From the New York Times today:
In another sign that the struggling economy continues to slow, consumer prices tumbled by a record amount in October, carried lower by skidding energy and transportation prices, raising the specter of deflation.
From a plugged-in reader’s comment we promoted last year:
Thanks for the questions regarding how I can be predicting deflation when everyone else seems to be saying inflation (and some price measures are pointing that way). It does seem contradictory, but it’s really pretty straightforward when you take it step by step…
It’s good to be plugged-in.
∙ Consumer Price Decline Prompts Fear of Deflation [New York Times]
∙ Promoted From Comment To Post: Satchel Does Deflation [SocketSite]
Wow, when prices fall, things sure do get cheap!
Yup. But I’m still optimistic.
Berkshire Hathaway is a steal right now. I have plenty of confidence that good businesses will earn record earnings five, ten, fifeen years from now.
Satchel was right! Where is that guy anyway?
I’d like to hear his thoughts on when inflation is gonna kick in.
Berkshire Hathaway is a steal right now.
This animal still has a lot of meat on the bones to be picked by this relentless market.
Buffett is a genius, but watch out. Market Oracles are always right until they are not. Remember the Greenspan fetish of only 2 years ago? He is now vilified by people who realize he is human after all.
Ahhhh, the good old days, when deflation was just something Satchel was talking about here, and not a freakin’ reality yet.
This original post is what turned me from an occasional reader of SS to an avid one.
Jimmy – hint on where Satchel is, he lives in Marin and has a high net worth and can often be seen giggling.
Satchel’s predictions were freakishly accurate. I just wish I would have re-allocated my brokerage accounts 100% at the time I first heard them — but his analyses did prompt me to make some fairly sizable moves that have saved me big sums. And several people I convinced not to buy homes now “or be priced out forever” are also (indirectly) grateful. I didn’t fully agree with his prescriptions for dealing with the problem, but he saw it all coming with amazing accuracy.
Everything that guy said was dead on.
Sobering.
SanFronziScheme,
I would rather bet on Warren Buffett than 99% of American corporate management.
While it will likely fall lower, I have no doubt that they are doing what they should to invest for the long term.
They are conservative, aim to grow book value, and value shareholders over management.
we are clearly in monetary deflation right now. however, the question remains if the Federal Reserve and our govt will try to monetize debt and cause inflation. that question is not yet answered. we will have to see. no reason to beat a dead horse, I’ve discussed this ad nauseum before.
but I’d be more interested to hear what the new Satchel (LMRIM) thinks of Treasuries.
in general, we disagreed on very little except for future Treasury yields (him thinking they would stay low, me thinking they would rise significantly)
I’d be interested in seeing if he is coming to the dark side of the force yet. (I still predict significantly higher Treasury yields in the not too distant future).
in the past I’ve tried to highlight when something “big” happens (like way way back when Bear Stearn’s 2 hedge funds failed). well, there MIGHT be something big happening right now. (not sure just yet)
Japan has suggested that the US start issuing debt denominated in YEN (not dollars). It is thus far unclear how much they will push this. If they do push this it will be one of the most important occurrences in our economic downturn, and possibly of the last 50 years… forever changing our global economic system.
at this point we borrow money in dollars. thus we are never technically at risk of default becuase in theory we could repay all of our debt by simply devaluing our currency (‘printing money’). but if our debt is in another currency (like Yen) this will not work. (ask Argentina or Russia as example). it would be a massive game changer.
we are rapidly approaching the time when foreigners refuse to lend us money at favorable rates. when that time comes EITHER we will have to pay more interest on that money (lower treasury prices which means higher treasury yields) or we will have to borrow in a foreign currency (difficult to say the least). as it is, most of our debt (Treasuries) are of short maturities…
didn’t we already learn a lesson about borrowing short to lend long? evidently we didn’t learn it well enough. but we’ll relearn it.
I would rather bet on Warren Buffett than 99% of American corporate management.
No brainer there.
But I trust cash more than Warren Buffett at this point. Been cash for 2 years, no stocks since july 2006. I feel really safer for days like today. Bargain hunting is coming closer and closer on all types of assets. We’re not there yet I think.
So, this whole ordeal is boiling to two essential questions: first, when monetization of this newly-created debt would bring a hyperinflation upon our heads, and, second, where to park all this hoarded cash? Satchel, where are you?! It would be nice to hear your perspective. I have to confess, Satchel’s posts converted me into a daily reader of SS.
Some great buying opportunities right now including Berkshire, Conoco, Intel, and ATVI. BTW, how are you sure that Satchel=Laughing Millionare Renter? They sound like very different guys to me, Satchel coming off as informed, thoughtful, and respectful, whereas LMR is shrill and nasty of the 4 year old “nyah, nyah, nyah” variety.
Cash and courage in a crisis is priceless.
Satchel coming off as informed, thoughtful, and respectful, whereas LMR is shrill and nasty of the 4 year old “nyah, nyah, nyah” variety.
LOL. After all the flak he got, you can’t blame him for sitting back and enjoying his gold pile while looking at the crumbling of the debt sandcastle from a distance.
Sincerely, is it really safe to bury all that gold in the backyard of a rented house? What if the landlord claims mining rights and starts digging?
ex-SF: Wow, I had to search to find that US Yen-denominated debt story. It doesn’t appear in
“the usual” places. Unbelievable.
Hopefully we are not dumb enough to do that.
Accounting for the occasional random internet comment zombie, SS manages to attract only very intelligent people, which is why I tend to read it several times a day.
Mostly what I learn from things like this is that the cumulative distribution function of economic knowledge against percentage of the population rises very steeply to cover most of us. Those that really do understand monetary policy seem to have a vested interest in keeping the rest of us uninformed.
Why do I have a hard time thinking Paulson is doing anything other than milking the last bit of wealth he can from all of us before the cord snaps back the other direction?
Also, now I want to go borrow a book on monetary policy.
SFS: I’m sure Satchel negotiated for mineral rights to the property as part of the lease 🙂
we are clearly in monetary deflation right now. however, the question remains if the Federal Reserve and our govt will try to monetize debt and cause inflation.
I would argue that the question certainly does not remain… There is absolutely no doubt whatsoever on this. We will have no choice but to print our way out of this mess. (We will print our way into a completely different mess, but that’s another story…)
Inflation is hardly a good answer but deflation is an unacceptable alternative. What’s happening now is massive deleveraging (e.g. hedge funds selling off everything from commodities to foreign currency to BRIC stocks to credit default swaps) and a worldwide “flight to quality” that is propping up the dollar and driving down the rate on treasuries, temporarily at least. Our government debt is amazingly still viewed as “quality” on this planet (today, that is).
But tomorrow is another story. The new administration is going to (hopefully) engage in massive fiscal stimulus in the attempt to put a floor under unemployment. The Fed is going to keep dropping rates (even though we’re already negative in real terms). The Treasury has already gotten permission to buy $700 billion of garbage… All of this will prove inflationary. We’ll have to wait and see if it happens in 2009 or not.
Every recession since the 30s has been inflationary. That’s because the Fed seemingly learned the lesson of the Depression. (Look at futures contracts today on oil prices eight years out and you’ll see that they are 50% higher than the price of oil today. I’m not the only one expecting inflation in the future…)
Inflation will not be painless but you just have to ask yourself if you prefer 10% unemployment or 25%… I think we all better be praying for inflation.
I too was lured to SS on a daily basis after reading and following a few of Satchels posts. Off topic here: If one desires to $ a home in the middle of this fiasco for reasons I won’t bore you with, and with the understanding that it may be a bit crazy and foolish… Would you say buy now before all this proves inflationary or wait it out a bit longer? Rates are still historically low, and I can’t bury the cash in the back yard as I don’t have one.
deflation is an unacceptable alternative
Not if salaries are renegotiated. If there’s one lesson about the Great Depression, it’s that you can’t have high artificial wages with cheaper goods. Producers will be slaughtered and will lay off this overpriced labor.
Deflation should run its course and serve as a cautionary tale for the future. Risk taking is OK, but you have to have a safety net (i.e. savings or low expenses).
If you reward overborrowing by devaluating debt, you’re just asking for more of the same. Add to this the collapse of the USD. The rest of the world will be using the cash they have been saving to buy our assets.
SatchelRocks, most people around here will probably tell you to wait. As weak hands get forced to sell into this market, you will obviously see more and more deals.
I sold my house in ’06 and sat on the sidelines, flush with cash for almost two years, renting a very average (but very cheap) place. I’m very fiscally conservative (put my entire 401K into cash in 2007 and shorted the S&P500 via SDS in April ’08).
Recently, I found a SFH in the City (an REO) that I bought for about $300k less than it’s selling price in 2005. Put 20% down and locked into a fully amortizing “conforming jumbo” at 6.125% for 30 years. Our mortgage plus taxes is below 20% of our gross take-home.
Did I buy at the bottom? No. Things will probably get cheaper. But I was never going to buy with all cash and needed a mortgage to get in. So, I think I got a pretty good deal that I have no trouble affording. I’m betting that we’re headed for the 1970s, not the 1930s. I’m sure people here might disagree but that’s the nature of speculation.
My advice to anyone is just not to put yourself at risk. I don’t believe that “it’s always a good time to buy” but I do believe that “you can’t live in stocks and bonds”. I’m in SF for the long haul. Good luck.
of course I’m not 100% sure that Satchel is LMRIM, but I’m pretty sure. the tone of the posts differs slightly, but the style of the posts is dead on. Look at the way both of them post local market statistics of specific properties, and the longwinded responses (he’s almost as longwinded as me)
plus, Satchel always had a slight “nyah nyah” tone, go back and read his old posts with fluj, or the many time people would get angry at Satchel’s shadenfreude.
Regardless, I call Satchel out. He predicted the easy stuff, now times are harder to predict (impossible really).
Dave: I disagree with you that inflation/hyperinflation is a given.
I have argued stridently for some time that we would see deflation then massive inflation (the ka-POOM theory). so I agree with you about future inflation.
but there are very intelligent people who do not agree with this theory and they may be correct.
in the end it all rests with just a few men. American history has shown that our govt prefers inflationary responses to financial crises mainly secondary to the trauma we endured with our deflationary Great depression.
This is in stark contrast to the Europeans who fear hyperinflation due to their Weimar Germany history.
thus, is it any surprise that our Fed Chairman is a depression expert, one quoted as saying he would use “helicopters of money” to prevent deflation?
however, Satchel was correct that TO DATE the Fed is for the most part sterilizing it’s functions (with the exception of their various term lending facilities that took worthless assets at par or near par in exchange for Treasuries). thus, we are thus far following a deflationary recession.
As I’ve said: I believe that we will change course when the pain gets too great… and then our leaders will institute inflationary policies… but that time is not yet.
and there is considerable disagreement as to whether or not the govt will do it at all
FWIW: do not be too complacent with inflation. an inflationary recession/depression could be as devastating as a deflationary recession/depression. hyperinflation lead to the fall of Germany as example.
it is VERY hard to institute inflationary policies and yet keep inflation expectations in control.
I am still rooting for inflation.
I have been hearing talk about the government enabling RE lending at below market rates to stabilize the RE market. TARP was a joke. Until RE stops going down, we are going to continue to grind our gears. It is not a comfy bed, but we are all in it (US corporate and govt leadership failed over the past 15 years)…
Back to the plan, basically everyone that wants to stay in their homes and can reasonably afford an amortized payment at 4% 30 year fixed the US government will facilitate their refi. If you are underwater, let the lender decide if they want the property or they want to let the borrower do a short refi at 97% LTV with uncle sam. I think this was done during the depression. Just keep paying your loans and don’t walk. Hopefully the prices will inflate up/and pass the loans over the next few years. Not sure on the math, but at some point this has merit. THe current system of having to be late and then they will renegotiate is insane and the core of the problem is RE going down. I know the real problem was RE going up but the tooth paste is out of the tube and the smart rich guys tied the entire economy to the RE values (oops, I mean prices). The loans were made based on the high values and the quicker we get to the bottom the better.
Deflation should run its course and serve as a cautionary tale for the future.
Sorry, but I couldn’t disagree more with this statement. Deflation should never run its course. I’d recommend that people read David Kennedy’s book on the Depression, if you want to get a handle on how bad deflation is.
