fact, a simple rule that no entity of any kind is allowed to borrow more than a certain multiple of their asset base would prevent, arguably, all future financial meltdowns.

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Grab a Bucket For Detroit – Part I

Detroit has irritated me as much as anyone over the years.  I tried my best.  I really did.  I bought a Mercury Topaz, then two Saturns, then an Explorer, then a Villager… and by then I couldn’t take it any more and I bought a Nissan Altima.  I love it more than I have ever loved any car.  And shame on Detroit for allowing my level of satisfaction, after five(!) American cars… to drive me into the waiting arms of the Japanese.  Shame on them!

That said, there are a number of reasons why we should loan our auto companies taxpayer money to use for restructuring, retooling, and survival.  I’ll provide some background in this posting and then individual reasons in the next several on this topic.

Those Who Don’t Understand History Are Doomed To Repeat It.  Here’s Some Now.
There was a time in the American capitalist experiment before global trade became what it was today.  Robert Reich describes the era and the logic to it excellently in his book Supercapitalism.  For reason that was rational at the time, more or less of a balance had been achieved wherein competition was much more managed than our Cold War rhetoric would have had us believe.  In the name of mass production, companies had built and supported many of the government regulatory agencies to make barriers to entry steeper and to deliberately limit competition.  They also, grudgingly, supported the growth of unions.

Mass production required accurate forecasting, and accurate forecasting required stability.  Limited, oligopolistic competition, controlled with the assistance of the government, and a generally docile labor force managed by the unions made that possible.   In this era the middle class was created and it thrived.  The disparity between rich and poor was more narrow than before or since.  There was a lot of wealth to go around.  This came at a cost.  This broadly distributed wealth that enabled the middle class to become what it did came at the expense of investor profits, which rarely exceeded 3% to 5% and also at the expense of innovation which, by its nature, diminished stability rather than increased it.

During this era, which Reich calls “The Almost Golden Age” (acknowledging that minorities and women were, for the most part, not invited to the party), where wages for working people became truly meaningful, the 40 hour work week became the norm, and healthcare and pensions became standard corporate benefits, to the benefit of us all.

This pleasant enough stability came to an end with the massive expansion of the Vietnam War.  In order to keep our troops supplied, we developed the modern shipping container and the ports, ships, rail lines, and trucks to get goods and containers to Asia.  Rather than dead head back, the ships would stop off in Japan, pick up a load of generally poor quality merchandise, and sell it here.  This was the beginning of the global economy and global competition.  By the mid 1970’s competition was happening with or without the regulations that had made everybody so comfortable, so we began shedding them, starting actually in the Carter era.  By Ronald Reagan’s 1980’s, de-regulation was in full swing, corporate downsizing reached a fever pitch, innovation and quality skyrocketed, prices (adjusted for inflation and quality) plummeted, and corporate profits exploded.

In short, we as consumers and we as investors benefited enormously from global competition, but millions of us as workers (including white collar workers, by the way) got creamed as cheaper sources of labor were found elsewhere.  And we as citizens got creamed as control and the benefit of the government shifted away from our interests to those of corporations and lobbyists, as the disparity between rich and poor exploded, as our infrastructure spending crashed, etc.  Huge numbers of our industries vanished overseas… steel, textiles, manufacturing, programming, customer service…

During Reich’s “Almost Golden Age” our industrial giants, as part and parcel of the bargain that made the age what it was, took on substantial commitments to their workers.  In the shape of wages, working conditions and healthcare, corporations took on layers of current costs, and in the shape of pensions and retiree healthcare, they took on layers untold of future costs.  Those few companies and industries that have survived so far are now “burdened” with these legacy costs that stem from a balance of power between investors and workers that has long since been lost.

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