STYLETHREAD -- LET'S TALK SHOP!

No, not that scared. Without getting into what I think is right or wrong, what bothers me is that we're getting a very, very narrow view of this very layered topic. Both major political parties want us to be afraid, and both want a corporate bailout urgently, without regard to any possible consequences. Yet this seems to be a really unpopular decision among the people of this country, and last I heard, it's a democracy.

I don't have a perfect solution, but I would like to hear more perspectives than the ones we're currently getting before the country decides the sky is falling and a $700 Billion corporate aid package is appropriate. I don't want to be naive either, but the discussion needs to be expanded and broadened quite a bit.

Here's an entry from a blog that I found very helpful:

September 28, 2008
The $700+ Billion Bailout--Posner
There has been such a flood of media coverage of the financial crisis that it is best to begin with some very simple, basic points.

Banks (broadly defined to include investment banks and the many other lenders) borrow--bank deposits, for example, are loans to banks--and then lend out what they have borrowed. As a result, their loans are much larger than their capital assets (cash, a building, etc.). If their capital shrinks in value, they have less protection against the possibility that the loans they make will not be repaid in full. If a bank's capital is 10, and it borrows 100 and lends 100, and the persons or firms it lends to return only 90, its net worth will fall to zero (10 [its capital] + 90 [the value of its loans] - 100 [the amount it owes its depositors] = 0.

Banks in recent years have increased the ratio of their loans to their capital because borrowing costs were low and financial experts thought they had discovered ways of reducing the risk of leverage (that is, of borrowing). Many of the loans were mortgage loans, and the value of those loans fell when the housing bubble burst. (Risky, and in some cases deceptive, mortgage practices had contributed to the bubble.) What made the situation worse was that rather than retaining the mortgages that they originated, banks (especially the major ones) sold the mortgages in exchange for securities backed by the mortgages. Those securities became a part of a bank's capital. The value of the securities depended on the value of the mortgages that the entity issuing the securities had bought; those mortgages were the entity's assets. As that value fell, the bank's capital fell.

The mortgage-backed securities achieved geographical diversification of mortgage risk. But the housing bubble, though not geographically uniform, was sufficiently widespread that geographical diversification did not reduce the risk of mortgage defaults sufficiently to avert the fall in the value of mortgage-backed securities.

A complicating factor was that the value of those securities was and is very difficult to determine, because each security represents a share in pieces of many different mortgages. The bank that owns the security cannot readily determine the value of all those different mortgages, since it has no direct relationship with the mortgagor, having sold the mortgage to the entity that issued the mortgage-backed securities.

Because the banking industry (and remember that I am defining "banking" very broadly, basically as all lending) was highly leveraged, and because much of its capital consisted of securities very difficult to value, the bursting of the housing bubble reduced the capital of the banks, but by an unknown amount. The reduction and uncertainty have curtailed lending by reducing the capital cushion that a bank needs to reduce to an acceptable level the risk that some of its loans will not be repaid. That is the "credit crunch, and it is painful because so many individuals and businesses borrow to finance their activities.

Ordinarily one would expect a credit crunch to be self-correcting. As lending dropped because of the fall in bank capital, interest rates would rise and this would attract more capital to the financial markets. We have seen this process at work in Warren Buffett's $5 billion investment in Goldman Sachs. Buffett has capital, Goldman needs it, so Buffett gives it to Goldman in exchange for preferred stock (which is really a type of bond but one that does not have a term--it is never repaid) paying a handsome interest rate.

But Goldman is pretty healthy. Many lenders have so much of their capital tied up in mortgage-backed securities or other novel forms of capital that are difficult to value that they cannot attract new capital at a price that would enable the lender to continue in business. The sale of the securities would just expose their lack of value. The federal government, however, has essentially unlimited capital because of its taxing power. It is prepared at this writing to contribute perhaps as much as a trillion dollars to rebuild the capital of the banking industry. The Treasury wants to make this contribution in the form of buying the dubious securities, but that seems to be a mistake, unless pressure of time allows for no alternative. If the Treasury pays the actual value (if anyone can determine what that is) of the securities, it will not be injecting new capital into the banking industry, but merely swapping one form of capital for another. If the Treasury pays more than the securities are worth, then it is contributing capital to the industry all right, but it is also enriching the owners and managers of the banks, which creates the familiar moral hazard problem as well as upsetting people by rewarding careless management practices. The more it overpays, the most costly the bailout plan to the taxpayer.

A more palatable approach would be for the government to drive a Warren Buffett style hard bargain, in which, rather than buying anything from banks, the government would invest in them in a form, such as purchase of newly issued preferred stock, or bonds with a long maturity, that would augment the banks' capital and thus enable banks to make more loans. That would avoid conferring a windfall on the banks by overpaying them for their bad securities; no one thinks Buffett is conferring a windfall on Goldman Sachs. After the industry was back on its feet, the government could sell the bank stocks or bonds that it had acquired.


From: www.becker-posner-blog.com

Ugh...I knew an economic adjustment would be coming, but didn't think it would be so bad.

And trying to read that blog entry made my head hurt.

And if I hear any more about that 3-week CEO of WaMu's salary package I may vomit.

I wish, well for many reasons, that I had lots of cash - I would be like Buffett and take advantage of the some of the fire sales and make a nice profit in 20 years.

fairlight wrote:

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I saw the same patterns emerge in every one of my jobs.  I had to handle so many complaint calls from people who took out leases to get a car. People were so seduced by the lower rate that they don't pay attention to anything else.

