The De-Stimulus Bill

Tymothyson wrote:

Won’t the stimulus bill fool people into thinking that the economy will get back onto its own two feet?

 

Tymothyson,

I think most level headed people do not trust the de-stimulus bill. That is at least what Wall Street is telling us with its record plunges.

Giving Thanks

Fellow prole Matt wrote,

Can you take some time to explain the recent drop in gas prices?  Is this a reflection of the economy or are the big oil companies simply throwing us a bone before Christmas?

 

Matt,

Big oil will never throw you a bone.  They might pick yours clean, but they’ll never throw you one. 

 

We’re in the midst of an economic crisis not seen since the Great Depression (the only reason it doesn’t feel like it to you and I as we go about our daily lives is because the government is literally printing money and giving it away).  There is a widespread panic that the recession will turn into a global depression, which would drastically reduce the demand for oil.  Also, with stock markets plummeting on every continent, people are selling everything they can and buying U.S. dollars.  This is resulting in huge dollar strength.  Since oil is priced in dollars, if the dollar strengthens oil will weaken.  These are the two main reasons oil is falling.

 

Fellow prole Tymothyson wrote,

Are they trying to keep us from giving up on gas-driven products?

 

Ty,

I love your cynicism.  Well done.  The Saudis along with big oil aren’t too concerned, that’s why they haven’t taken drastic measures to stem the decline.  If oil were to stay where it was, at $150, then people would start looking for alternatives.  However, now that there has been such huge price volatility, if oil does go back to $150 people won’t be as motivated to search for another viable energy source because they’d think the rise in price would only be temporary and would soon return back to $50 or lower.  That is when it will not stop at $150 but continue higher.  The Saudis won’t mind that.

No Light at the End of the Tunnel

Big Lova wrote,

What is your outlook on where our economy is headed? With the dow at its lowest point in the last 5 years, do you think that the average will continue to drop? What do you think will be the turning point and when do you think this will happen?

 

Big Lova,

There is no light at the end of the tunnel for our economy.  There will be no turnaround until housing recovers.  Unfortunately, it is still too expensive as the average person still can’t afford a home with a traditional fixed mortgage.  Combined with our slowing economy and rising unemployment rate it is unlikely for housing to bottom anytime soon.  So get ready for a bumpy ride.

Fancy Financial Instruments

Big Lova wrote:

 

“Why do you think the news of the OTC derivatives hasn’t reached the news wire, or has it and there is preventatives holding the information from the general public?”

 

I don’t think the media is deliberately hiding information about OTC derivatives.  It is just that these instruments are so complex the general public would simply not understand them.  I doubt the media even grasps their financial magnitude.  There is an earlier post from July 23^rd you should watch where President Bush refers to these as “fancy financial instruments.” 

 

If you look hard enough you can find the information.  In fact, Time Magazine recently published an excellent article explaining derivatives and how they’re connected to the current financial debacle.

No Love for Banks

Big Lova wrote:

 

“How are banks all across the globe on the brink of chaos?  If what analysts are saying about the real estate market and banks loaning individuals money when they shouldn’t have being the initial cause of the trouble we are facing now, how would this affect banks for example in Iceland?”

 

The reason banks in Iceland, and all over the globe for that matter, are receiving no love right now is because they were all purchasers of the mortgages which are now defaulting.  You see during the real estate run-up, everyone was buying homes, everyone was taking out home equity lines of credit (HELOC), and everyone was refinancing their houses.  Trillions and trillions of dollars of mortgages were originated.  Big banks took all these mortgages and packaged them into products for investors to buy.  These products were called Mortgaged Backed Securities (MBS), Collateralized Mortgage Obligations (CMO), etc.  Investors from Iceland and the rest of the world, seeking higher returns, saw these as attractive.  Now these investments have turned sour and abracadabra, here we are.

 

However, that is only a small part of the story.  The real reason for all the pain, which is not being told by the media, is from instruments called OTC derivatives.  Back in the hay-day, banks were making so much money that they craved more.  To satisfy their craving, they started selling credit default swaps, which are basically insurance, on the MBS’s and CMO’s they had sold to everyone.  The amount of insurance that was sold was in the hundreds of trillions of dollars and banks all over the world, including Iceland, were participating in this highly lucrative and secretive market.  Now with the MBS’s, CMO’s, etc. defaulting at higher rates than most people expected, the banks are now forced to make good on their promises of insurance.  Of course, no bank, or country even, has hundreds of trillions of dollars.  For these reasons we are currently seeing the governments and banks, in Iceland and the world, scrambling for solutions.

 

I hope that was not too technical and answers your question.

Zimbabwe or Bust

$100 000 000 000 banknote with three eggs, a sample of what it could purchase

 

Matt wrote:  Couldn’t the government send me a $1,000 rebate check with my IRS return to make-up for the rising cost of fuel for example?