Deflation is not just a 50% off sale at Best Buy. That sounds great, especially if you have dry powder… True deflation grinds the entire economy to a halt, discourages any and all investment, destroys economic productivity, and puts a gigantic portion of the population out of work. An inflationary recession is far more preferable and far less expensive in the long run.
Japan still hasn’t been able to dig itself out of a deflationary environment, even with negative real interest rates (for decades). Hopefully we can avoid their mistakes of propping up failed institutions but I’m less confident here.
Actually, Satchel posted tons of graphs showing how the Fed was creating all this inflation this summer. Big graphs from the St. louis Fed showing growth in money base.
His post in Dec 07 was good but the whole year he has talked about how inflation is going to to through the roof because the Fed was printing money.
it wasn’t just a few posts it was months and monhts of how we were getting monster inflation.
Even a stopped clock is right once.
Actually, we need the Fed to print money so ppl will start lending…right now money and debt are all dissapearing at an alarming rate. No helicopter ben in sight.
“Also, now I want to go borrow a book on monetary policy.”
Start with Rothbard’s “The Mystery of Banking” 🙂
I was riding my bike the other day early on a crystal clear morning up some of the short but tough climbs out here in Tiburon (Avenida Miraflores, Round Hill – cutting through the centi-millionaires’ backyard easements to connect with the fire roads to Gilmartin, etc.) and ran into Satch riding his exceptionally rare (and exceptionally pricey) silver Nagasawa, and he related a few things.
Risk/reward on long-dated treasuries is starting to favor getting out of them, but he laughed at the “disinformation spoof” placed by TPTB about issuing “Samurai T-bonds”. That’s not a serious consideration.
Asian stocks are starting to look attractive, and perhaps index equity positions in the usual suspects (Japan, China, Korea, India, and a basket of the smaller ex-Tigers) would be warranted at approx 1% net worth per month over the next 12-18 months.
The US is toast. It’s surprising how poorly equities have wiped out – only a fool wouldn’t have expected a 30% wipeout, but 45%+ demonstrates some masterful foolishness by Bernanke that surpised even Satch. Bravo.
Overall, the macro response has been a joke, and will only get worse under Obamanomics. Anyone thinking inflation is a possible method of getting out of this debt overhang should really consider what happens when interest rates rise in a scenario where debt/gdp is still over 350%. Think 15-20% mortgage rates, and/or a complete freezeup of credit availability and political rationing a la Russia 1980. When enough debt is destroyed/defaulted/repaid/absorbed by the USG, then the Fed and USG will be able to reflate. By that time of course, just about every dime of illusory wealth will have been siphoned out of the pockets of the population (since it’s based on credit).
No surprise that the USD has been so strong – that’s what always happens in a credit deflation of a strong/reserve currency country, and of course no surprise that commodities crashed while gold basically held up (check the price in EUR or Indian Rupee or Icelandic Krona or BRZ. etc.), but there cold be some weakness in USD terms coming. It’s an insurance position, not a trading position. (Ultimately, the USD is toast too, but as they say in the long run we’re all dead, and that “ultimately” aint’t going to be too comforting when in USD terms your house in SF goes down 40%, which it will.) Fortunately for Wall Street and Bernanke, his monetary shenanigans last fall allowed the smart people to offload their commodities positions on stupid pension funds right at the top!
Last, for all the constructivists out there who think that these idiots running the show (Paulson, Bernanke, et al) or idiots advising them (e.g., Krugman, Feldstein, etc.) are worth listening to, he pointed me to a fun article on our favorite web site:
http://www.mises.org/story/3215
Remember, no need to sling criticisms at me – I’m just the messenger 🙂
What is surprising is how everyone thought the government was going to bail EVERYONE out. Then, all of the sudden, government money got VERY scarce. Instead of buying crap, we bought shares, but we DIDN’T do both. We took the TARP money and used it for all sorts of other things, but we DIDN’T see more TARP money. In fact, they used half of it and left the other half for the next administration.
I get the sense from the above that congress agreed that there would be a single $700B shot and that was it: no more. If that’s the case, the inflationary forces caused by the government will be more than outweighed by the deflationary forces in the marketplace.
Additionally, we are essentially duplicating Japan’s playbook. They didn’t get massive inflation: what they got was a decades long deflation. We aren’t japan, but I think as long as we duplicate what they are doing, we get pretty close to what they got.
Obviously, if you get massive deflation, you may get a correction and some inflation. As Jim Rogers said 6 months ago, “Oil might GO to $50, but it can’t STAY at $50.” Can oil rise back to $100 in 6 months. Sure.
In any event, deflation or inflation, you cannot have an asset class that went through a bubble go higher. Tech stocks did not rise 6% in 2001, in spite of the fact that inflation ran at 6%. So you can have an asset class drop even in an inflationary period.
The world is awash in houses: we built too many because that’s what bubbles do: they misallocate resources, and that misallocation is what causes bubbles to ultimately pop: the supply in the pipeline overwhelms even the artificial demand and then the artificial demand pulls back but the pipeline is full and keeps spitting out the objects of the bubble and the bubble pops. Inflation isn’t going to change that.
It isn’t going to change the fact that we have too much of everything and no real income, just debt. And consumers appear to have tired of all the debt, in the same way that gas is dirt cheap but SUVs are no longer flying off dealer’s lots.
We have more car companies than we need, more retailers than we need, more of everything than we need. We can add another zero to all prices and wages (e.g. things that cost $1 will now cost $10), but that doesn’t solve the problem, though it does cheat people who issued long term debt. However, a lot of those people are foreigners, and if they decide, because we cheated them, to take their marbles and go home, we get even bigger problems. So I’d be surprised if we try to inflate our way out of this.
And even if they try, who is to say that it works. If you hand banks money, they don’t have to loan it out. Right now, they won’t. The forces of the market to deflate are currently stronger than the will of the government to inflate. As ex-sfer says, that can change based on the whim of a few, but right now, that’s the way it is.
Dave – thanks for the response and good luck to you as well.
Peanut Gallery:
“I have been hearing talk about the government enabling RE lending at below market rates to stabilize the RE market.”
I too have heard similar but it has been mostly speculative and I thought one had to be late with payments or something?
Have you heard anything regarding these refi’s being direct via banks or gov backed some how?
Anyone thinking inflation is a possible method of getting out of this debt overhang should really consider what happens when interest rates rise in a scenario where debt/gdp is still over 350%. Think 15-20% mortgage rates, and/or a complete freezeup of credit availability and political rationing a la Russia 1980.
All one need do is look at the USA circa 1981-1982 to find 15% mortgages. Painful? Yes. Unprecedented? No…
Debt is high relative to GDP but the denominator in that ratio is not fixed. In the last deflationary period of this country, GDP fell 30% in real terms from 1930-1933. Mortgages might as well be 100% at that point because there will be zero demand.
You could be right that we’re headed down that path but inflation is still preferable, and that’s what the govt will try to engineer. Lack of credit available is far better than lack of demand.
…it does cheat people who issued long term debt. However, a lot of those people are foreigners, and if they decide, because we cheated them, to take their marbles and go home, we get even bigger problems.
They have no choice but to support the currency. Everything is inter-connected. They already suffered tons of losses on our toxic debt.
Speaking of “Rich foreigners”, Russia could be on the verge of a 1998 redux.
Deflation isn’t so bad, after all it means things get cheaper. So you can just wait to buy everything until you can afford it. Hmm…will everyone waiting to buy things because they will be cheaper to buy tomorrow have a negative effect on our economy?
Will “buy now or be priced out forever” give way to “buy now or everyone’s getting laid off”?!?
“All one need do is look at the USA circa 1981-1982 to find 15% mortgages. Painful? Yes. Unprecedented? No… ”
Ah yes, but think of the price of the asset. A nice house in St. Francis that costs $2M today cost $250K back then. And wages are not 10x higher today!
It’s pretty simple. 350% gdp * 15% debt service = 45% of national income just to pay the debt service! Good luck USA living on the rest of that 55% of income! And it will be very hard to “roll” the debt, when the lenders fear that repayment will only be made with worthless toilet paper money (how do you repay when 45% of your income is needed just to service it?).
Back in 1980, debt/gdp was more like 150%. And the government still spent more than 20% of its revenues on interest costs alone (today it’s less than 10%), and of course we didn’t toss away 40-50% of government revenues on unproductive welfare programs (primarily social security and medicare). Stocks also traded at p/e’s around 7 or 8.
The adjustment will be murder in an inflationary environment. Don’t get your hopes up too much – the debt deflation awaits, and then we’ll reflate (once stocks are at 7 pe’s, SF houses are at 3-4x median income, etc.) That’s the optimistic scenario. The dire one is a hyperinflation, as it would be impossible to control a breakdown in the credit system that would arise from the monetary inflation that would be needed to counteract this debt deflation storm.
No easy answers in a credit deflation, as Mr. Bernanke is finding out. The fact that he took the job shows that he doesn’t have the intellect to understand the problem. He’s just a fall guy. IMO we’re going to find out that we’re not any smarter than the policy makers in the 1920s and 1930s. If we were, we wouldn’t be in this pickle.
All satchel talked about for 2008 was how we were going to have inflation forever….instead we are in a deflationary spiral that we can’t get out of. He was the most poster wrong ever..i hope socketside was kidding.
Deflation is easily addressed, as explained by Bernanke in a 2002 speech:
“the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”
How is it possible that the US gov will offer 4% 30-year refis to existing home owners in an environment where 30-year mortgages for new buyers go for 15-20%? These two scenarios cannot co-exist.
Bernanke keeps lowering rates, but to his great frustration, the long end of the yield curve remains virtually unchanged. Pushing on a string.
I predict the next rabbit Bernanke will pull out of his hat will be lowering 5 and 10 year rates. How? By buying up treasuries in this maturity range. Prices go up, yields go down. Pressure on the long end. Finally 30 year mortgages start to come down. And while this is an unusual Fed move, there is precedent.
This will help stabilize housing prices by keeping current owners in their home and attracting new buyers. Once this happens, these toxic mortgages stinking up every bank’s balance sheet will no longer be so toxic. And everyone will go out and buy sofas, TVs and BBQs which will help the economy.
Problem solved.
LMRM, I’ll keep an eye out for Satchel zooming by on that Nagasawa. That asset will probably rise in value in any inflation/deflation scenario:
http://www.yellowjersey.org/NAGASAWA.HTML
Since it’s no longer possible to go long in Nagasawa frames, what do you think about shorting the long treasuries (or shorting anything else)?
DataDude–if he were going to buy 10 years he might as well just buy the mortgage debt directly. Mortgage rates to be honest are already pretty low by historical standards. We don’t really need cheaper mortgages, rather we need housing to come down to its equilibrium price 20-30% lower than here. Finance that at 6 % and you’ll be fine.
the people claiming that Satchel predicted monetary inflation clearly didn’t understand his posts. he has always been a pure deflationist although he understood that we would have interim asset price appreciation short term (which happened and is now past)
LMRIM stated (channeling Satchel):
Risk/reward on long-dated treasuries is starting to favor getting out of them
VICTORY IS MINE! (smiling).
I knew you’d come around to the danger that is US Treasuries.
On the point of the Yen denominated Treasuries… you seem to put everything together but then you balk at the last step. sheesh… I can lead you to water but you won’t take that sip huh? 🙂
You say:
it will be very hard to “roll” the debt, when the lenders fear that repayment will only be made with worthless toilet paper money
I agree fully and this has been my contention for some time which is why I have been calling the recent Treasury rates a bubble and due to correct nastily.
but then you follow with:
Risk/reward on long-dated treasuries is starting to favor getting out of them, but he laughed at the “disinformation spoof” placed by TPTB about issuing “Samurai T-bonds”. That’s not a serious consideration.
