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Nothing Proposed Will Solve the Credit Crisis
As far as I have seen, no one has offered any solution to the credit crunch that makes any sense. Frankly, I am beginning to think there is no palatable solution. However, let's look at the plans that have been offered to see what the problems are.
First -- let's see what the basic problem is. US banks (and every other bank out there) use a fractional reserve system:
Fractional-reserve banking is the banking practice in which banks are required to keep only a fraction of their deposits in reserve with the choice of lending out the remainder while maintaining the obligation to redeem all deposits upon demand. This practice is universal in modern banking
.....A demand deposit at a bank (e.g. checking account) or banknote issued by a bank (bank-issued paper money) is essentially a loan to the bank, repayable on demand, which the bank uses to finance its investments in loans and interest bearing securities. The nature of fractional-reserve banking is that there is only a fraction of cash reserves available at the bank needed to repay all of the demand deposits and banknotes issued. The reason people deposit funds at a bank or hold banknotes issued by a bank is to store savings in the form of a demand claim on the bank. One important aspect of fractional-reserve banking is that the note holders and depositors still have a claim to repayment of their funds on demand even though the funds are already largely invested by the bank in interest bearing loans and securities
So, the short version is the bank takes deposits and either makes loans or buys other higher-yielding assets. Either way, the bank makes money on the "spread" or the difference between the rate of interest they pay on deposits and the rate of interest they get on their long-term loans or investments.
Now, let's assume that a lot of banks have purchased securities with their deposits that are backed by mortgages. Also remember that we are in the middle of a really massive housing correction, meaning the price of homes is decreasing big time. As a result, the value of the assets purchased by the banks is decreasing. Whenever you hear about a bank "writing down" its assets, what they're essentially doing is saying, "these assets that we purchased that are backed by mortgages aren't worth what we thought they were." So banks are now saying these assets -- that are also backing loans they are making -- are decreasing in value. Hence, the banks have less ability to make loans. Hence, a credit crunch.
Also of importance right now is that everybody is writing down the value of their assets and their portfolios. As a result, people who would lend to these financial institutions aren't making loans for fear the borrower will announce a big writedown between the time they receive a short-term loan and the time they pay the short-term loan.
So the big problem is these mortgage-backed assets that are decreasing in value that are also owned by everybody.
Central to the government plan is that the government will put together a fund and buy the troubled mortgage assets from all the financial players. Also according to the government, most of these assets are undervalued in the market right now because of the panic. Therefore, the government will hold these assets until they rise in value to a level above the government's purchase price, thereby making the government a profit.
There are several really big assumptions in the above scenario that make no sense.
1.) The biggest stupidity is the government thinks these assets are undervalued right now and will eventually rise in value. Really. That's nice. And who is the wizard with the crystal ball? Has it occurred to anybody that these assets are correctly valued at current levels and will continue to drop? But Bonddad... Hank Paulson says that won't happen. The same thing goes for Bernanke. Neither of them saw this coming either, meaning their judgment is really suspect.
2.) What price will the government buy these assets at? If the government purchases these assets at prevailing levels, the financial institutions will have to take a big loss. That means their ability to make loans will be greatly effected. The only way this plan makes sense is for the government to purchase these assets at an above market level, thereby freeing up the banks etc.... to make loans. And that assumes the assets will increase in value over an inflated price to reward the taxpayers for their investment.
3.) If you were a financial institution with bad assets would you sell the government the best asset or the worst asset? In other words, do you think the government will get bonds that have a high or now degree of increasing in value? Simply put -- everybody is going to sell the government their worst garbage.
Raise your hand if you think this plan will work.
The progressive solution falls short for two reasons.
Mark-to-market exists for a very important reasons: it tells us what an institution is worth. The whole argument that some assets are undervalued in a particular environment is true; right now there are some assets that are valued below what you could sell the for in a roaring economy. The question now becomes, what assets would sell at higher prices in a strong economy and which ones wouldn't? The answer is simple: we have no idea. And anyone who tells you they can tell is lying because there is no way to perform that analysis with any degree of accuracy. There area simply too many variables to consider. People have been trying to do that for years. In market parlance, they are called value investors. Most aren't that good.
And that leads to the second problem, which is tied to the above issue with mark to market. The plan calls for a cash injection directly into the banks. That's fine. The problem is financial institutions have been getting infusions for the last year and their stock prices keep dropping. The reason is the issue with bank's assets, which keep dropping in value, thereby requiring more cash. Essentially, financial institutions have turned into a bottomless pit, a financial black hole into which investors have been throwing money. There has already been a ton of money poured into the financial sector in the form of equity injections. And banks still need the money. If memory serves, we've already seen over $300 billion going into banks with no end in sight. In other words, there is no guarantee this will cost less than the Paulson plan.
