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.

Absolutely.

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 Ditech.com 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...

Risky Business

George Will, not a man I either admire or whose bromides and harangues I pretend to really even listen to, once said one of the smartest points about American government policy.

Unintentionally, of course. He's not that bright. He originally had been speaking of the tax code when he said that businesses tend to privatize profits but socialize losses.

In other words, a business can deduct its losses from the IRS (and by extension, the government) but will work like the dickens to retain as many earnings as possible and avoid as much tax as possible, even to the point of tax evasion.

Unfortunately, as Paul Krugman points out today, this policy is not limited to the tax code:

The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

That’s what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It’s also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)

But Mr. Paulson insists that he wants a “clean” plan. “Clean,” in this context, means a taxpayer-financed bailout with no strings attached — no quid pro quo on the part of those being bailed out. Why is that a good thing? Add to this the fact that Mr. Paulson is also demanding dictatorial authority, plus immunity from review “by any court of law or any administrative agency,” and this adds up to an unacceptable proposal.

In other words, ladies and gentlemen, we've co-signed a home loan for a friend, without any access to his income, and now the bill is due, he can't afford to sell enough of his crap on eBay and the mortgage is due.

If this was the first or only bailout we had endured, that might be OK. After all, it would be an experiment, and experiments are allowed to go bad.

But this is neither the first time we've had to bailout out bad loans (Krugman correctly refers to the S&L crisis of the 80s), or even companies in deep fiscal trouble.

We've been down this road before, and will sadly travel it many times into the future unless we change the paradigm. More on that later, perhaps next week.

We are in essence buying $700 billion dollars of near-worthless paper...after all, if it had value, the banks could package and sell it...in the hopes that some miracle, mirabile dictu!, and they gain value again.

Some will, many will not. While I find it hard to believe that these so-called "adults" of the Bush administration haven't calculated a generous breakeven point for the bailout where we stand to make back our $700 billion, I can pretty much guaran-damn-tee you that point is highly, perhaps even exuberantly, overoptimistic.

I haven't run the numbers, but I'd be willing to bet Paulson's gamble will show us losing a few hudnred million, maybe we recapture $400 billion. Maybe. Not likely.

Meanwhile, these banks, the WaMus and Wachovias and Wells Fargoes, all get to line up at this big pig trough for their slop of Fed money, in the hopes that somehow, banks that managed to keep their books in order privately, like Citibank, who ended up with a saudi bailout will begin lending them good money after bad.

With no penalty to the banks who got Federal money. No management changes. No seizure of assets to offset even a small portion of the bailout. No censure of the board of directors for failing their fiduciary oversight, and all golden parachutes intact.

Meanwhile, if you owe a mortgage and you have trouble paying it off, you lose your house, even if the Fed somehow steps in and finds you a shelter, but then again, the Republicans have cut those unnecessary social services because, you know, it inflates the deficit...

George Will is correct: Our priorities are all screwed up.

Not That This Was Unexpected, But...

...yer an idiot, Paulson:

TOKYO (Reuters) - U.S. Treasury Secretary Henry Paulson said the turmoil in global markets will "extract a penalty" on growth but the financial system and economy was strong enough to withstand it without provoking a U.S. recession.

"The economy and the markets are strong enough to absorb the losses," Paulson told the Wall Street Journal in an interview published on its Web site on Thursday.

Paulson also said the repricing of risk in markets should not surprise anyone and was inevitable, and that nothing should be done to guarantee market players against losses or restrain them from taking risks.

All this article really needs is a video of someone whistling past the graveyard. Or maybe this:So many reasons Paulson is an ass here, so little bandwidth.

First, he has a point: easy credit is no different than any other economic bubble and economic bubbles burst. Period. But here's the thing: this was a bubble the Fed could have AND SHOULD HAVE done something about years ago.

I find it hard to believe that Alan Greenspan (and now Ben Bernake) don't watch TV from time to time. Hell, you can't turn on the TV but for coming across and ad for Ditech.com or Countrywide Home Loans, advertising "No money down, no principal payment" loans at rates that make the prime interest rate look like a high-yield bond. Did it not occur to them, the way it occurred to me, that there might be something wrong in an economy where it's worthwhile for a predatory lender to run commercials hawking a dangerous financial product 24/7? So you bump up interest rates a bit, and you save a few people from making the biggest mistake of their lives.

You know, Alan, Ben, and now Hank, it's OK to do a little thinking about work while you're away from the office. Most of us have to do that, from time to time.

And now here's ol' Hank talking up the economy, you know, don't worry, everything's going to be fine, as the Fed pumps $50 billion dollars into the monetary system to shore up the credit markets.

OK, so a basic economic lesson here: when a government is forced to pump that kind of money into the system, where does it come from, in a nation running hundreds of billions in deficit spending each year?

Here's a hint: It ain't from a savings account.

There are two ways for the Fed to get their hands on that kind of dough that quickly: borrow it (meaning it will have to be paid back and then the question is, from whom was it borrowed?) or print it.

If it's just printed, then simple supply and demand will tell you what happens to the value of the dollar in your pocket: more supply lowers the "price" of that good, so by extension (and yea, I know, the analogy has holes in it, but it fits the argument more clearly than a real analysis), more money drives the value of your dollars down, meaning it will take more money to buy something.

In other words, inflation. Which the Fed tames by raising interest rates, thus stifling the demand for money.

If the money has been borrowed (ignoring for a moment from whom, tho I have my suspicions), then all this does is shift the risk off the original badder debts from the lenders (rapacious bankers and sub-prime mortgage companies) to, well, us.

In effect, the money the Fed has pumped into the credit markets is a guarantee that the government will stand behind the loans out there already (although not all of them, to be sure...I doubt we can get our mitts on something like $7 trillion to finance all the mortgages out there), meaning the ultimate responsibility for repaying this money isn't on the lenders, but on the guarantors, and since the Fed has authority but no responsibility, that privilege falls on our shoulders.

Where has this money come from?

Well, the make-up of the Fed is a bunch of money center banks, like say Citibank, Chase, Bank of America, who created and run the Federal Reserve System. No one knows for sure who precisely is on the Fed board, but these three are a safe bet.

These money center banks, which also sit on the central bank boards of nearly every other major nation in the world as well as the World Bank, would have the resources to finance, short term and at a rate of return commensurate with the critical nature of the emergency (in other words, usury) the hundreds of billions of dollars needed to stem the global economic collapse that is threatening the world.

As I said, for a price. They get us coming and going here, because who do you think funds the money to the mortgage markets to lend to people like you and me at attractive rates to pay off the credit cards (that they've issued) to try to get solvent by borrowing off our salaries in perpetuity? And now who's funding the bailout of those same sickening loans?

All this, so we could buy a new computer. Or car. Or second home.

So why is Paulson an idiot? He's bluffing, of course, and it's not a particularly good bluff this time. He sees (or he should) what should be evident to anyone after reading this far down: there's an enormous risk involved in the game the central bank is playing.

All it takes is one of the members to say "basta!" and the house of cards falls, forever. You've heard stories about The Great Depression, but you might (and I think you will) be living through something far worse in the very near future. And mind you, we were able to grow out of the Great Depression only by getting our asses into a world war, something we can't afford to do right now, because we've exhausted our financial and materiel supplies on this ill-starred and ill-fated invasion of Iraq, along with the more justifiable but still tragic war in Afghanistan.

Many of the 25%ers, the folks who still support George W Bush thru thick and thin, believe an apt comparison can be made to Harry Truman. It's clear from reading this, they're two Presidents too close.