This isn’t coming from OUR powers that be. it is the logical extension of your above point. with dollar hegemony/reserve currency we have always had the luxury of US dollar denominated debt. when times got tough we only needed to raise interest rates to defend our hegemony. however, the hegemony is under attack. The foreigners have LOST money on our debt this year. They are tiring of our toilet paper dollars, but cannot yet break free for reasons you well know (beggar thy neighbor trade policies and dollar recycling)
Thus, it doesn’t take a huge theoretical leap to think that the foreigners are starting to rethink lending us money in USD. There is a very real concern that the foreigners will force us to borrow in their currencies. if so times will be quite painful for us. Argentina squared.
but again, I’m not sure if the rest of world will push this or not. it is a VERY risky gamble. clearly, the Japanese are floating this trial balloon because they can. they are our “allies”. But make no mistake, others are also interested in this, especailly China. But China (our trade antagonist) cannot politically float this at this time, hence it comes from the Japanese.
It is risky for the rest of world to do this though. they have a nasty choice:
1) continue supporting the dollar and allow the US to borrow in USD which allows the dollar recycling and thus their export driven economies to continue… but then face massive currency exchange risk and the risk the US will devalue it’s currency
2) force the US to borrow in a different currency, which immediately increases the chance of US Default on all debt causing immediate worldwide depression.
I do not think we can ignore this Yen Treasury story for now, as it is currently the most important story out there IMO. however, it is still very unclear if they will push this or not. (I have my doubts as well). regardless, US Dollar as primary reserve currency is clearly on the path to extinction.
as for inflation/deflation, I still favor the ka-POOM theory (deflation for 1-2 years followed by massive inflation), but continued deflation is clearly possible. I’m still betting that when the cards are all played that Mr. Bernanke will live up to his namesake. he was born to play the hyperinflator. A few more months of deflation and the country will be BEGGING for hyperinflation (through handouts, stimulus, tax breaks, New Deal 2, etc).
FSBO,
I’d be really careful about shorting the long bond. Although risk/reward is slightly against a long position at 3.99% rates today, there is an nontrivial chance that these trade down to sub-3%, making a short bet painful. Any substantial rise in the rate would collapse this economy even further – remember, treasuries are the floor rates for the entire 300%+ gdp debt ex-treasuries – and people will rush back into treasuries. My sense is the USG is moving away from caring about housing. They never really cared too much IMO (they just wanted to make it seem that way so that people would keep paying as long as possible, and the games continue…).
I’m still short most of the commercial REITs, although much of the juice is out of those trades. It will be a beautiful day when GGP gives up the ghost (and it should be within weeks), and for good measure I’d like to see SPG and VNO go into the ash heap of history 🙂
I don’t see too much more short downside in US equities but I’ve been wrong before! This is truly an epic crash by historical standards, I guess in retrospect practically guaranteed by the actions of boob Bernanke. He challenged the market through his repeated tinkering (cutting prior to options expiry repeatedly, jamming specs with stupid ill-though out restrictions, myriad Sunday night shows) and Mr. Market is demonstrating to him what it thinks of his theories. He should resign. That would send the market up 1000 points, but even barring that, it doesn’t seem a good risk/reward to bet on significant further declines from here (maybe after a rally of a few months, tho?…..)
My guess is that we are 60-75% past the “financial” crisis. The crash of the real economy is just getting started, though. Part of the reason that the “issuing treasuries in yen” story got out IMO is to prepare people for the idea that interest rates might be going up at some point and that the USG does not have the flexibility to make the pain go away (except for certain Wall Street execs). At some point, rates might have to be raised (as in September 1931) if it looks like the dollar is going wobbly. We are already going to get the 1932-style tax increases as promised by Obama. Everything old is new again!
On Nagasawa frames, the track frames are rare, but silver road frames (set up for derailleurs) like the third one here are the holy grail:
http://www.yellowjersey.org/trnaga.html
I bet there’s not 15 Nag road frames in the whole US!
I agree that housing should come down to it’s equilibrium price, let’s call that 20-30% lower than here. But the government seems hellbent to keep prices inflated. The gov fears that if house values go down an additional 20-30%, droves more people will bail on their mortgages. Making the toxic assets even more toxic.
I hate intervention. But the government doesn’t. What new home owners really care about is their monthly payment, which as you know is a function of sales price and mortgage rate. Wouldn’t the gov rather have prices stay high (so current owners don’t walk) and rates go low (so new owners can afford and existing owners can refi)?
If 30-year rates were 3% for everyone, prices would stabilize at a higher level, and new buyers would enter the market, for fear of missing a once-in-a-lifetime rate. Right now, the perception is that only existing homeowners who probably bit off more than they could chew are being rewarded with low rates. That doesn’t seem fair. And it doesn’t help renters willing to buy at the right (monthly) price.
If the gov wants to de-toxify mortgage backed securities, instead of buying these putrid beasts and placing them in a parking lot where they rot for the next 30 years, doesn’t it make more sense to increase the quality of the underlying assets?
LMRIM:
I agree with your latest post fully. Remember though, the Yen Treasury story isn’t being floated by our powers that be. it’s by the foreigners.
it is perhaps just a bargaining tool that they are using to keep us from devaluing our currency. sort of a “you better raise those interest rates and defend your dollar or you’re borrowing in Yen” type of thing. because I too have a hard time believing they’d be so dumb as to lend us in their currency. we’d be bankrupt in a week.
the essential problem however is that we as a nation have borrowed too much. can we ever pay it back? at 4%? 10%? 15%?
the US may find itself in trouble since it has to keep rolling over short term debt. especially since we’ve benefitted from such low “teaser” rates on our debt.
Just as homeowners found out they were overextended and could no longer handle their reset/recast on their Option ARM.
FSBO:
I agree with LMRIM.
the markets are all contrived right now. everything you do for the most part is a bet these days.
if we had transparent free markets then shorting the long Treasuries would be a no-brainer. however, never forget the possibility that the Fed could buy the long bonds itself to bring those yields down, as somebody else above mentioned.
also: Treasuries are still the most safe investments out there… so if the garbage hits the fan you could see a flight to quality (haha) and Treasury prices could soar (making yields plummet).
“if the garbage hits the fan…”
Have you looked at the current yields? We are there, my friend. 3.32% on the ten.
As for all the wonky discussion on inflation/deflation/hyperinflation, I’d remind everyone to take a deep breath and realize that we’re not “there” yet. We are experiencing some disinflation (not deflation) today. It’s mostly based on the yoyo value of the dollar over the last six months.
However, look at Kohn’s comments today. He is tipping the hand of the Fed and engaging in monetary saber rattling. Greenspan did this in 2002. We weren’t close to having deflation then either but the Fed will do everything to keep us away from it short of hyperinflation.
Inflation benefits debtors. Deflation benefits creditors. Our nation is a debtor nation. There is no doubt which direction the political winds will carry us. Expect massive fiscal stimulus on the way in the next six months to accompany all this monetary stimulus. Deficits will not matter, just like the Fed/CentralBank balance sheets currently don’t matter.
“Remember though, the Yen Treasury story isn’t being floated by our powers that be. it’s by the foreigners.”
Ah, ex SF-er, you’re almost all the way there. TPTB in the US and Japan have been the same since that day on the USS Missouri….
Externally-denominated debt is what sunk Weimar, and more recently Russia and Argentina. Yen denomination of the debt would make default more likely, not less likely, and so would not increase willingness to finance. The Japanese know that the *only* thing that makes USD debt valuable is reserve currency status (otherwise, our external accounts and deficit picture look like Indonesia circa 1997, except without the growth and with a whole lot of unproductive oldsters who want a handout :)).
Issuing in a currency other than USD presupposes the tacit admission that we no longer have the reserve currency status. That would be game over for the financing of US external accounts and we would immediately suffer the fate of Indonesia 1998 or Russia 1999 – instant swing in the current account to surplus accompanied by domestic depression.
It might happen of course, but I’d bet the more likely scenario is an environment that feels very much like a “mild” depression, as asset prices spiral downwards, price inflation is only a few points either side of zero for a long time (I’ve never predicted anything but mild deflation similar to what Japan experienced; massive CPI inflation can probably not happen under a pure fiat system), and savings are slowly rebuilt. The USG will try to make this transition easier, which will of course make it worse.
My only hope is that people will stop believing in the tooth fairy of “good” government – the USG and the Fed do not care one bit about the average US citizen, or the idea that inflation would “benefit” him because he is a debtor. He is simply an interchangeable labor/consumption function (especially because he has no real capital). The more pain he is in, the more he turns to government. The Depression was the best thing that ever happened to the USG!
LMR wrote: “Ah yes, but think of the price of the asset. A nice house in St. Francis that costs $2M today cost $250K back then. And wages are not 10x higher today!”
Median household income was about $15,800 in SF in 1980. Although the median isn’t $158,000, we are both a lot richer and a lot poorer than we were in 1980 and I’m sure everyone agrees that a 158k salary, although not the median, is hardly remarkable in SF.
Sorry, I meant “massive CPI deflation can probably not happen” above.
The Yen article is very premature. We’ve seen the default swaps on US treasuries rise but a default is impossible unless we start printing debt in yen or euros.
But as we move more and more private debt to public debt, there may come a time when we have to start issuing carter bonds or whatehaveyou. however, all the major economies are going to have to do large fiscal stimulus…
Japans GOVT debt to gdp is already at 200%. ours is 60 something, gernmany is about 60% as well (all #s like 2007) We are essentially moving about 100% of GDP debt from private hands to public hands. Everyoneis doing it. If all these countries borrow at the same time it crowds out private invesment but it won’t chop the US off as the world’s reserve currency.
Most of the rise in the currency is demand for US bonds and for dollars to repay debts denominated in dollars abroad. People are going to remember this crisis for a while. With bonds priced this way and the dollar this high, if I were the Japanese and Chinese this would be the time to do a portfolio reallocation.
I’d watch the US dollar. Eventnaully it will start to fall, and if 10/30 years start to rise really quick raising the cost of borrowing…look out. I guess the proper thing to do is hedge swiss francs. That guy earlier who thought 6% mortgages was expensive is not gonna be pleased.
i used to think that was the scenario that was going to happen actually but I am not so sure now. All this borrowing globally should just push up the cost of capital for the rest of the economy. It won’t necessarily result in the loss of reserve currency status for the US at least not in the near term. People forget how much we produce.
We spend about 50 billion too much a month too much….we need to raise our exports and cut our consumption by that much. ASAP to get out of this.
Sacthel Fan,
The Treasury would finance/insure the loans to the borrowers. Would be done through the banks and GSE. At the end of the day, keeping RE from crashing will save the treasury and stake holders more than alternative. We need to clear the toxic loans off the books, both the underwater and negaming stuff. Only reason banks renegotiate loans now is to try to avoid foreclosure/walk away. I kinda understand the fed is a private power but at some point the US government would make a strong argument for the private players to play along if it made sense. As far as the fed not wanting their $ assets to lose value, I am no expert but RE crashing will hurt the fed as well if the debt markets crash. I am not convinced that the Fed is as independent as has been described.
DataDude,
I am thinking these low rate loans will be around for some time via fake government subsides. 15% mortgages would bring back creative financing and kill the new loan originations. Would also help to overshoot the RE price bottom. Not sure who, but someone in power does not want the debt markets to implode. Mass walk aways could do it.
apart from Swiss Francs, what is the proper hedge for a patient buyer with piles of cash who can’t believe that the collapse in prices he has been waiting for since 2001 could be snatched away by hyper-inflation?
Steve,
There are a lot of options. None of them perfect.
1) Short 10/30 year bonds. There are risks here though if the world goes into a global depression. If inflation doesn’t come back- you’ll get hurt here and this probably won’t work.
2) Long yen. Problem is the Japanese have huge amounts of public debt and if the carry trade comes back they will start to lend money abroad again and the yen will fall. making the hedge not work as well.
3) Gold-again if the economy goes into global depression that won’t work either.
Lots of ideas but if the economy goes into a depression none really work as well because wealth goes down. It’s just a question of least worst. If someone has another idea I’d like to here it too!
Although hyperinflation (say, greater than 20% inflation for more than a year – everyone has a different definition) is pretty unlikely IMO, if THAT is the risk you are trying to hedge, I’d suggest:
1. A little Japanese Yen. Japan has a lot of debt, but basically a balanced external picture and trade is not a huge part of their economy (much larger than in the 1990s, but still only around 15-18% of GDP, on par with the US). They are resource dependent and dramatic weakening of the yen would not benefit them, and their export sector is not large enough to tempt them too much (yen may weaken against gold, but rise against USD).
