Monday, September 29, 2008

Gravity Sucks

As anybody who's ever ridden a bicycle or even stood up knows, what goes up must come down.

This is as true for the stock market as it is for anything else. Granted, it's a whole lot harder for the market to fall back to sea level, something about retained earnings and asset values underpinning stock prices, but trust me on this: it is not impossible.

Enter Paul Krugman:
...The bailout plan released yesterday is a lot better than the proposal Henry Paulson first put out — sufficiently so to be worth passing. But it’s not what you’d actually call a good plan, and it won’t end the crisis. The odds are that the next president will have to deal with some major financial emergencies.

I'm not arguing that this is the mother of all financial crises. I am arguing, however, that the MOAFC stands a better chance of happening now, when the market is weakened and the solutions ineffectual, just like an opportunistic flu is more likely to incubate when the body's defenses are weakened.

The trouble with this bailout package is, it's like giving a bandage to a patient who's suffered a heart attack because he got a papercut filling in his admittance forms.

The real trouble is, well, ask a hundred pundits the cause of this problem, and you'll get a hundred different answers, all of them wrong.

Ask a hundred different economic pundits and you'll get a hundred different answers, of which 95% are incomplete.

Make no mistake about this: this crisis is pervasive and infiltrates the coziest sectors of our economy, and the world's economy. There was no single simple cause and there will not be a single answer, although the ultimate solution may end up being enormously simple. I think. I'll post more on my solution later this week.

We were worried about avian flu? This is an economic avian flu.

Curiously and coincidentally, this flu, like the avian one, has its roots in Asia. America exports debt. Period. We're good at it. We export roughly $700 billion annually (there's a reason that the bailout was pegged at that figure, and that's the reason right there).

Asian nations, flush with cash as their economies have overheated, have invested heavily in American debt, first in Treasuries bill and notes, and then when the purchase of those became unprofitable (for the same reason mortgages became attractive) in mortgage backed securities.

The gamble everyone made was that housing prices could only keep going up. Remember the title of this column?

As housing prices peaked and slid down a little, banks stopped lending money, forcing Fannie Mae and Freddie Mac to step in to keep the supply of mortgages consistent with the (overmarketed) demand.

How many and Countrywide commercials were there each hour just a few years ago? Five? Ten? Twenty? It's no surprise that these companies were the canary in the flu mine. They had the riskiest loans with the least capitalization, and needed to borrow the money they were lending.

And banks were only too happy to lend to them. Why? Because banks knew that the Fed and Treasury would step in when things got hairy. After all, the Fed helped arrange the bailout Long Term Capital Management. They'd have to step in where people's homes were at risk!

This is not the only cause of the current crisis and books will be written about them all, until eventually a comprehensive picture is put together, but I think this is a reasonable timeline of this crisis and how it unfolded. Call it the tree on which to hang the ornaments.

But like a Christmas tree, what goes up eventually must come down...