 

Matt,

 

Thanks for the question, but why stop at $1,000?  Why not $1,000,000?  If the government gave everyone a million dollars then wouldn’t that solve everything?   All you have to do is look at the current situation in Zimbabwe.  Everyone in Zimbabwe is a millionaire.  In fact, it has been proposed to raise their minimum wage to Z$100 billion.  Are they better off?  Of course not.  The country is going through its worst economic crisis in history.  There is 80% unemployment and widespread shortages of food and other basic essentials.  So even though they are all millionaires (even billionaires), that is still grossly inadequate to meet even the most basic living expenses. 

 

The key is in understanding the simple laws of supply and demand, the basic fundamentals of economics.  If you increase the supply of money that would in turn increase the demand for goods (i.e. gasoline) which would by law cause prices to increase.  So to answer your question, No, the government giving you $1,000 would not help make-up for rising fuel costs because that extra $1,000 you would get would be offset by gasoline costing $1,000 more.

No Easy Answers

 Regarding “The New Shot Callers” post, Borderline Convert Byanca wrote:

 

Let’s say the government didn’t interfere. China and Japan get nervous…. Decide to pull out all of the money they have loaned….what then? Where’s our US dollar then…

 

There simply is NO solution.  Had the government done the right thing and not guaranteed Freddie and Fannie debt, we would now be experiencing an outright financial crisis. The dollar would be falling sharply along with real estate prices, gold would be soaring and the recession would be deepening.  But even in the midst of all that chaos, the dollar would eventually find a bottom and a new rebuilding period could begin.  This scenario, which is politically inconvenient in the short run, is the best long-term solution.

 

However, by choosing to nationalize Freddie and Fannie, the government has merely delayed the disaster. In hyperinflation, which is where we are headed, a currency can lose all of it’s value. This scenario might be more politically favorable in the short-term, but the long-term effects are catastrophic (i.e. Weimar Republic, Zimbabwe, and Argentina).  Thus this borrowed time will cost us dearly, as the day of reckoning will now involve much steeper losses for our currency.   

Cut the Spending

Borderline convert Byanca wrote:

 

“I suppose a world without taxes would work just fine… except… who pays for the military?”

 

Dear Byanca,

 

First off, your question assumes our taxes pay for the military.  The government runs a budget deficit, which means they spend more than they take in from taxes and other revenue sources.  To finance this, the Department of Treasury issues debt to foreigners in the form of Treasury bills, notes and bonds.  So places like China, Japan and countries from the Middle East, who buy our debt, are the ones actually paying for our wars.

 

Secondly, the abolition of all taxes is not the goal.  It is namely the repeal of the 16^th amendment, which introduced the income tax.  Our country prospered for over 100 years before this bill was introduced.  Excise taxes, sales taxes, and tariffs were and could still be sufficient sources of revenue to support a properly sized and run government.  The problem is, since its creation, the government, and therefore spending, has increased exponentially creating an incentive for more and higher taxes.

 

While the military or some force is certainly necessary to protect our inherent rights to life, liberty and the pursuit of happiness, it has become overextended and mismanaged.  For example, there are still thousands of troops stationed in places like Europe, Japan, and South Korea.  The lingering post-WW2 fears have long since abated and these regions all enjoy political peace and economic stability.  This reform does not apply to the military alone.  Every branch of government could be eliminated or streamlined back to efficiency in order to reduce the need for taxation, but I will not get into them at this time.

 

Yard Sale

Dissident Paul wrote,

 

“At what dicount is the FDIC selling these banks? 1st National Bank of Nevada and First Heritage Bank N.A were shut down by the FDIC on Firday, July 25th and since been acquired and reopened on Monday, July 28th by Mutual of Omaha Bank. How much of a discount was offered for a Omaha based bank to do due diligence and finance a bank saturated with non-performing loans over the course of a weekend? Or is the Fed leaking insider information?”

 

Dear Paul,

 

You pose excellent questions that some I’m sure will remain unanswered.

 

Here are some facts we know:

 

Historically, the Federal Deposit Insurance Corporation (FDIC) has used three basic resolution methods: purchase and assumption (P&A) transactions, deposit payoffs, and open bank assistance (OBA) transactions. Of the three, the purchase and assumption transaction is the most common and was how this particular case was structured.

 

Before the banking crisis of the 1980s, the price paid by the assuming institution for assets other than cash was based on the value at which the assets were shown on the failing institution’s books.  Because asset values are generally overstated in a failing bank or thrift, the FDIC’s ability to sell assets to an acquiring institution based on book value was limited. As the number of failures increased and liquidity and workload pressures grew, the FDIC began to base the purchase price of assets on their value as established by an asset valuation review performed by FDIC staff.

 

Now we don’t know how much that staffer valued it at, but we know it was priced to sell in less than a day.   It’s rumored to be under $0.35 on the dollar.  Also, this transaction will cost the FDIC $862 million of its $50 billion in reserves.  Please note $13.4 trillion in assets still held by 8,494 institutions are insured by the FDIC.  I wonder why they were so quick to get rid of this…