2. A lot of gold, preferably in physical. USD value of gold would go up.
3. Perhaps a bit in agricultural and other “softs” commodities through an ETF. I think these would perform better in USD terms than industrial commodities, as real demand would fall dramatically if the producer of 25% of world GDP goes into hyperinflationary depression (and that’s what would happen).
4. This is not appropriate for a passive portfolio, but rental real estate in areas where prices have already crashed should do well. (SF would not perform well until well after the correction.) Worse neighborhoods would be better, as there would be numerous government programs (a la Section 8) that could be gamed by the smart investor (money flows from the stupid governmen/taxpayer to the smart). As leveraged as possible, of course, again taking advantage of any government programs that are ostensibly to help “average people” but which of course will be gamed by the smart.
All that being said, I wouldn’t get too worried. SF prices are getting their adjustment and I don’t think you will have to wait too much longer to get your dream place. I highly doubt hyperinflation will get in your way. Maybe in a year or a year and a half you will be able to lowball a desperate seller (there will be many) and get a nice property that you’d like to live in for a long time. I bet you’ll get it for under 1999 prices – and it will probably still go down after you buy it but the risk/reward will be very good especially if you are really looking for a place to live.
LMRIM or other posters: when you say 1999 prices – would you say your estimate of how far prices will fall is in line with condo prices etc. listed on the attached chart? http://www.blackstone-sanfrancisco.com/199.html
PeanutGallery or other posters:
“The Treasury would finance/insure the loans to the borrowers. Would be done through the banks and GSE. At the end of the day, keeping RE from crashing will save the treasury and stake holders more than alternative.”
I agree but have you heard any solid evidence this is the plan or is this your idea of what will or what should take place? Do you think those that are locking in to or have locked in to the atypical jumbo comf will get trapped if this happens given the product they are in will not be the norm on the lenders or GSE books? I wonder if they would have to refi under an entirely new product or perhaps shift some of the balance over the new limit to a 2nd if possible?
Note that the BlackStone chart uses average prices, not medians. While neither is a great indicator of the market, averages can distort the picture far more because a few outliers can dramatically change the number.
On the gov’t intervention point, I agree that some increased direct intervention to finance/insure loans to borrowers is a real possibility, but I would not bet that any such program would extend to the SF price range and therefore would not lend much (or any) support to the SF market except the very low end. No way one could sell subsidies for “San Francisco millionaires.”
Agreed, Trip. On that note, I’m starting to think the problem is so large that it’s basically impossible for the government to keep home prices artificially inflated, even if they wanted to. We’re talking a total mortgage market of $11 trillion supported by less than $600 billion of equity, nearly 19x leverage. Our GDP is $14 trillion and falling. There’s just not enough to go around with all the pigs already at the Fed’s trough.
Although attempts will be made, no doubt. Bair’s $24 billion throw-away is gaining support in DC. Adverse incentive, anyone? It’ll be interesting to see who replaces Paulson next year.
Oh, and a Nagasawa, LMRiM? How esoteric is that? I’ll take a Mapei Colnago or IF titanium custom anyday, but that’s just me.
That real estate chart is kinda funky. Honestly if you wanted a sense of a natural price I’d take the prices in 1949 and apply inflation going forward. You’ll find the line doesn’t deviate too much from inflation until recently. Math I saw somewhere else suggests another 25-30% decline for SFO generally.
LMRIM – since we’re pretending to not be who we really are, I’ll throw in my .02 with my even less well disguised moniker.
TIPS. The real yield to maturity spiked as high as 3.5% for the long dated end of the curve (2026 and onwards) a few weeks ago. I bought a truckload once the real yield got over 3%. The old saying is buy insurance when you don’t need it. Well, I think hyperinflation is long off in the future, but, given my income, and net worth, I will gladly take the real yield of 3+%, with no default risk, for long dated US govt obligations. No brainer really. The real ytm is down to 2.8% now, not nearly as juicy.
Oh, and before you talk about CPI being a bad measure of inflation, I’m aware, but I’ll take it anyway (my need for additional risk free wealth builiding is around CPI +3% anyway).
Short term, Nominals win, long term, TIPS will – and by a rather substantial margin. I’m a long term kind of guy.
As for policy solutions, well, as much as it pains me to say it (I am a free market guy, and it would probably hurt me in more ways than one…), the answer is national single payer health care. It may not be what is best for me, but it is what is best for the economy. The health care subsidy to wages in our competitors industrial production is their major advantage. Solve that problem and we have a prayer.
Nagasawa frame? You guys are psychos. I have a good ol’ time on my Trek mountain bike — and if it gets stolen, well 1/2 hour’s work buys me another.
Oh yeah enon…–it’s totally him…it’s not the only name he has used either. his writing is so easy to spot–its very distrinctive. Also he tends to footnote.
I am fairly new to all this..bare with me. You guys sucked me in here. It seems most think median is the best marker to comp price increase and decrease with; fair. I see Case and others typically give info for single family. Where would you vote is the best place to measure condos in SF – price, increase, decrease, % and so on? One post notes the below – good measure?
“That real estate chart is kinda funky. Honestly if you wanted a sense of a natural price I’d take the prices in 1949 and apply inflation going forward. You’ll find the line doesn’t deviate too much from inflation until recently. Math I saw somewhere else suggests another 25-30% decline for SFO generally.”
I clearly am not getting in to the details as you all are, your obviously more experienced; but I am interested in playing catch up and will do the leg work if you don’t mind just pointing me in the right direction.
Thanks in advance.
Our GDP is $14 trillion and falling.
What is amazing to me is that the govt debt of 11 trillion now is so close to this number. Our government basically consumes all that we produce when you take into account interest owed.
No sense talking about econ, enon’s doppleganger. The US is toast. There is no solution that is politically possible. Crisis sooner or later will force a very large scale adjustment. In the meantime, it’s still a nice place to live….
Dream bikes, though? Now that’s a subject worthy of discussion! A Toei for long slow weekend rides, A Pegoretti Marcelo for mornings when your fat body wants to relive some college racing days from 20+ years ago, a twisted 1980s Rossin in the closet to remind you of what those days were really like, and a 60s vintage Masi made by Faliero himself (or at least a 70s vintage made by Confente) hanging over the fireplace of a rented perch from which one can safely watch the unfolding crash – that’s where my interests run these days.
Oh, and GOOG is at $264. I just wanted to throw that in!
LMRM, would you or Satchel entertain a free lunch to the highest bidder? I’ll bid Zuni’s and $50. =)
I’m impressed with the depth of knowledge in regards to finance.
Laughing Millionaire needs to be seen clearly here – he wrote some very good stuff here that I found illuminating —- but he gave us all a “tell”: he called social security worthless.
SS has been a wonderful success – it has saved millions. Yes, even now. Even if it only helps with a little bit of money, that little bit is a lot to millions of poor folks, not Bay Area millionaires.
How is it be called a “success?” Can’t you pick it apart theoretically? Sure, but the answer is as simple as, “find something that works better.” SS is social insurance; not everyone is a “winner” in capitalism. Social insurance is necessary. No capitalist nation has figured out a better way in the real world to deal with the “losers.”
LR has a very petri-dish, hermetically sealed view of economics and societies. For this reason I have no doubt that his cocksure doomsaying is myopic, though in the short run he may be right about many things.
Because if he can’t properly value how important social insurance is, he can’t understand capitalism. It’s that fundamental. It’s a hole in his swing. Investors, beware……
LMRM, hope your rental does’nt get foreclosed in the process of the unfolding crash. I really don’t understand how people can boast in the middle of a disaster. Not everyone is as smart as you, but that does not mean they deserve to be crushed while you laugh away. You may be very smart, but I would not trade places with you no matter what. I’m happy when things are good in general, and not the other way around. Your laugh is an “evil” laugh, too bad, smart people can do alot of good but are just a-holes when they are cold and have no empathy for their fellow man.
I just looked at one of LM’s favored links, it said there, “There is nothing the state can do, and which society needs done, that cannot be done far better by the market.”
My god, this POV is exactly what has gotten us into this mess. This is reflexive anti-government, pro free market fundamentalist rubbish.
Folks, watch out who you’re listening to before making investing decisions. Really. He may be “rich,” but you know, a lot of people who have money have it due to luck, not merit….
David,
“My god, this POV is exactly what has gotten us into this mess. This is reflexive anti-government, pro free market fundamentalist rubbish.”
I’d urge to to continue reading in that site. There are many papers and essays. Keep an open mind – you might discover that I understand this better than you think I do. If you really think this mess has been a failure of the free market, I really urge you to do some reading there (that goes for everyone reading this).
Start with this brief essay on the very subject you referenced:
http://mises.org/story/3165
And about “luck”, well certainly that’s true. The accidents of our birth determine so much (smart or dumb, healthy or sickly, etc.) FWIW I was born into a very poor family (financially), and I’m not so rich by Bay Area standards, which of course are very high due to the presence of an extreme number of “lucky fools” (as Taleb would put it) who happened to be in the right place at the right time (the cook at Google, anyone?).
I used to beleive in the free market too Sathcel but this crisis has made be revisit that view.
Specifically:
1) Lifting the leverage caps on investment banks
2) Lack of regulation of credit default swaps
Now. One can make the argument that the free market is partly regulated therefore it’s not really free at all. However, I can make a pretty good case that if leverage was not allowed to get so large and all this securitization of loans into packages would not have been allowed to happpen, and lending standards allowed to laps etc then a lot of the what has happeend would not have.
The problem with the Free market is emotional extremes of greed and fear. A “steadying” hand is needed to temper the shaky one. Both in times of fear and greed. Otherweise, you get inefficient allocations of capital in BOTH times which we are seeing now.
Either we accept big crashes like the current one as a necessary evil, or we just accept to carry the burden of regulation as a trade-off to more security (looks like we’re going down that road).
We sleep better at night with the second option, but our lives will have less spice.
“Start with this brief essay on the very subject you referenced:
http://mises.org/story/3165“
Read it. The article makes a solid case of how laissez-faire economics has been wrongly accused and how the government has corrupted the free market. All that’s great and is probably true, but that and a quarter gets you 25 cents. Like other ideologies of any ilk (liberal, socialist, libertarian, whatever), it’s yet another “ism” that’s impracticable in reality.
I will not even pretend to be clever enough to know what the answer to this mess we have created is, but to borrow a quote from Ferris Bueller “-Ism’s in my opinion are not good.”
Maybe the solution is just letting it all go to hell, sacrificing the weakest members of society to the alter of the true free market, and starting over again. I’m by no means rich, but I’m fairly protected from this mess. Then again, I would like to think we’ve progressed beyond the “Lord of the Flies” phase in our society, but I’m probably wrong.
Repeal of Glass-Seagal as we are all too smart now to get into the same mess those fools in the 20’s got into.
“Start with this brief essay on the very subject you referenced:
http://mises.org/story/3165“
Dear God! Who could possibly get through that?
With a bit of skimming and googling I learned that:
Let’s blame poor people and their democratic enablers (CRA) for the mess
The media is marxist
This George Reisman fellow is one of those fevered Ayn Rand acolytes
No thanks. Not that there probably aren’t some valid points buried in there, but it’s the kind of politically-tinged stuff that passes for economics on fox business channel.
I’ll stick to the reality-based-community.
I can make a pretty good case that if leverage was not allowed to get so large and all this securitization of loans into packages would not have been allowed to happpen, and lending standards allowed to laps etc then a lot of the what has happeend would not have
bingo.
LMRIM is a Misean style Austrian Economist, and there is nothing wrong with that. I myself subscribe to 99% of what Misean wrote. I myself have read and reread Huerta De Soto’s groundbreaking Money, Bank Credit, and Economic Cycles myself (it’s sitting right here next to my computer).
But the Misean ideology has been twisted somewhat in that they are completely unable to recognize the massive failings of the “free market”
say what you will, but free markets are IMPOSSIBLE to achieve. IMPOSSIBLE. Why? because as soon as we try to deregulate then every yahoo a$$hole runs out and ruins it.
try deregulation of the energy markets? BZZZZ wrong answer! Enron will manipulate them causing brownouts.
try deregulation of the financial space? BZZZZ wrong answer! the Shadow Banking system and the unregulated CDS market will grow to such a size that there is no solution.
say what you will, but the CDS problem is due to UNREGULATED markets. as was the leverage in the off-balance sheet entities and the hedge funds.
there were PLENTY of major boom busts prior to the Fed and prior to regulation in our markets (the 1800’s specifically). they are getting worse and worse. The free marketeers would like to blame everything on the Fed and the Govt, and htey do share much of the blame.
but some of it is ever increasing financial innovation and complexity, much of which occurred OUTSIDE of the regulated space.