The basic problem is the value of the assets that are dropping in value. Everybody wants to waive a magic wand and make them more valuable. To quote the Mike Meyers' character Fat Bastard, "that's crap." These assets are cheap because they're cheap. In some cases they aren't worth the paper they are printed on. And yet everybody thinks they're worth more then the market will value them at right now. Maybe they will be, maybe they won't. But right now the market says they're not worth anything. We can't simply say "they're worth more because of all these assumptions." Those assumptions could just as easily be wrong as they are right.
And that leads to the central problem: we're in a period of massive asset deflation. Housing is dropping like a stone. Hence, lots of mortgages are underwater -- meaning the mortgage is worth more than the house. That means people increasingly default on their mortgages. That means assets backed by mortgages (like mortgage backed bonds that are causing the current problem) will continue to drop in value. And no magic wand can make those mortgage backed assets more valuable.
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a highly leveraged mess---- maybe 30:1
This is not about liberal vs. conservative.
The total value of derivatives is about $600 T. It is based on about $5 T in mortgages.
Current bailout will not work, only burns money. We do not have $600 T.
We have to give $ at the bottom, help pay mortgages, because that is the least expensive fix
In 1995, my stepdad died and Mom inherited one of those large, '50s style, ranch houses in a nice suburb in the San Fernando Valley. It was appraised at $225,000. It was a life-only bequest, meaning that hen she died, the house passed to my stepsister, who now owns it. It was appraised at $650,000 in August, 2007, right after Mom died. It's value now--who knows? She can't sell it, because no one can get a loan who would want it. My kids tried to buy it, but were told they were 6 months away from qualifying. It's sad. Her inheritance goes down every month. The house now sits empty, with 3' tall grass on the front lawn. The owner lives in another state and the realtor and she have fallen out -- I can only imagine. Inflated wealth. I don't know what he first bought it for, but a lot more like $50,000 than $650,000. BTW, no mortgage. It's paid for.
It sounds to me like that we have too many houses on the market. Perhaps the government could buy a house which has been on the market for some time and demolish it. Maybe some materials could be recycled and and some of the construction workers put to work. That would effectively reduce the unsold housing inventory. It would be interesting to know how many houses would be needed to be taken out of the current market for the market to stabilize. Crazy idea? Perhaps not as crazy as buying "toxic" assets from the bankrupt financial institutions.
A two bed room house, is a two bed room house is a two bedroom house...until you improve it it o r it falls into further disrepair. It will always be worth a two bedroom house in the place that it is in.
Afford ability is another issue will the house sell for more dollars in the future? If wages stagnate,
perhaps the perceived value of the two bedroom house will fall relative to income. If wages rise and the inflated currency or the rise in M3 ratchets up the perceived value will rise..
Inflation will whittle away at the debt , if someone cares and tends to the two bed room house.
but in the end it will be a two bedroom house.
If these homes are allowed to fall into disrepair the values will fall.... wood and bricks and mortar when they are empty depreciate through decay quickly. so we have to maintain employment in areas that are hardest hit by the foreclosure crisis. enterprise zones etc and keeping values of home sin those neighborhoods relative to income so the median home prices are worth no more than on third of the median income. It is back to basics, the formula that has worked for centuries.
Government must adjust spending monetary policy's to meet the mean reality that we are in right now.
WE KNOW THEY ARTE GOING TO SELL GARBAGE BUT IN THAT GARBAGE IS COLLUSION. FRAID AND CRIMINAL CONSPIRACY.
THE RICO ACT CAN BE APPLIED IF THE FBI AND THE JUSTICE DEPARTMENT WILL GO AFTER THEM.
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If fixing existing banks is not working, we should create new banks.
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.7 trillion could create 20 new banks that are utterly lacking in bad assets.
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Those banks would immediately be able to make credit widely available.
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In 5 years, their stock could be sold to the public.
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Banks are easily replaceable. They are not like auto manufacturers.
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If the existing banks cannot do the job, get new banks.
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It all leads back to the housing bubble and how housing was artificially inflated by Federal Government programs.
That fact it, housing is way overvalued and the average American can't afford to buy a home since wages have not kept pace with the housing bubble.
The Federal government should just get out of the way and let housing deflate - probably by around 20 percent or so.
20% deflation if were lucky really wages are going down not up the price of homes have to come down to wages and since all the new jobs are at mcdonalds thats where the home prices have to come down to
handyallen1 - 20% was a ballpark conservative figure.
Lax mortgage underwriting and securitization of mortgages with the consequent de-coupling of shared risk between lender and borrower led to higher demand and housing inflation. This was not a government program, but rather the absence of one.
Are you implying that Fannie Mae and Freddie Mac contributed nothing to the Housing Bubble?
The dirty little truth that eludes American citizens and which has not been openly discussed in the past decade is the inflationary track we have been placed on by the Administration, including the Treasury, and the Fed.
