Posts Tagged ‘credit’

Nouriel Roubini was one of the few people who very accurately predicted our current economic meltdown.  Recently he wrote that the cause of the meltdown was “the bursting of a huge leveraged-up credit bubble”.  He goes on to say in this recent article that he believes the economy will get worse before it gets better. The question we should be asking ourselves is why? We know that the nation’s banks made terrible decisions about granting credit, not only for houses, but also for credit cards, auto loans, furniture loans – you name it. If you could walk and breathe you could get credit to buy almost anything. In retrospect the result of all of this is obvious: a lot of people who couldn’t possibly pay back their loans didn’t pay back their loans.  For a long time the banks new that they shouldn’t give loans to non-creditworthy people, so why did they change their minds? The banks had found a way out of their potential liability – they sold the loans. A whole industry of derivatives and credit default swaps emerged.  Loan obligations were sliced and diced and sold and resold and insured and eventually very few people in the banking industry actually had the ability to understand the true value of the new derivatives they had created.

There was one other really bad problem with these loans – they had exhorbitant interest rates.  Even people with good credit would have had a hard time making the required payments. As Roubini said, it was a bubble, and it has burst with devastating results.  The Secretary of the Treasury raced to solve the problem of our collapsing banking system (they had loaned out their money and it wasn’t being paid back) by creating the TARP fund, a $700 billion government fund that was a way to funnel money to banks. About half of that money has been doled out, but the economy is still on the ropes.  Why? Because the banks have their money back, and they have no desire to loan money in this economy! Who would? So we sort of have an economy of self-fulfilling prophecies where the banks are afraid to loan money to businesses because they don’t thinks the businesses will be able to pay them back and businesses are  failing because they can’t borrow any money and the banks are saying, “See, we knew they would fail!”

Our banking system has gone through many incarnations since the U.S. began. The current system of a U.S. Treasury and a Federal Reserve that works with private banks is a cobbled together operation that has certain weaknesses, like a propensity to creating credit bubbles and to creating what we have now: a credit vacuum.  It is time we took another look at the structure of our banking system, particularly with regard to creating a new type of bank, a Federal Direct Loan bank that would issue loans directly to consumers at low interest rates. This bank would compete with the private banks and keep them honest.  It would also be a lender even in the most difficult times, ensuring that individuals and businesses could obtain credit and therefore ensuring that the economy would continue to function even when the wealthy private bankers have decided that they don’t want to play.

Something tells me that this would not be a popular idea on Wall Street, but I’m guessing it might fare better on Main Street.

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A year ago the smart people knew that the real estate game was over. People were defaulting on their mortgages and the big insurance companies were having trouble covering the credit default swaps (the insurance they had given on the toxic mortgages). It was looking bad for the U.S. and the smart money started bailing out of U.S. dollars – they started buying oil, a good hedge against the inevitable loss in value of the dollar. The dollar started to tank against the Euro and other currencies and as the value of the dollar went down it cost more money to buy a barrel of oil. They call that inflation. People bought even more oil. Goldman Sachs predicted that oil would be $150 a barrel this December (they sort of missed that one, didn’t they?) The thing everyone on Wall Street knew was that with the fall of the housing market, the U.S. economy would be in deep trouble, because, unlike what John McCain said, the fundamentals of the economy were not sound, they were almost completely rotted out.

As the stock market plummeted to half its former value, world stock markets joined in and in the resulting panic they fell even more than the U.S. market and, can you believe it, the value of the dollar increased. That was because these other economies were so dependent on the U.S. economy that investors knew their businesses would suffer even more than U.S. businesses. So now oil is down to the $50 – $60 dollar range.  A lot of this up and down movement has to do with the value of the dollar and not the world’s supply of oil.  We’re not running out of oil, and despite what John McCain kept chanting, it really won’t help to DRILL BABY DRILL!

Now the U.S. auto industry is on the ropes.  It’s their own fault, of course, for building cars that nobody wants.  The problem is that about 3,000,000 jobs depend on the pathetic abilities of the auto industry to produce a desireable product. So, the heads of the auto industry asked for a government bailout, but so far Congress hasn’t been too sympathetic because they know the U.S. auto industry doesn’t have a Popsicle’s chance in Hell of surviving much longer anyway. The Japanese, Koreans, and Chinese are just too smart.