That said, one thing that is worse then total free markets is poorly regulated markets and even worse are regulated markets that are not enforced.
as for the misean link, unfortunately there are better Austrian Economics texts than that one.
I challenge an Austrian Economist to answer this:
How was the crisis caused by AIG’s CDS exposure caused by the government?
answer: it wasn’t.
what part of government forced or even coerced AIG to write those CDS contracts?
is it not clear that AIG wrote CDS specifically because they were unregulated?
in the same way, is it not clear that the financial houses specifically created off-balance entities (SPEs) to avoid regulation and disclosure?
how would LESS regulation have improved these outcomes?
the true issue is that it is clear that corporations can not be trusted to self regulate. once they get to a certain size, they tend to selectively report their economic status.
perhaps this wasn’t true 100 years ago. but it certainly is true now.
The problem with most theoretical economic and social philosophies is that they assume that everyone is :
– smart
– honest
– altruistic
– rational
Sadly few people are so perfect. A working socioeconomic system must account for at least a few greedy irrational egomaniacs on the loose and discourage them from preying on those not as savvy.
C’mon, the Catholic church figured 2000 years ago out how to deal with the fact that their congregation suffered from chronic personality flaws (confession and repentance ya know). Surely we can find a system of modern government that can do better. Maybe we already have the state of the art ?
“A working socioeconomic system must account for at least a few greedy irrational egomaniacs on the loose and discourage them from preying on those not as savvy.”
Ours does account for that. These people are screened in college, law school and on trading desks big and small. The ones who pass the test – the most greedy, irrational and egomaniacal – are passed directly into Government Sachs and the Fed (for those who are not motivated by money but who are willing to serve as lapdogs for their masters), and then on to a nice position in the bureaucracy, say, Treasury Secretary… 🙂
Ok ex-SF er…I am going to take a shot at taking the opposite side of the argument to answer you question on how the government caused the CDS problem.
1. It repealed GS which kept ibanks and banks separate.
2. Ibanks and other non banks needed to get source of funds other than deposits
3. Repeal of leverage limits on banks
4. Lack of regulation of CDS allowed more and more debt to be securitized and raised
Removal of the regulation while leaving old regulations in place doesn’t count as “free market
It’s kinda weak but you get where I’m going?
Now bear in mind, I just argued against myself. i.e. i think come out on this with the belief that we need free markets but with the steadying hand of an efficient regulator to limit inefficiencies in markets with greed and fear.
p.s. some austrian economic stuff is good–on asset bubbles for example. but its an incomplete theory and is often missapplied. this was more of a regulatory problem, other than maybe 2002-2005 money supply growth has been flat. this really has been a regulatory problem and I am not sure I buy the idea you blame this all on Greenspan (other then regulatory lapse in mortgages)
You’re forgetting about the primary cause of this mess: the fact that the financial institutions boards who are supposed to represent the interests of the shareholders are in fact puppets of the managers who they are supposed to oversee. With no oversight, massive short term accounting “profits” were booked that led to actual cash bonus payouts.
In short, the managers of the companies were left to pillage the shareholders through clever accounting when literally NO ONE was representing their interests.
Look at WaMu. They booked the full payment due on pay option loans when the borrower paid the minimum payment. The shareholders got $1000 in cash and a $2000 IOU from someone who had zero down and no income to support the full payment, and WaMU booked the whole $3000 as income and paid bonuses on the “profits” from it. Out went $500 in bonuses, and the shareholders basically got $500 of the $3000 payment due and no real chance of being repaid.
Pension funds invested billions into mortgage backed securities because NO ONE cared about the real risks, just the high phantom returns and the fact that they had been blessed by ratings agencies who were as corrupt as could be. The poor people who handed over their money had no oversight. They counted on the boards who allowed the managers to book phantom profits to claim high returns.
No small business owner would have allowed that to happen, but the world has become disassociated from its money.
Does anyone wonder why people are flying out of the stock market and treasuries are dropping to 0% interest? The corporate securities system is more corrupt than the Mexican justice system!
Glass Seagal my ass: the problem was the incentives were completely out of whack. If the incentives had been properly structured by the boards of directors, none of this would have happened because no money was really made. It was just an accounting scam to separate people from their money when the managers of these organizations pilfered it.
Plain and simple.
Tipster–while i think corporate governance is a problem. it’s really a small part of the equation here. board governance is weak across all industries –not just banking. the problems here are pretty regulatory, and monetary specific..and in my view 80% of it is regulatory.
Ok ex-SF er…I am going to take a shot at taking the opposite side of the argument to answer you question on how the government caused the CDS problem.
cooper:
your arguments prove MY point. all the actions that you list was the government trying to get OUT of the way, it was an attempt at DE-regulation.
The financial firms all took that deregulation and went hog wild.
so as I said: “free markets” is nothing other than a utopian ideal, as there is no effective way to get to free markets. As soon as we try it everybody goes into a frenzy of stupidity and greed ruining the party.
Going with your arguments (it’s the governments fault because they deregulated) then the answer surely is not more deregulation, is it?
but that is what LMRIM would argue… that we need more and more deregulation (in fact no regulation) since only “free markets” work.
except that free markets don’t work. neither to centrally planned economies.
well-regulated well-enforced markets work.
instead we have crony capitalism.
Well I was sort of trying to play devil’s adovcate by saying–the deregulation still left plenty of regulations that led to artificial and destructive risk taking. I didn’t do a very good job in my argument tho.
However, I think we agree on the most important part. Our political system just doesn’t afford the chance for the free market –we have never had it here. Maybe Singapore or something? I don’t know where it exists anywhere if it does.
The best we can hope for is some sort of semi efficient regulation that interferes efficiently in times of greed and fear. The invisible hand tends to loose it’s grip in times of extremes as we have pretty readily seen. So even if you had absolute free markets it wouldn’t work, we’d run into problems of extremes.
Free markets work.
The massive adjustment we’re witnessing now is a testament to the power of free markets.
Risk cannot be regulated away.
Failure cannot be regulated away.
Risk/reward or two sides of the same coinn.
All regulation does is try to shift risk or reward from some operators to others. Just introducing inefficiency, adding nothing meaningful.
Now the weak need to be protected. Answers meay be in better education, promote volunteerism (oh no, an ism) etc.
With no clear way out of our current economic mess, with debt high, a housing crisis, and all the other facets, I haven’t heard too much talk about intentionally inflating us out of this mess, which is a little surprising. Though we have a negative cultural reaction to inflation, and it would undoubtedly create significant short term (multi-year) pain, it solves a number of issues:
1. Sovereign debt
2. Housing prices
3. Personal debt
4. Falling exports (the dollar would weaken)
Of course, it creates a number of other issues (like how to stop it once it’s started), but I’m not convinced yet that those are any worse than what we’re currently/about to experience anyway. We don’t have to go Zimbabwe, but relatively modest intentional inflation of 10% or so for a few years would provide part of a solution (but not the whole solution).
The best intelligent discussion I’ve seen is at Information Arbitrage ( http://www.informationarbitrage.com/2008/10/is-volatility-embedded-in-the-system-for-a-generation.html ), but I haven’t seen much else. Which is surpising…
It would be pretty easy to get out of our mess.
The problem is two-fold: 1) the broad economy has been structurally (perhaps intentionally) misaligned by cheap money for too long, leading to 2) too much debt supported by too little real income, too little real savings (voluntarily deferred consumption) and illusory asset values.
The solution should logically address these two aspects of the problem:
1) Cut taxes dramatically, especially on savings, capital formation and incomes.
2) Cut government spending dramatically because all government spending represents consumption – either of income through taxation, future real income through debt and/or inflation, or consumption of the existing pool of real savings.
3) Allow wages to fall and fall quickly, removing as many barriers to the adjustment as legally feasible, thereby incenting business creation (by lowering the cost of one of the primary inputs, labor – the other being capital which is being incented above in 1)). This leads to higher real income across the economy, and ultimately more real income for workers.
4) Don’t resist the asset price deflation – encourage it. It’s pissing in the wind anyway. Properly priced assets wil attract credit support. Deflation in goods and services will help cushion the blow to nominal (and real) wages as wages fall.
5) Bankrupt all businesses that are insolvent, and auction them off for whatever they will fetch. Remove the tide of easy liquidity, find out who is swimming naked, and drown them.
6) Tell all the CDS players (there are only 10-12 major ones) to get in a room and settle it all among themselves. No bailout for any participant, and any exec will lose everything in th ebankruptcy of his company if a deal isn’t worked out. Give them 90 days, no more. Make the cartel fight it out among themselves a la JP Morgan in 1907 with the famous meeting in his Upper East Side mansion’s library. They’ll reach a deal. Don’t let these jerks hold the US economy hostage – make them settle it and allocate the losses among themselves.
7) Allow interest rates to rise, not fall, to reflect the risk. Stop trying to reinflate bubbles that have blown up – it’s pissing in the wind as well.
There is zero chance that the USG and Fed will adopt any significant portion of this approach, so I’ll repeat what I have been saying: the US is toast.
Not to be a nitpicker, folks, but it’s Glass-STEAGALL.
Glass seagulls are something your grandmother probably collects, along with elephant figurines and Elvis plates.
LMRIM,
Your proposal has about as much chance of working without sending the country into massive social disorder, violence, and chaos as a communist revolution.
You can spout all you want about theory and isms, but unless they can be feasibly implimented in the REAL world (meaning that they are politically and socially acceptable or possible), they are nothing more than theory and isms. Communism works on paper too.
Yeah, LMRIM/Satchel’s latest unhinged post is exactly the reason I don’t read what he writes anymore.
I’m surprised he has so many fans on this site… (then again, 48% of the American public believed Palin was qualified to be VP). I guess the saying is true, no-one ever went broke underestimating the intelligence of the American people 😉
“You can spout all you want about theory and isms,”
This plan doesn’t even work in theory. You have to ignore the positive feedback that the coupling between production and demand in the current system creates to think that this might “work”.
We’re already seeing this loop play out. Demand decreases. Employers cut back. People have less money. Demand decreases. Wash, rinse, repeat.
In the standard austrian, hard-money, free market system there’s no mechanism to interrupt that feedback loop. In a debt-money based system it’s even worse because once wages decrease below a certain point entities start defaulting and there’s a pull-back in lending that crushes demand even more.
Luckily our beloved helicopter commander Bernanke understands that demand can always be created by creating money and handing it out.
“without sending the country into massive social disorder, violence, and chaos as a communist revolution.”
as long as the people believe that cooperating with the system is more likely to put food in their belly than not cooperating your society will be stable. That’s why job programs that keep everyone busy, tired and fed are inevitable and necessary as this plays out. Even if they are “inefficient” from an austrian viewpoint.
The elites often think that a good response to an economic crisis is to sit back, shrug thier shoulders and say, “The peasants have no bread? Let them eat cake.” However, history teaches us that that plan rarely works out well for the elite. The peasants have a way of making their problems the elite’s problem.
Why the hostility to LMRM’s post at 9:30AM? He’s advocating a smaller govt, lower taxes, and fair and open dealing among parties. That’s exactly what we need – plus more integrity and transparency in all markets. We’d have fewer “elites” and more income equity if we truly followed these principals. What we have is an inept and corrupt govt and crony capitalism. Yes, we need some intelligent regulation. But asking for ever increasing govt intervention is insane.
“I’m surprised he has so many fans on this site… ”
I am fan because he has saved me mucho dinerito… he (along with many others like exSF-er, trip, tipster etc etc) has explained what happened, is happening and likely to happen.
I doubt if any of us on here have any influence on what Barnankes, Obamas and Paulsons will do, but to see this discussion take place here is like having a front row seat to watch the central issue of our time unfold.
“We’d have fewer “elites” and more income equity if we truly followed these principals.”
Nope. The end state of a pure capitalist system is that one person owns everything and everyone else works night and day for just enough food to survive.