Rather than seeing first hand the rise in prices of consumer goods and services, the country has seen it in the "appreciation" of assets. Lowering interest rates increases the money supply. What should have been a dampening force on the economy -- the balance of trade deficit -- has resulted in foreign countries buying government securities. This too has increased the money supply. And deficit spending has increased the money supply.
We have flown too high, and much like Icarus, we are destined for a fall. When we talk about buying bad debts in the form of subprime mortgage assets, we miss the big picture. It is not only mortgages and securities which are at the heart of this issue, it is the price of so many other assets, including other financial instruments, which are about to be pounded by deflation. The mess is too big to control.
The right terminology leads to more direct problem-solving.
Yes, we have a "credit crisis." But taking the facts from a different perspective, this is exactly the same as a "contraction of the money supply." Or, if you prefer, a DEFLATIONARY crisis. We haven't seen deflation since the start of the Great Depression, so the thinking is unfamiliar to most.
Government action can only make a given institution more creditworthy by giving it funding. Do it piecemeal, institution by institution, and you may or may not help the systemic problem, depending on specifics.
People are pulling cash out of accounts and into safes and under mattresses. A fairly small amount of this behavior can collapse lending instutions, even those well-run. The collapse of banks leads to more cash withdrawals, leading to more failures, leading to more withdrawals, and a high-speed reversal of the usual money creation process. For evidence of the current money supply contraction, see, for example:
http://seekingalpha.com/article/58199-money-supply-growth-it-s-much-worse-than-that
Vast sums of real money are disappearing from the economy. Only the Federal government can produce more. If this doesn't happen, quickly, an unprecedented financial collapse will ensue. The Federal govenment might need to literally print trillions of dollars.
One immediately hears cries "but that will lead to inflation!!" Umm, yeah. That's why we need to recognize the current problem as a deflationary crisis. One can only reverse a deflationary crisis with inflationary stimulus.
They have been trying your idea for almost a year now, hasn't done squat and it won't.
This is an issue of confidence now as much as anything else. Losses exist and have to be taken and all of these off balance sheet assets need to be moved onto an exchange and marked to market and then at least the remaining institutions will know and trust who they are dealing with and we can get moving from there. Kill mark to market accounting (which is what is unfortunately going to happen) and no one will trust anyone and we stay stuck while cash flows eventually kill all the institutions pretending to hold anything of value.
This should be painful but it is really not complicated. Of course the wrong thing is what should expected to be done. Freaking ridiculous.
I don't understand why we allow public money to be controlled by private institutions.
I posted here about 8 months ago that Bush was on his way to a trillion dollar deficit this year. At that time the “official” estimate was about 220 billion. After the stimulus the estimate jumped to 450 billion. The final score just came in at $962,171,446,556 from October 1, 2007 through September 30, 2008. The following day, on October 1, 2008 the deficit went up $99,500,170,215 and has gone up an additional $30,000,000,000 in the past 3 days. The $700,000,000,000 Wall Street bailout with its $150,000,000,000 side of pork hasn’t hit the books yet. The structural deficit for 2009 that all of this is riding on is an additional $600,000,000,000. I’m not sure as to how much of the $300,000,000,000 housing bailout, or the $200,000,0000,000 Fannie and Freddy bailout or the $85,000,0000,000 AIG bailout has been put on the books. If the recession deepens and tax revenues tank and calls for more spending are answered the total for this year could reach 2 trillion dollars in red ink. They’ve just raised the debt limit to $11.3 trillion dollars. If they have to raise this debt limit in less than one year then bend over and kiss you sweet a$$ good by.
You can watch your future go down the drain at:
http://www.brillig.com/debt_clock/
Something no one is talking about...............Just wait till someone figures out we will need to replace ALL of our military hardware. Sand does nasty things to machinery................Oh, no one's going to mention it? Fine then that means we won't have too. Great! LOL........... As a great man once said, we're screwed.
WHY IS THE FBI USING THE RICO ACT !!!!!!!
DuganS1. If you could have lived with acute curiousity and memories from Dunkirk through World War II, through the extraordinary campaign of 1948, the Korean War, the Eisenhower years of solid accomplishment, the New Frontier, the Great Society, Vietnam War without raising taxes, then the paranoic Nixon War-extension disaster, Ford, Carter micro-management you would have recognized the power of the most productive middle class in the history of mankind. This was the golden age of the American Organization.
