October 1, 2008

CRASH TALK OCTOBER 1

Dean Baker, Huffington Post - The main cause of the economy's weakness is not insolvent banks and lack of credit; it's the loss of $4 trillion to $5 trillion in housing equity as a result of the bubble's partial deflation. Families used their equity to support their consumption in the years from 2002 to 2007, as the savings rate fell to almost zero. With much of this equity now eliminated by the collapse of the bubble, many families can no longer sustain their levels of consumption. The main reason that banks won't lend to these families is that they no longer have home equity to serve as collateral. It wouldn't matter how much money the banks had, they are not going to make mortgage loans to people who have no equity. And house prices are not going to come back. This is like Pets.com. We are not going to get the price of $200,000 homes in central California back up to $500,000.

Phil Mattera, Dirt Diggers Digest - While we wait to see whether the revolt against the Big Bailout survives, we can take some comfort in reports that numerous financial institutions are being investigated by the FBI and other law enforcement agencies for possible criminal violations in the practices that led the country to the current crisis. . .

If the feds are aggressive about these investigations, we may learn that the corruption in the financial sector goes far beyond floating some overly risky securities.

Take the case of Wachovia, whose banking operations were just forced into the arms of Citigroup after its customers began to lose faith in the North Carolina institution. Wachovia's problems were not just its portfolio of faltering mortgage-backed securities. Over the past year, it has been embroiled in a series of extraordinary scandals.

- In April 2008 Wachovia, accused by federal regulators of failing to take action against fraudulent telemarketers it knew were using its facilities to steal millions of dollars from unsuspecting victims, agreed to pay a fine of $10 million, contribute $9 million to consumer education programs and make up to $125 million in restitution to victims.

- That same month, the Wall Street Journal reported that Wachovia was being investigated as part of a federal investigation of Mexican and Colombian money-transfer companies believed to be involved in the money laundering for drug traffickers.

- In July there was a report on the Dow Jones Newswire that the Brazilian unit of Wachovia Securities (not part of the sales to Citigroup) was being investigated for aiding wealthy individuals commit tax evasion.

- In August Wachovia, following the lead of several other big financial institutions, agreed to buy back near $9 billion in auction-rate securities from investors who charged that they were misled into purchasing the volatile instruments.

And all this is apart from the Wachovia Securities broker in Ohio who, apparently on his own initiative, bilked millions of dollars from customers through fraudulent stock and real estate transactions. He was sentenced to four years in prison and ordered to pay more than $9 million in restitution.

Wachovia may be particularly unlucky that its alleged transgressions got discovered, but there is no reason to believe it is an isolated miscreant. Many of us have long suspected that fraud and corruption are rampant in the financial world. The pressures of the current crisis may finally expose the true extent of the rot.

Matt Welch, Reason - John McCain joins President Bush and Secretary of Goldman Sachs Henry Paulson in the "pass-this-bill-or-prepare-to-eat-garbage" coalition: "If the financial rescue bill fails in Congress yet again, the present crisis will turn into a disaster. As credit disappears, students will no longer be able to get loans for college, and families looking for a new home will be unable to get a loan. New car sales will come to a halt. Businesses will have difficulty securing credit for operations and may be unable to pay employees. If we fail to act, the gears of our economy will grind to a halt."

At this point I'm amazed that he (or his many alarmist cohorts) left out the part about being forced to sell ourselves into white slavery to the Red Chinese. . . Remember back when people jumped all up in Alan Greenspan's grill just for him uttering the phrase "irrational exuberance"? We now have the president, his cabinet, and his would-be successor predicting imminent economic collapse if we don't immediately pass a trillion-dollar bailout rescue that will force taxpayers to overpay for currently illiquid mortgage-based debt instruments. . . Has there ever been a two-week period when America's putative leaders expressed less faith in the country they claim to run?

Frank Barbera, Financial Sense - So often in the past, we hear investment advisors speak of "investing for the long term" and that over time things always come back. That may yet be true, but that advice does not address the human aspect of investing, which is the frailty of human nature. As a hedge fund manager myself, I have experienced my portion of tough times when managing investment portfolios. It is the kind of pressure that mounts -- sometimes by the hour, steadily wearing on the nerves -- slowly and relentlessly eating away at you from within. . . .

In any battle, a good commander needs to know precisely when to fall back, and there is always a time to fall back. Yet for the average investor, he is indoctrinated into a more passive approach -- 'forget about what is happening now, and look forward to a better day down the line' -- he is told. Yet, if John Q Public sees his portfolio sinking day-after-day, week-after-week, and perhaps month-after-month, we have to ask out loud, "Is he really going to have the intestinal fortitude to stick with a dollar cost averaging strategy and keep "pouring in" what must soon look like more 'good money after bad'? -- How long will it be before his resolve is worn down, before his psychology is crushed by the weight of crumbling markets?". . .