Meanwhile, the keepers of America’s money – the Treasury and the Federal Reserve – decided to completely ignore what they had told Congress they had to do (or the world would implode, they said, and we would all disappear into the black hole that the CERN supercollider is going to create, if it ever works, – or something like that). Instead they gave some of the $700 billion bailout to their friends at Goldman Sachs (the smart guys who predicted we would have $150 oil in a month) and their other banking buddies. This money was sort of a gift. (I think the correct euphemism is that the U.S. taxpayer bought stock in those companies.) I can’t wait until I get my dividend check from Goldman Sachs! For some reason Congress wasn’t too happy that Sec. Paulson and Mr. Bernanke seem to have forgotten about the Troubled Assets they were supposed to buy with all that money. “Remember the TARP?” Congress said. “TARP??  Ummm, no,” was the reply.

One is tempted to say that the 800 pound gorilla in the Congressional chambers that no one wants to talk about is the fact that our economy depended solely on the Housing Market Ponzi Scheme (HMPS). But I think that would be a simplification, because there is really a different underlying factor that drove the U.S. economy for the last ten years or so: Credit. Yes, credit with a capital C.  Our U.S. government, in complicity with the banks and the U.S. financial community over the past twenty five years, has allowed interest rates to reach what used to be criminal values. The very predictable result was that people who were desperate for money signed up for loans they couldn’t possibly repay. The lending institutions knew this and flipped the loans, after they sliced them and diced them, as fast as they could. The people who bought the loans knew they were hot potatoes and immediately bought credit default insurance on them or they flipped them again.

It was all great fun and lots of money was made while everyone tossed the hot potatoes around – until the original borrowers defaulted. It was sort of like playing musical chairs with money. Somebody had to lose, and the game kept going until there were only two players left: the U.S. government and their buddies in the banks.  So the government gave their friends in the banks a bunch of money to be used in any which way they pleased! The banks decided to just sit on it – not lend it, not invest it, not do anything with it – just gloat over it and hoard it – and here we are!

You might think that our one trick pony was the housing market, but it wasn’t.  It was the usurious credit market, and, let me tell you, the credit guys don’t want to play that game any more.  Oh, no.  Whew! Boy, did those guys ever learn their lesson, right?  They’re just happy to count their blessings and have their billions of dollars back!

Meanwhile, the rest of us are sort of starting from scratch now.  The housing industry is a dead horse; so is the auto industry. The rest of our industries have been outsourced to China.  The smart people know all this, which is why they’re not investing in anything, and which is why the DOW is still down about 50%.

It’s up to Barack Obama now to play FDR after George W. Hoover leaves office.  The first thing he needs to do is shoot the one trick pony of the credit industry, i.e. he needs to put the teeth back in our laws against usury.  You can’t run a stable economy based upon letting crooks get away with theft by credit.

Then Barack needs to take us into the 21st Century with a new economy based upon developing new energy sources and new, energy efficient, transportation. That should kick start things; then it will be up to American entrepreneurs to dream up lots more new things to do.  But in our haste to create this new economy, let’s all remember one thing we have to do or we’ll just fall into the same trap again:

Shoot the pony!

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A few days ago Alan Greenspan, the former Chairman of the Federal Reserve, said that he was shocked that our financial system has broken down.  He said that we are in the midst of a credit tsunami and that, “I still do not understand exactly how it happened”.  In short, our nation’s, and indeed the entire world’s economy, has been threatened with disaster because of bad loans, and Mr. Greenspan doesn’t understand how this happened.  Over the long years that he was Chairman of the Fed he oversaw the creation of a system of financial operations whereby the banks and other financial institutions would regulate themselves.  Greenspan believed that they would be careful in their decision making because if they made ill-advised loans they would suffer the inevitable financial loss.  It seems that this didn’t quite work. Our financial institutions were only too happy to make idiotic loans to people who had utterly no ability to repay them and in the process the world’s financial system is on the brink of collapse because the world’s financial institutions all wanted to play this new game.