Each person needs a certain amount of resources to survive. Ownership of resources allows a rentier system that allows one person to extract rents from another. Competition between people who only have their labor to sell reduces the price of labor to just what is needed to survive while allowing those who own necessary resources to capture excess value for themselves. i.e. the rich get richer and the poor get poorer.
Free market capitalism is the absolute best system for organizing resources for the production of wealth but it’s the worst system for distributing that wealth.
FSBO,
I wasn’t trying to be hostile. I might agree with many of the things that he said, but what he said, and what you followed up with, are IMPOSSIBLE politically. Do you think that TPTB can put into place anything that you’ve talked about with support from the people? Our economy doesn’t matter much if we can’t maintain political stability.
LMRiM does not take into account the extra degree of complexity that globalization has added.
Sure, bringing a few good-ole-boys into a room and letting them sort it out sounds like a great idea. But this mess is not concentrated on the Street anymore. There are RE/debt bubbles everywhere with more or less the same issues: too much debt on overvalued assets.
And this is my plan to get us out of this.
* A $400 billion plan for power transmission lines, new energy technology depoloyments and energy infrastructure. Most people exepect some kind of stimulus of about 3% which assuming GDP is at 14.4 trillion would be about 432 billion. This is important because it not only is stimulative but it also has implications for our current account deficit. This deficit is a critical problem and we need to fix this shortfall for the long term viabity for this country.
* We need a $50 billion plan for the auto makers contingnent on major restructuring and cars based on new fuel technologies. What is major restructuring? It means getting rid of employees getting paid for now work or getting retirement payments when they are able to work. We need new exporting businesses to start forming in all sorts of manufacturing businesses. Forget making chips in Taiwan, we need to be making this stuff here. When the dollar starts to fall again, our competitiveness will increase.
* Similarly, we need to have rebates for purchases of fuel efficient cars as well as large taxes for inefficient SUVs. Isn’t that interfering with the market? Sure it is but we already regulate fuel economy standards and our auto industry can’t survie having standards so much lower than the rest of the world.
* We need to issue as much debt as possible right now 10-30 year debt moving duriation way up. In a year, this rate of borrowing could be 8% or higher. The Treasury Secretary needs to refinance the “national mortgage” now while we can.
* The spreads going on in agnecy debt is really silly. Everyone on the planet knows the US guarantees this debt just like treasuries yet we pay huge spreads which in fact makes mortgage costs higher. You might as well just turn this into treasuries becuase that’s what they are and the cost of financing would be a lot lower. Paying huge spreads on Fannie Mae debt is silly and a waste of money when it’s a nationalized entitity.
* $250 billion in infrastructure for roads, bridges an telecommunications infrastructure.
* Temporary aid to states to prevent state tax increases. State budgets have gone way out of control with some growing spending 40% in just a few years but they need time to graudally bring this spending down.
* We need to revisit our regulatory policy. No question that the free markets are an ideal. However, it does not work in periods of fear and greed. In those periods a free hand needs a steadying hand. While everyone loves to make money lax underwriting in mortgages and removing leverage limis and unregulated CDO exposure caused a lot of problems. This problems were compouned by overlapping an in some cases over regualtion in already exisitng areas of banking. These overlaps often excacerbated risk and caused behavior that made these problems far worse then if there had been no regulation at all.
* The ECB and Bank of England need to move their rates down with the Fed immediately. All countries with
* From the US standpoint, spendign on consumption is not the answer. Any consumption going forward needs to address long term imblances in the current account balance. Instead of consuming – we need to expand exports and our own domestic production espeically in energy (traditional and alternative).
You’re going to get your wish, cooper, on a lot of that.
The micromanaging of the economy by the elites in the face of market forces that are desperately trying to develerage and reset the real economy to economically sensible activities will be a disaster. The only tools that the government has with which to attempt to get in the way of these forces are inflation and taxing, both of which will impoverish real wealth generators further. The result will be Depression.
PS – don’t worry about the current account. A 10% fall in GDP will swing that puppy around to surplus quite nicely 🙂
Ok here is my revised version–no typos and written slightly better on how to avoid a depression and deflation.
* A $400 billion plan for power transmission lines, new energy technology deployments and energy infrastructure. Most people expect some kind of stimulus of about 3% which assuming GDP is at 14.4 trillion would be about 432 billion. We need to get rid of capacity in dealerships, production and product lines. New technologies are important because if we get rid of legacy costs these industries are competitive on the global stage and can lead an export boom for the United States. This is important because it not only is stimulative but it also has implications for our current account deficit. This deficit is a critical problem and we need to fix this shortfall for the long term viability for this country.
* $250 billion in infrastructure for roads, bridges an telecommunications infrastructure.
* We need a $50 billion plan for the auto makers contingent on major restructuring and cars based on new fuel technologies. What is major restructuring? It means getting rid of employees getting paid for now work or getting retirement payments when they are able to work. We need new exporting businesses to start forming in all sorts of manufacturing businesses. Forget making chips in Taiwan, we need to be making this stuff here. When the dollar starts to fall again, our competitiveness will increase.
* That $700 billion in loans and spending, some of it over multiple years however we need it to offset the $10 trillion (and more) in assets that is disappearing elsewhere. It’s a large increase in debt but its really just shifting debt from the private sector the the public one. Before all is said and done, we may need to do quite a bit more but $700 in spending is a start.
* For long term energy sustainability (related to current account deficit) we need to have rebates for purchases of fuel efficient cars as well as large taxes for inefficient SUVs. Isn’t that interfering with the market? Sure it is but we already regulate fuel economy standards and our auto industry can’t survive having standards so much lower than the rest of the world. Now that the car makers are in a jam, now is the time to fix this.
* We need to issue as much debt as possible right now 10-30 year debt moving duration way up. In a year, this rate of borrowing could be 8% or higher. The Treasury Secretary needs to refinance the “national mortgage” now while we can. The US treasury is basically using an option arm to finance our debt and we need to finance to a 20 year fixed pronto.
* The spreads going on in agency debt is silly and wastes the tax payer money. Everyone on the planet knows the US guarantees this debt just like treasuries yet we pay huge spreads which in fact makes mortgage costs higher. You might as well just turn this into treasuries because that’s what they are and the cost of financing would be a lot lower. Paying huge spreads on Fannie Mae debt is silly and a waste of money when it’s a nationalized entity.
* Temporary aid to states to prevent state tax increases. State budgets have gone way out of control with some growing spending 40% in just a few years but they need time to gradually bring this spending down. Over time, just like personal spending, states and localities have been over spending and consuming. This gravy train is over but we need a short term cushion to make these transition a little less painful and bloody.
* We need to revisit our regulatory policy. No question that the free markets are an ideal. However, it does not work in periods of fear and greed. In those periods a free hand needs a steadying hand. While everyone loves to make money lax underwriting in mortgages and removing leverage limits and unregulated CDO exposure caused a lot of problems. This problems were compounded by overlapping an in some cases over regulation in already existing areas of banking. These overlaps often exacerbated risk and caused behavior that made these problems far worse then if there had been no regulation at all.
* The ECB and Bank of England need to move their rates down with the Fed immediately. All countries with large cushions of cash reserves need to engage in fiscal spending to boost domestic consumption to offset lost exports. This will also help the consuming nations by creating markets for them to sell to.
* From the US standpoint, spending on consumption is not the answer. Any consumption going forward needs to address long term imbalances in the current account balance. Instead of consuming – we need to expand exports and our own domestic production especially in energy (traditional and alternative).
diemos,
We agree on a lot but on this I think you are off base.
“The end state of a pure capitalist system is that one person owns everything and everyone else works night and day for just enough food to survive.”
Why would that be? How would he ever manage the whole economy himself? Wouldn’t his underlings use the occasion to steal his wealth? This sounds more like a feudal system, where a king cuts a side deal with his lords to keep the people as serfs.
The genius of our system was to make private property sacrosanct (something that did not exist in the vassal-serf-king world) and to have a clearly written constitution restraining the state to its proper role as an enforcer of fair standards and defender of fundamental rights recognized in that constitutive document (not rights dreamed up whole cloth by unelected judges of course).
“Competition between people who only have their labor to sell reduces the price of labor to just what is needed to survive while allowing those who own necessary resources to capture excess value for themselves.”
This is only if the labor is interchangeable. Shouldn’t certain labor (skilled, intellectual property, the best bike frame builder in the world, etc.) be able to hold its own? Do you really see the doctor dutch auctioning his labor down to the level of a strawberry picker so that both are at subsistence level? What about incentivizing the lowest skill producers? Subsistence wages do not lead to very productive workers, as the Tsars found out pre-1861.
For smart people like you and me and the people who read SS there is always a temptation to think some elite (maybe us, the “government”, that Ph.D at the Fed, etc.) needs to save the population from itself. We need to right the market when it throws a hissy fit, or plug the gap when the populWe should resist that temptation. The limited government/recognition of private property system works, and it was good enough to get the US from an empire wilderness to the richest and freest country on the earth in less than 150 years (a little more of course if you include the mercantilist/corporatist philosophies of most of the Colonies).
Anyway, though, like Brutus I recognize that this is politically impossible now. The populaion has been thoroughly infantilized, looking to the government to smooth all vicissitudes of life. I think we spiral down from here, and I think we’ve passed the point of no return (we probably passed that point a long time ago – maybe 1930s – but the bill is now coming due).
PS – I’m glad you saved some money, chuckie, and I’m glad that some of Trip’s friends were (indirectly) influenced to not throw away some hard earned cash on SF real estate at the very tippy top.
Satchel–One would have thought on the current account. but did you see it last month -it was like 50 billion. WTF. that should have seen the big decreases in oil prices and retail imports.
Time, time, coop. Did you see all the Mercedes lined up at the port of Los Angeles 🙂
The gears move slowly.
“How would he ever manage the whole economy himself? Wouldn’t his underlings use the occasion to steal his wealth?”
But then it wouldn’t be a pure capitalist system. 😉 Sure, a single guy is unstable and a real power structure is a pyramid. But that only points out that the populace will only tolerate a certain level of inequality before they take matters into their own hands to do wealth redistribution. Either individually through crime, collectively through government, or if government won’t play along then through revolution.
“The genius of our system was to make private property sacrosanct (something that did not exist in the vassal-serf-king world)”
Being a rentier was once a monopoly of the king and his vassals who sent the soldiers out to steal as much from the peasants as they could get away with.
The change opened up that monopoly and allowed anyone to become a rentier by acquiring property.
Cooper – One element that I don’t like about your plan is the further subsidies channeled to an automobile based transportation system. Autos require a lot of land (inducing sprawl) and are one of the leading causes of death and injury. They certainly have their place, but not as the backbone of an efficient transportation system.
Automobile based transport scales poorly and leads to inefficient use of resources, especially land. Even if you could run cars on a Mr. Fusion fueled by pixie dust, you still have to solve the other space and safety issues. Hybrids and all-electric cars are nice but they are only stalling the inevitable and actually increase demand for more personal vehicles : positive feedback is not a good thing here ! Think surburban sprawl and NIMBYs who oppose denser development because they don’t want to deal with more traffic and difficulty in finding a curbside parking spot.
The core of urban and interurban transport should be shared transport. Cars should be used to fill in the gaps where shared transport doesn’t make sense.
Enough ranting about my pet topic. To those who slam LMRiM’s Ayn Rand-ish views and wonder why people here like him : he’s not a one idea dude. He spews lots of ideas and you’re free to pick and choose which you think are relevant or valuable. This is not an all-or-none proposition.
In related news, for anyone who actually thought that Obama was going to represent something different, it was just announced that his pick for the Treasury Secretary is Tim Geithner, head of the New York Fed. That’s the same NY Fed that is arguing that it doesn’t have to comply with a Freedom of Information Act (FOIA) request because it is private and not a government agency. The same one that is headed (as chairman) by Jamie Dimon, who also by happenstance heads one of th last banks standing, JP Morgan.
Geithner used to work for Summers at Treasury. And Summers used to work for Rubin at Treasury in the 1990s. Rubin is the one who was behind the repeal of Glass Steagall (with help from the Repubs), which Clinton signed of course. Rubin went from Goldman Sachs to Treasury and then to Citibank (once Citi could lever up – in fact, one of the main reasons that Glass Steagall was repealled was because Citi had already agreed to acquire Travelers, which wouldn’t have worked unless the law was changed, which required Rubin to go to Treasury in the mid-1990s – then Rubin moved right in to collect his $$).