If a job is lost, then all of a sudden that pool of investment capital which was being 'dollar cost averaged' and held aside 'for the long term' -- well, that capital is immediately liquidated and becomes the new day-to-day living capital. . . Risk control and a stop loss mentality would have avoided this outcome. . . Capital preserved in a crash is capital available to invest when real bargains are on the table when the long nightmare finally comes to an end.

Barbera has an interesting chart showing the difference since the 1920s of the typically recommended buy and hold approach as opposed to a more cautious switching and avoiding the big declines techniques.

Dean Baker, Prospect - There seems to be a view that stock market wealth is money from heaven. Ownership of stock is a claim to the future profits of the corporations whose stock is owned. If the value of stocks increase because the economy is expected to grow more rapidly, and therefore future profits will be larger, then it is reasonable to say that a higher stock market is good news for everyone. But suppose the stock market goes up because the markets think that the government will tax school teachers and fire fighters to hand money to Wall Street banks. Is this one good for everyone? Finally, suppose that the Wall Street titans haven't a clue what future profits will be (these are the folks that pushed the NASDAQ above 5000), and a rise in the stock market is driven by irrational exuberance. In this case, the higher stock market simply means that stockholders have a greater claim on the same amount of national wealth. This would be like handing out a trillion dollar bills and giving them only to shareholders. That's good for the shareholders, but not for the rest of the country. It would be nice if the folks who report the news understood that the stock market is not the economy.

Dr. Don Swift - A small part of the problem is the sub-prime loans. The big problem is how they were marketed.

The threatened disaster is largely the result of efforts to weaken economic regulations that were put in place under Franklin Roosevelt to protect us from another depression. Former Senator Phil Gramm of Texas was the architect of this wrecking operation, and he had the enthusiastic support of his friend and sidekick, Senator John McCain. The Arizonan admits that he knows little about economics but incessantly brags that he isd a big deregulator.

Gramm crafted the most important legislation that opened the door to the unsafe practices that led to the housing disaster and placing 3,000,000 homes in danger of foreclosure. Phil Gramm's Financial Modernization Act of 1999 gutted the Glass-Steagall Act, which was designed to protect our financial institutions. It removed the firewalls the New Deal had placed between securities firms, banks, and insurance companies. This led to a wave of mergers. Some say this act unleashed an epidemic of speculation that led to the bursting of the current speculative bubbles. As head of the Senate Banking Committee, Gramm had repeatedly turned down requests from the Securities and Exchange Commission to hire more people to investigate securities fraud.

Gramm's Commodity Futures Modernization Act was a 261 page "Enron Clause" that was added to a huge omnibus spending bill December, 2000. Enron Corporation wanted this legislation and Gramm's wife , Wendy, soon joined the Enron board. The act destabilized the California energy market. By deregulating energy markets, it paved the way for the Enron scandal and opened the door for abuses in energy trading, and accounts in part for high gas process. It also deregulated the trade in derivatives, which is based upon all the new debt instruments that Warren Buffett "financial weapons of mass destruction" designed by "madmen."

Gramm's deregulation made it possible to bundle sub-prime mortgages into a new form of security, thus hiding the problems with individual mortgages. Credit card accounts were also "securitized." . . .

McCain's campaign is loaded with lobbyists and he has a track record of doing their bidding. But this is only a tangential issue. The financial markets got into deep trouble because of legislation McCain championed that stripped away safeguards that were put in place under Franklin D. Roosevelt. If the nation does not turn its attention to restoring and improving these safeguards, we will be looking at ever larger bail-outs down the road.

Dr. Don Swift is a retired professor of History from Edinboro University of Pennsylvania

Question about the Senate bailout action: how does it fit with Article 1, Section 7 of the Constitution which declares for raising revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills."

Rasmussen Report - Voters are evenly divided over whether Congress should take action to help the troubled financial industry or just let Wall Street work out its problems on its own, according to a new Rasmussen Reports national telephone survey. Forty-five percent say Congress should take action, but 44% say Wall Street and the financial industry should take care of their own problems. Eleven percent are undecided. The survey was taken Monday night after Congress rejected a $700-billion taxpayer-backed economic rescue plan prompting the biggest drop in the stock market in 21 years.

Fifty-two percent of Republicans say Wall Street should work out its own problems versus 40% who want Congress to take action to help the financial industry. By comparison, 51% of Democrats want congressional action, while 38% think Wall Street should be left to its own devices. Unaffiliated voters are evenly divided. Interestingly, retirees, whose investments are being buffeted by the shifts in the stock market and generally have a more immediate need for that money, favor letting Wall Street and the financial sector work out its own problems by a 47% to 41% margin.


Investors by a 49% to 41% margin want Congress to take action to help the financial industry. A plurality (44%) also believe congressional rejection of the economic plan will hurt the economy.

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