Mr. Greenspan professes not to understand how this could happen, so I thought I would give him a little help.  The cause of this seemingly strange behavior by the world’s financial institutions was not “irrational exuberance” –  that is Alan’s term for us little investors who get duped into making dumb investment decisions and then get taken to the cleaners by the big boys at the investment houses. I would say the proper term to describe the behavior of the financial institutions would more appropriately be “insatiable greed”.  Given that, by their very nature, bankers are greedy, I use the term “irrational” to denote those loans that had interest rates so high that any intelligent person would know they couldn’t possibly be repaid. So we have mortgages and credit card debts with excruciatingly high interest rates, which periodically get adjusted higher and higher, and we have the poor people who got saddled with these mortgages and credit cards who had no idea they had entered credit hell.

This, however, was only step one for the greedy banks. They’re not completely stupid, in fact they seem to be a lot sharper than Mr. Greenspan. These banks knew that these really shaky loans were really hot potatoes so they protected themselves by selling the loans as soon as they made them to some unwitting bank on the other side of the world. This was made easier by lumping a whole bunch of these loans together and then slicing and dicing them and repackaging them so no one had a clue as to which package had which loan.  All that was left was for the ratings agencies to certify that these were AAA-rated, mortgage-backed, securities and everybody bought them.  Of course these buyers also bought insurance for these securities from insurance companies like AIG who called this insurance a “credit default swap”.  There was also a host of “derivatives”, i.e. other things the banks could sell that derived their value from these loans – things like options and futures. The market for credit default swaps and derivatives was a hot one too, and the best thing about the whole thing was that there were (thanks in part to Mr. Greenspan)  no regulations because the banks were policing themselves – out of their own self-interest (despite the fact that they were selling these worthless investments as fast as they could). It’s a shame that Mr. Greenspan can’t get his arms around this…

Well, of course the inevitable happened. The people who got in and got out early made enormous fortunes and the poor “stuckies” who got left holding the worthless pieces of paper went broke. They were basically cheated by the fast talking, crooked, financial institutions who sold the loans and the derivatives to them and forgot to mention that the loans were made to people who couldn’t possibly repay them.  So much for self-policing. Someone should tell Mr. Greenspan that this is a good example of why we have regulations – it’s because there are plenty of greedy people out there who have no internal moral compass and who will do or say anything to cheat you out of your money. A lot of these people seem to choose careers in finance.  These people need to be watched all the time, Alan. The have insatiable greed and they think they can beat the system and they don’t care who gets hurt as long as they make a fortune – and a lot of them did.

This isn’t only Alan Greenspan’s fault.  It’s also the fault of Senator Phil Gramm who wrote legislation that eliminated many of the banking rules that had been created during the Great Depression because everyone knew that the financial institutions were a bunch of crooks then. It’s the fault of Senator John McCain who has made a crusade out of deregulation, whose ideal form of the marketplace is no-rules capitalism.  It is the fault of all the “pure” capitalists, like George Bush, who fail to believe or even care that pure capitalism is like a car with no speed controls, no brakes, and no steering wheel. It is the fault of bankers and financial people who believe that pure capitalism is a religion that you must believe in or else you are not an American. But mainly, it is the fault of the intelligent people who knew from the beginning that the wheels would eventually fly off. They knew they had to flip the loans as soon as they made them. They knew they could make a quick buck, but then they had to get out fast. They knew that the outcome would eventually be a disaster for the world’s financial systems that they had poisoned with millions of worthless loans.

If Alan Greenspan truly wants to understand what happened he need only look at the really smart people who profited from this debacle, the people who knew what would happen when they made and sold worthless loans, but eagerly participated anyway out of their irrational greed, and out of their complete lack of morality or caring what happened to anyone else in the world.  It was these no-rules capitalists who knew exactly what they were doing who created Alan Greenspan’s credit tsunami.

It’s such a shame that poor Alan doesn’t understand, isn’t it?

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