Nothing special about Summers. I actualy met with him in the mid-90s when he was undersecretary (or deputy sec) and he’s the same as the rest of the gang. I never met Geithner, but I’m sure he’s the same. I worked with Rubin’s son Jaime for a very brief time on some transactions in the very early 1990s, when his dad was CEO of Government Sachs.
Get the picture? Same old, same old. The banksters remain wholly in charge.
For anyone who is interested in Rubin’s role in the repeal of Glass Steagall, her is a link. Note the date (1999).
http://lists.essential.org/corp-focus/msg00048.html
Today, of course, people (especially the Obamatons) want to paint this as a Republican/Bush issue. I don’t let them off the hook, especially Paulson’s role in the lifting of leverage restrictions in 2004, but the same gang has been and will be in charge. You’ll never get “enlightened” regulation. These guys ares irates, and they write the rules.
oops, “pirates”
Satchel – Who would you like to see at Treasury?
“The banksters remain wholly in charge.” Amen – and Geithner has an even more sinister connection than the usual Wall Street associations – he worked for Kissinger & Associates for 3 years. Democrat / Republican – these guys all come from the same (cess)pool.
Meet the new crony-capitalist, bankster/fraudster boss – same as the old crony-capitalist, bankster/fraudster boss. 67 million Obama supporters won’t get fooled again.
Anybody want to read these tea leaves:
TAF and TSLF auctions were undersubscribed (bid-to-cover ratio less than 1) these past couple of weeks. Does this mean:
1. Its getting better
2. Its a lull before ARMageddon (see Alt-A thread)
3. The string pushing has begun and the banks aren’t biting
I definitely agree that Obama’s pics are old guard guys. but if I was a president who wanted to change things without any real experience, I’d pick guys with experience to help me do that. let’s give him a chance. ps i would have picked Jamie Dimon. Hands down smarter and better than Geithner.
6) Tell all the CDS players (there are only 10-12 major ones) to get in a room and settle it all among themselves. No bailout for any participant, and any exec will lose everything in th ebankruptcy of his company if a deal isn’t worked out. Give them 90 days, no more. Make the cartel fight it out among themselves a la JP Morgan in 1907 with the famous meeting in his Upper East Side mansion’s library. They’ll reach a deal. Don’t let these jerks hold the US economy hostage – make them settle it and allocate the losses among themselves.
LMRIM:
your #6 is not feasible. You either misunderstand the CDS problem or you glibly gloss over the CDS problem. there is no way you can understand credit default swaps and write such nonsense.
the CDS problem is THE biggest problem our economy faces right now. there is NOTHING as important as the CDS problem. And contrary to your assertion, there are not like “10 to 12” major players. The players are diverse and numerous (hundreds if not thousands, and international), and far too many to get into a room.
When Lehman failed there was an attempt to set up a central clearing house prior to them failing to try to net out the trades. Do you know what happened? It failed MISERABLY due to cascading cross defaults.
The CDS was completely unregulated for years. the problem with this
-many players made BIG bets that their butt can’t cover
-nobody knows who those players are
-nobody knows what trades they made.
-nobody knows who traded with whom
-everybody has cross traded and “hedged” with other people (who may be insolvent)
NOBODY expected the Reserve money market fund to have to break the buck when Lehman Failed. But it did. it almost caused a run on all money markets. and pensions.
this is from a pissant company (Lehman)
why do you think Citi may fail this weekend (versus a few months from now?) Because HORDES of speculators are shorting the stock and buying CDS on it’s bonds.
the CDS monster by the way is the #1 evidence of why free markets can NEVER work. Look at that market… completely unregulated. and COMPLETELY dysfunctional.
Part of the solution to the CDS mess will be to figure out a way to net the trads and then make CDS ILLEGAL (yes, illegal). The CME and other exchanges are trying to set this up right now but there are issues (of course). But the CDS market is THE 500lb gorilla in the room. everything else is pixie dust comparatively.
to blithely talk about 10-12 firms getting in a room figuring out a soluton to the CDS monster is to not understand the problem at all.
If a pissant company like Lehman can take down the Money Market system, imagine what would happen when/if AIG goes down. Or Citi.
Of note, I have talked about the CDS monster since I started on SocketSite years ago. I feel that I know more about it than many many many people. And yet I know the most important thing: nobody knows what the hell would happen if we let it all just happen. the second most important thing: contrary to popular believe, the trades do NOT “just net out”.
I agree with LMRIM on one thing:
geithner as a choice shows that obama’s economic team will be more of the same.
of note: it is especially interesting since Citi is looking for a bailout this weekend.
how convenient: the current NY Fed official (in charge of Citi) is also the Treasury-Secretary-elect.
what are Citi’s chances of a bailout with those odds.
in the end, unfortunately nobody seems to understand that our current system is rotten to the core and needs to be replaced. thus, they will do everything to “save” this garbage we have now.
I do understand a bit of the CDS problem, ex SF-er, though you’re right – no one knows the full extent.
The writers of CDS insurance like hedge funds etc. have to post collateral with the banksters. They mark to market, and are not inclined to extend credit when the position is going against you. Remember, I was THERE (well, not CDS, but huge unregulated swaps from the hedge fund buy side).
The big AAA banksters and their special purpose AAA captive subs don’t post any collateral with the buyers of the default side – they’re out of luck if the big guys go kablooey and the underlying company or structure (on which the CDS protection is written) goes kablooey. But who’s on the other side of these CDS? Mostly specs. So, they don’t get the benefit of the insurance they bought. Too bad.
When LEH went kablooey, the trades netted to about $6B exposure, which was paid without the world coming to an end. IMO, the Fed has created this nightmare now. By holding out the promise of a bailout, and by beginning the process of lending against bad collateral (Bernanke is a total fool, and much dumber than his 19th century “nemesis” Bagehot – “lend freely against good collateral at a penalty rate”), he has now effectively frozen all the private lending markets. The banksters will hold the entire economy hostage until they extract every ounce of welath from the population. There is no stopping this monster that Bernanke has put into place, and that’s why we’ve passed the point of no return.
How does the Fed lending against collateral, whether bad or good, stop private sector lending.
It seems to be that private lending stopped right around the Lehman collapse and when the first money market fund went down. When that fund went down the CP market started to collapse.
Before that the CP market was actually rising every week. It was only after the failure of Lehman that you saw private lending collapse.
I think you are trying to make this big case for stopping all government intervention but actually it was when the government stopped intervening (lehman) when private lending really collapsed.
Coop, when the collateral is bad and you don’t want to mark it, you swap it with the Fed. You’re supposed to pay it back, and all your private counterparties know this. But no one knows who has posted what with the Fed, so no one knows who is insolvent. Ergo, lending becomes frozen – who wants to lend to potentially insolvent parties whose financial condition is being intentionally hidden by the fed? That’s one transmission mechanism.
Another is because the Fed has signaled its willingness to eat the bad debt (ultimately by passing it off to the taxpayer – did you notice that in the recap of the AIG loan, part of the original loan was paid off to the Fed (about $20B)? Therefore, now the game is to hold the economy hostage so that the Fed absorbs ALL the bad debt. It’s much better if you are an exec at one of the anointed banks, don’t you think? That’s another transmission mechanism.
When the Fed stepped in to provide below market CP to supposedly AAA companies, what do you think is happening to the CP market? Well, what would happen if you are a supplier of cheese to a pizza place and the USG started supplying the cheese for free?
Anyway, all this talk about failure of regulation is like 1984. These were all REGULATED institutions. HIGHLY regulated. Banks? Insurance companies? Where were the cops? It’s not the hedge funds that are the systemic risk is it? Have you seen any big bailouts of “unregulated” hedge funds? Neither have I.
There are a lot of caricatures of free market or Austrian economists that are very shallow. The regulators were coopted. They always will be.
Barney Frank couldn’t figure out that his boyfriend (who I am pretty sure worked for Fannie Mae) was running a prostitution ring outof Frank’s own Capitol Hill apartment (true story in case you haven’t heard it). This guy is going to spot what the banksters are doing?
Rubin (and his deputy, Summers) were waist deep in the repeal of Glass Steagall. Are these the wise regulators we have been waiting for?
What about Bubbles Greenspan – how did he do at spotting the problem? Where was Bernanke?
Paulson? He was key in getting the SEC to lift the leverage limits on investment banks, and then he cashed in $500M of Government Sachs stock TAX FREE and then went to Treasury and is now directting the free cheese giveaway. Is he going to fix the problem?
Regulators will always be fighting the last war. The incentives are set up all wrong. Some of us were screaming when Sir Alan Greenspend “saved the world” in 1998, knowing that bigger bubbles would follow. His actions to “save the economy” (it’s always the same garbage line) after 2001 led literally to the (second) bubble that is going to “break the world” (to paraphrase a famous account of the Great Depression).
And yet with all this experience, the people can still think of nothing better but to imbue these wise Solons (and the same Solons – Geithner/Paulson/Rubin/Summers, Greenspan/Bernanke!!) with yet more power. That’s one of the reasons I am laughing (through metaphorical tears of course): the American people are going to get exactly what they deserve. Let’s revisit how the economy looks by next fall (remember how Bernanke’s cuts and the Spring 07 stimulus checks were going to forestall the recession?)
Paragraph one. Yeah if people don’t know who is hiding bad paper at the Fed that’s a problem but That’s a transparency issue. I agree that causes big problems but the answer there is to demand full transparency even for stuff that is sitting at the fed, not for the fed to stop providing a backstop. The backstop itself isn’t actually causing the problem you are talking about, it’s only in instances where things are hidden. And if what you were saying were still a problem, then libor would still be a problem and the fact is it just ain’t. It’s dropped like a rock. So people are not worried about this at all–money rates don’t lie. Peopel do.
P2. Eat the bad debt? I thought that was just AIG paying the Fed loan down with CP. Once the Fed went in to the CP market, a lot of folks, including AIG took advantgage of it and that’s what the 20 bullion is. Why wouldn’t they?
LOL on barney frank but that doesn’t have anything to do with your argument.
Agree with comments on Rubin, Paulson and their roles etc but that doesn’t change the argument at all methinks.
interesting podcast here covering some of this ground:
http://www.lewrockwell.com/podcast/?p=episode&name=2008-11-20_072_how_the_government_wrecked_the_economy.mp3
the interviewee thinks they’ll print the dollar into oblivion and argues for an inflationary depression. i tend to agree that the USG can’t really *afford* deflation — it’s the biggest debtor around with a falling tax base AND the spending is only going up. A *managed* inflation is more in its interest.
These were all REGULATED institutions. HIGHLY regulated.
That is not true and you know it. AIG’s CDS problem was 100% unregulated. AIG has never been regulated by a federal entity, and states don’t regulate CDS. (nobody does)
in fact, CDS are SPECIFICALLY by LAW UNREGULATED. So stop with the bs about “it’s all regulated” because it isn’t.
the off balance sheet entities are also highly UNREGULATED which is why they were created in the first place. Sure, Citi is regulated, but its SPE is not for the most part
LMRIM: we’re going to have to disagree on the CDS issue. I can see that you think you understand more than you do about it. I don’t want to get into details, but I have a very front row seat on the CDS problem, and I can see that you are making assumptions from other markets that do not apply to the CDS issue and using those assumptions to simplify what is happening, but you are in error.
Putting people in a room has ALREADY been tried (behind doors). It did not work. There are too many important players, and they are global not American only.
a pseudo-clearing house to net CDS trades was also tried (in the open). This failed miserably, and was ONLY related to Lehman’s CDS. however, they did not have enough time or power to force everybody into it.
The ONLY way to “solve” the CDS problem is to FORCE all CDS players into a single open exchange with full transparency, and then let the chips fall where they may. (which by the way is a hell of a lot more “free market” than your hair-brained lock-the-strongest-bankers-in-a-room scenario)
The problem: the initial models of how the clearing house will work are scary. Some show that we can do it and survive as an economy. but change just a few small assumptions, and the models show a significant percentage of US institutions immediately bankrupt due to cascading cross defaults. and not just banks by the way… remember, a huge number of VIABLE US corporations/institutions/pensions/government agencies rely on the CDS market to hedge (again, I have a very front row seat here).