The rise of Reagan, bankruptcy of basic industry and research, economic dominance of finance wheeling and dealing, credit cards, easy credit, debt, trade deficits, more debt, massive scortched earth burning of our industrial base, fraudulent governmental data on employment-inflation-GNP, and control of media by private wealth and Wall Street , led the American Republic into the poorest, most bankrupted, corrupt and internationally unreliable power in the world. Now we are alone in the world, increasingly economically and diplomatically isolated. We are an organization that has been declining at a geometric rate since 1980. The openness, honesty and courage of our leadeship, starting withe the President will decide whether we have a possibility of recovering our previous renaissance. Historical experience does not furnish much hope when an organization has listened to easy solutions and gone down the slippery slope of greed, hubris, controled information, self interest and concentrated power, and self delusion.
I have lived through the best and worst of times of the American Republic with worser ahead.
I don't understand the Reagan comments. Industrial production went to all time highs during Reagan's Presidency and the trade deficit was very close to in balance just a few years after he left office. If you want to get technical, the trade deficit exploded well into record levels in the late 90s during the Clinton Presidency. At any rate, free trade has been very good to consumers, particularly lower income consumers, because it's resulted in a dramatic increase in the number, the availability, the price, and the quality of consumer goods for every American. Even the poorest Americans now days have a great computer with high speed internet, a big screen TV with a hundred channels on it, and an ipod with any song they want to listen to available. As far as being "economically and diplomatically" isolated, I don't understand that. We're less economically isolated than ever before and diplomatically the United States has had these same issues since WW2.. or ever. I also don't understand the comment about the media being controlled by "private wealth and Wall Street", because if anything, the media has slanted significantly to the left in recent years.
Reagan started the war against the middle class. He started by dismantling the unions and giving tax breaks for the rich through his trickle down or voodoo economics as Bush I called it.
OK Bonddad, one more time.
Public Credit.
Ever heard of it?
Social Credit.
Without debt money.
Monetary history.
C.H. Douglas, advanced thinker and pioneer of monetary reform.
We are sitting here today at our keyboards in the blogosphere, and we have the answer to all of our financial problems at our fingertips.
Both figuratively and literally.
I point to the Douglas / Keynes discourse on the nature of money here:
http://www.cooperativeindividualism.org/douglas-c-h_exchange-with-keynes-1930.html
Obviously Keynes got an education.
Very few out there can read through this, but if you do you will understand the science of money in economics.
http://douglassocialcredit.com/resources/resources/major_douglas-testimony_ottawa_1923.pdf
Give it some time.
Douglas Home page
http://douglassocialcredit.com/douglas.php
GlobalResearch's Richard Cook reviews Douglas' writings om Money And The Price System.
http://www.globalresearch.ca/index.php?context=va&aid=6870
It's OUR money.
Monetary Transformation NOW !!
Is it a worthy plan?
Of course not, but as another Tribune editorial states, the media will not cover the opposition. Instead of a carefully considered plan, calling in many economists, the president, secretary of the treasury and politicians determined that they knew best how to solve this crisis. When cooler heads in the House rejected it, they rewrote the SAME plan, added sweeteners(?) for “the Republicans”, and proceeded to take the first vote in order to pressure the House to approve it. Approving the bill before the House vote was pure pressure politics. This 400 page rewrite took them a week that could have been used to craft a better bill. The newly rewritten bill then contained many spending and benefits provisions that had NOTHING to do with the original credit crisis. The severity of this credit crisis demanded a good bill that used market forces to help rescue the credit market, not a hastily crafted confiscation of taxpayer money. Your congressmen at work.
For those who say that this is not about bailing out the Billionaires--
It is completely about bailing out Billionaires! The Financial Masters of Wall Street are the ones who securitized those mortgages, sliced diced and repackaged them into AAA crap and sold it to wealthy funds around the world who should have known better. They caused the spike in housing values. They caused the lowering of interest rates to an inflation adjusted rate of 0! They sold the "creative" financing that Greenspan ordered them to come up with in 2003 to create more debt to pump up the GDP--all based on lies.
While honest Americans, one of which you are not, are forced from their homes and put on the streets, your heroes on Wall Street are still taking multi-billion dollar payment and severance packages--and now are being paid directly BY US with our money for their theft.
You and the other neo-con apologists try this line about how it is middle class working Americans who are to blame because you are either too stupid or too criminal to admit that the entire country has been had, this time, and we have your friends in Finance to blame.
Rule of Law,
I couldn't agree more. These financial masters are just masters in dishonest business who've been lying and stealing for a living.
I think there was no other solution to defreeze the credit than this bailout plan.
But as soon as the credit system is running again, as soon as bankruptcies on a large scale are avoided, then it's time to bring the guilty masters in dishonest business in front of a jury.
Depossess the bastards, build a jail, and throw them in it with a diet of bread and water. And make them work hard and honestly inside the walls for a change. Welcome, Phil Gramm !
After all, it would be unfair for those thieves to enjoy shelter and food on the citizens' dime.
Oh, the irony of it--Actually being forced to create something of tangible value, like the food they eat! I love it, Francoise!
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