In the end, the issue is that the notional value of the CDS is so large (5-6x our entire GDP) that if the trades don’t net out perfectly then the losses can be larger than our entire economy.
as they found with Lehman, the CDS monster is everywhere and in places you don’t expect. Nobody expected the largest Money Market Mutual fund to break the buck due to Lehman. And once that happened it was almost death to all Money Markets. and Lehman was one piddly little firm. nowhere near a Citi or an AIG or a GE.
we still will have to do a central clearing mechanism at some point however. Before hand the government will have to set up nationalized institutions (banks, food distribution centers, utilities, etc) OR a mechanism to allow completely insolvent firms to continue to operate, or otherwise there might be no mechanism for people to cash their employment checks, grow food and move it from here to there, get energy where it needs to be gotten etc. there may be food riots.
But to simply think that there are 10-12 banks that will go down if the CDS market explodes is rediculous.
Instead, think about firms like Goldman and Wells Fargo of course, but also firms like GE, and also agricultural companies (that use CDS market to hedge) and transportation companies and energy companies and you name it.
And those banks would not hesitate 1 second if they thought they could collude together to make a profit even if the outcome was to bankrupt the entire “real” economy. they haven’t hesitated thus far have they?
in sum, the problem is that the cds market is COMPLETELY OPAQUE AND UNREGULATED so nobody knows where the trades are. the trades DO NOT necessarily net. and the problem is huge.
You are very glib: I have to ask, where is your money? because doing what you suggest raises a strong possibility that it would all be wiped out. (especially your trading account). are you a gold bug with gold in your back yard? even that might not save you, since I’m not sure how you’d buy gas to drive out to where the food is located (since they don’t grow food in Marin).
now of course my scenario is very grim. like I said, the CDS problem may net out. but NOBODY KNOWS (including me, you, the Fed, the Bankers, etc) and NOBODY IS WILLING TO TRY IT. Russian Roulette is not always the best way to have an economy, ya know?
When LEH went kablooey, the trades netted to about $6B exposure, which was paid without the world coming to an end. IMO, the Fed has created this nightmare now.
This is not true. Lehman’s CDS issue caused a run on the Money Market funds.
I agree with you on many points
-The Treasury and fed are exacerbating the problem
-the regulators are often captured by those they regulate
-regulation is not a panacea.
however I disagree that the govt is the ONLY problem. you can twist and wiggle all you want, but in the end the unregulated CDS monster has a huge role in this and has nothing to do with our horrific govt.
you can of course argue that the Fed/Treasury/Govt are now exacerbating the problem, and you have no argument from me. But you cannot lay the blame of this solely on the govt. we could easily be exactly here with no govt whatsoever. (and in fact we often did in the 1800’s).
the difference was that in the 1800’s everything was local, so bubbles didn’t usually get so big (but there were doozies like the Tulip bubble). now we have a complex globalized economy so the bubbles can and will get bigger, with or without govt. it’s called irrational exuberance-and it doesn’t require government.
as I said: much of the problems we’re seeing are caused because our govt TRIED to start de-regulating. and as soon as they did that, every bank and non-bank institution went hog wild at the trough of greed.
this is why free markets won’t work, because we can never get there. a few a-holes will just ruin it for us all as soon as we take a few steps towards deregulation (and they consistently do it).
Good points, ex SF-er. We’ll have to agree to disagree about CDS. I actually have a very good friend at BlackRock who I used to work with and who was at the LEH cds auction settlement, and is heading up the creditor committee for BL’s interests in the court proceedings (they’re represented by Akin Gump), so I’ve got a pretty front row seat too 🙂
I agree about a CDS clearing house – no question. That’s why I said that we should give the big players 90 days or else they are force-bankrupted. I have no problem if the USG and Fed want to sit in the private meetings, but they should keep their mouths shut. Otherwise, the psychos running the banks are going to steal the taxpayers’ lunch money by bullying their patsy, Bernanke.
You’re right about breakdown in the monetary system. If the payments system truly breaks down, 25% of Americans would be dead within 2-3 months (and I know that you understand why that would be a minimum number, even if many fools think that’s hyperbole).
Austrians are not wholly against regulation. They believe in clear property rights (always) and transparent system for adjudicating disputes, enforced by a disinterested and limited government (most of them,anyway :)). The problem today is that the government is no longer merely upholding the system, they are interested in ensuring outcomes (“it would be terrible if those poor GM workers lost their private pensions”, etc….). That’s where the weak chink in the armor of regulation appears. The players know that by “capturing” the regulators, they can ensure the outcome that is best for them, and that’s what they do.
All off balance sheet enterprises are creatures of regulation. They are specifically exempted from consolidated balance sheet treatment on the basis of a few smoke and mirror moves – which were of course written into the regs by the lobbyist law firms. Because the arrangement is “blessed” by a massive regulatory framework, they are allowed to operate and they gain investor acceptance (the “nice” and “smart” government says it’s ok, so I guess it is!”). Similar arguments can be made about the role of the governmentally-sactioned rating cartel (the “NSROs” which is sacrosanct under the SEC regs), FDIC insurance, PBGC backstops, etc.
As a Federal 1934 Act filer, AIG is wholly regulated as to its disclosures, which of course it takes advantage of by waving its good housekeeping seal of approval regarding its CDS shenaningans. And of course, all its income subs are state regulated.
All this regulation/planning ground has been well trodden by Hayek and others, who showed that you really can never have a “mixed” economy. Once the regulators get into planning (and that is exactly what is going on, and has been – as just one example, the Fed “plans” the evolution of real economic activity by arbitrarily setting the cost of capital), there is massive incentive to capture the regulators. Watch what happens with the “green” energy fiasco about to be undertaken.
Anyway, it’s all academic now. We’re toast! About where I keep my money, I’ve got 3 years’ worth of living expenses (current prices) in physical gold either here or in offshore depositories, 3 years’ worth in yen offshore, 10 years’ worth in front end treasuries (or older I-bonds yielding 3% + CPI) directly on deposit with the Treasury, and the remainder is in trading or other accounts. I’ve moved as much as possible into bankruptcy-remote vehicles, but it’s pretty hard. I plan on buying rental real estate (likely not in the Bay Area) starting in 2009 with some friends and family, and I intend to game every foolish incentive that the USG puts out there and do it with as much leverage as possible.
And if it all blows to hell, I may dust off my law degree and start doing some bankruptcy work. We really live an exceedingly modest lifestyle (nice cars, but – god forbid! – formica countertops in a rented house) and there should be a lot of distressed assets ripe for picking by small fry like me when the wipeout comes. I want to leave something substantial for my kids – the next 30 years could be quite messy 🙂
LMRM,
Read “Systems of Survival” by Jane Jacobs sometime. It has an interesting take on the issue of structuring regulation.
Thanks diemos. I’ll order that from the library today! (Can’t buy it – need to conserve as hard times are comin’ 🙂 )
“it would be terrible if those poor GM workers lost their private pensions”, etc….). ”
It’s curious why people would allow themselves to be paid in empty promises instead of demanding cash up front. But then private pensions rose in popularity during WWII as a form of deferred compensation when wage controls were in place. I guess that this is another side effect of government meddling.
diemos,
About the deliberate dependence on government and other “too big to fail” quasi-government structures that it being fostered, I’ve always found this essay thought-provoking:
http://www.truthlovemusic.com/phpBB2/viewtopic.php?t=2071&sid=e34054402b192646c5713209f596aab8
(“The Decline of Loyalty” – It was posted once before on SS, so you might have seen it already.)
Not very well written, but a nice, easy treatment of a very profound insight into the role of the state and the dependence of those who would sate their human need to believe (religion has been around since the dawn of man, after all) with belief in Government.
The above comments prove that there is no limit to the amount of rationalization that the anti-government types will go to support their position. When unregulated off-book investments blow up, it is because the government regulated other investments, causing people to have faith in them? This reminds me of the arguments that Communists make, that their system is really the best, except “no one has ever tried it.”
If a minimally regulated economy was really such a great thing, then someone would surely have seized upon it by now, and would be dominant economically. Instead, every advanced economy in the world is a mixed economy and the most stable, with the happiest citizens and the fastest long term economic growth, all fall in about the same range, with 30-50% of economic activity coming from the public sector, the rest from the private sector.
And somehow we have had 62 years since _The_Road_To_Serfdom_ with no overall growth in the government share of the total economy. Those who believe that “the government” is one monolithic entity, with a cabal of power seekers, profoundly misunderstand the how democracy works. I guess it is easier, in these troubled times, to imagine that there is a very small group of smart people running everything like puppet masters, but the much scarier truth is that there is a constantly shifting group with plenty of infighting that doesn’t really have any more of a clue than you and I what they are doing.
Maybe a tiny bit more clue.
Oh, I almost forgot…
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/ ___| ___ | __ ) ___ __ _ _ __ ___| |
| | _ / _ \ | _ \ / _ \/ _` | ‘__/ __| |
| |_| | (_) | | |_) | __/ (_| | | \__ \_|
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Too bad we don’t have a “preview” button. Looks like my ASCII art got mangled.
GO BEARS!
The Is is not the most advanced economy in the world. It’s got a backward tax structure with tons of deadweight loss and other waste. Relied to heavily on an income tax with lots of special interest tax breaks etc. And is over regulated in some areas and has no regulation in others. Places where it has regulation are often hold overs from the 1930s.
If you want to talk advanced economy look at Singapore–nice simply regulation, low barriers in labor, capital, and tax structure. It’s not even close. Much of the US growth in the last decade was fake growth. All consumption bred that was driven based on borrowed dollars. It wasn’t real and we better get our act together pronto.
I agree with the comments on the anti regulatory bunch tho NVJ. I think it’s hard to make a case that keeping the leverage caps, some decent underwriting standards and CDS regulation would not have kept us out of a lot of trouble. The anti govt regulators are having a tough time with that one and I have seen nobody on this site make a case for how too much regulation is what caused this.
“The Decline of Loyalty” Thought provoking, and I’ve spent some time thinking about it. But I’d probably have to write an essay to respond to it and I’m not sure that’s appropriate to SS or on-topic. The one thing I will throw out there, the family is not the basic unit of society, the tribe or village is. And being part of a family does not guarantee that you will be taken care of as many a nebraskan kid or eskimo grandmother can attest.
diemos, being part of just any family may not guarantee your well being. But being of friend of Hank Paulson sure could help. I’m looking forward to the discussion on this $300B Citi bailout. That amounts to $1,000 per every person in this country just for one bank. I don’t care what the term sheet says – this is insanity (or maybe I’m no longer sane).
So I guess that Vikram Bandit and Prince Alwaleed are friends of Hank too. The guys at Cerberus must be really pissed. The only correct call Paulson has made was not to bail out the automakers – but, as much as I support that one single decision, doesn’t it seem a little lopsided: Citi & AIG get 1/2 a trillion; the automakers get squat. Now I’m certain that once the friends of Barrack start to get funding in earnest the automakers will get plenty – but where exactly in the constitution does it say that the treasury secretary gets to pick winners and losers and give the tab to multiple generations of American taxpayers? The federal government is completely out of control.
Singapore is an interesting case, it is hard to get a reliable source on what their overall govt spending is, but it appears to be around 20%. Part of how they pull this off is by not having a military, not something most sovereign state’s could pull off. I will look into them more though. Being small in population and size is probably a big plus, too.
There is a great WSJ article I wanted to share:
http://blogs.wsj.com/economics/2008/11/24/guest-post-inflation-should-be-just-around-the-corner/
This is the kind of thinking that is prevalent right now and you can see that their inflation “target” of 5-10% is what I have been suggesting is looming on the horizon for some time now. Policy makers will probably aim for 10% and miss by a few points on either side. Buckle your seat belts, we are in for a ride.
Part of how they pull this off is by not having a military, not something most sovereign state’s could pull off.
I went to school with several Singaporeans, and believe me, they had compulsory military service. Double checked and that is still the case”>http://en.wikipedia.org/wiki/Singapore_Armed_Forces”>case. Maybe you are thinking of Samoa 😉