 

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 I might get jumped on for this, but I'm a little bit annoyed about how all the blame is being put on the banks/goverment for what's happening. I believe that a portion of the blame must be placed onto every single homeowner who took out a mortgage/bought a house that was beyond thier means. I get that all those lower-rate loans were terribly enticing, I totally get that. I'm not trying to blame people for wanting to own thier own home and getting seduced by the banks. However, I think it's a little unfair to let the American People off of the hook on this one. If the banks are being blamed for giving loans to people that were possibly not going to be able to pay it back on time, then those people need to carry some of the blame. Common sense and a little bit of awareness about one's financial situation might have corrected a lot of the problems.

Living beyond one's means is so rampant in American society, and it sometimes makes me really sick. Living off of credit cards is just as bad as buying a house that you can't afford. I really think that high schools need to bring back "adult skills" classes. When I was in, I think, my freshman year of highschool, we all had to take a class where we learned how to budget for a household. We also learned terribly exciting things like what a mortgage is and how to get one, and even how to write a check and balance that checkbook. Money in has got to be greater than money out- it's as simple as that. I think a lot of people forget that part. If money out is more than money in, then there's a problem.

On a different note- there was a great article in the NYTimes a few days back about how Sweden went through the exact same situation as we are facing now, and they handled it much differently. It's a great article, and relativiely simple to understand.

http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html?_r=1&sq=sweden%20bailout&st=cse&adxnnl=1&oref=slogin&scp=2&adxnnlx=1222953208-1Ik1k8duQnRgaVY44DQ68g

relrel wrote:

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fairlight wrote:

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I saw the same patterns emerge in every one of my jobs.  I had to handle so many complaint calls from people who took out leases to get a car. People were so seduced by the lower rate that they don't pay attention to anything else.

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I really think that high schools need to bring back "adult skills" classes. When I was in, I think, my freshman year of highschool, we all had to take a class where we learned how to budget for a household. We also learned terribly exciting things like what a mortgage is and how to get one, and even how to write a check and balance that checkbook. Money in has got to be greater than money out- it's as simple as that. I think a lot of people forget that part. If money out is more than money in, then there's a problem.

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I was going to say something similar about how I wish the government makes it mandatory that people have to attend classes like that. I was afraid the board would be like what is up with this big brother bitch?

That is awesome that your high school had that type of program.

 

Heh, my school had a money class  - I took it and it was awesome!  We learned how to balance a checkbook and how to do our taxes and how to shop for life insurance and how to figure out interest and things like that.  Unfortunately, the teacher of the class retired and they got rid of the class because nobody else wanted to teach it ...

As someone who went through the whole mortgage process and bought my home literally moments before the 'housing crisis' struck, I have a slightly different theory on the role of homeowners' blame in this thing.  Mortgage brokers are crazy, and yet you have to rely on them quite a bit to help you figure out how much a loan is going to cost you - now and in the long term, with all the different options they have to run on their fancy pants computer programs.  The options are staggering, and change by the minute as rates change and lenders offer different deals.  To a point, you have to trust what they're telling you.  It's still up to you to decide if you can 'afford' the options they're giving you, because what they tell you you can 'afford' is BS, or at least it was before everyone freaked out.  We went in knowing the upper limit we felt comfortable paying, but we would have been allowed to borrow nearly double that amount.  That mortgage would have been like 75% of take home!  But if you were walking in with a relatively modest salary wanting to buy a modest home and the broker said 'Sure, you can totally get that house!', people believe them.  Because in theory if you can afford that house they'll let you buy it - the definition of 'afford' just gets run over. 

Part of the purpose of the deregulation of the system was to provide the opportunity for every American to own a home, but of course every American can't afford to own a home, so the industry started playing it fast and loose and buyers went lalalalalala I can't heeeeaaarrrryouuuuuuwheredoIsign? when they talked about all the 'specifics'.  Neither thing was right, but IMO if the industry hand't been deregulated to the extent that it had, we wouldn't be where we are now.  As a 'regular person' I certainly didn't know just how lax the rules had become behind the scenes, however informed I am about my own finances.  There was greed on both sides, but I don't think it was the green eyed, gimmegimmegimme sort of greed.  I think it got out of hand because people kept nudging the boundaries to see if they could go a little farther, a little farther, a little farther.  It's the very thing regulations were created to prevent.  But those only work if you us them!

Farrah wrote:

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I agree with relrel so feel free to jump me too. There are many Americans that put themselves in the situations they are in with their homes being foreclosed and the credit crisis because they didn't do their homework before they bought, and they tried to hard to keep up with the Joneses; never ming that the Joneses are probably up to their ears in debt too. People in this country do not know the meaning of the word no and if you don't believe me just look at all of the stuff that people give their kids nowadays and think back to how much stuff you had when you were a kid. I didn't have a mini-hummer car to drive around, I had a big wheel. When I was 5 I didn't have a $300 gaming system complete with 20 games to play on it at $50 a piece, I had Candyland and Chutes and Ladders. If people think that tha 80s was the ages of excess they really need to start looking at what is going on right now.

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Quite frankly, at this point I would rather have my money go to help our country get out of this mess than to fight a war that I don't think we should be in anyway. That is just me and my 2 cents though.

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ITA.  I'm so frustrated over Americans' (in general) lack of sacrifice.  Hubby and I moved into our house (built on 20 acres) in Feb.07, and yes, the lender told us we qualified for X dollars.  Seriously it was at least 200K more than we needed, we could get a 1 arm or a 2 arm, or an interest only loan.  It was enticing but WE DID NOT NEED IT.  So you know what, we didn't take it and got a 30 yr. fixed.  How frickin' hard is that?
BUT- speaking of farmer's and loans.  We could not get a loan to buy our property when it only had vines on it, even though we "qualified" for 4 x's the amount of the property selling price.  A farm loan wouldn't work because it was only 20 acres and at the time the vines weren't worth (to the bank) the amount of the property.  A construction/home loan wouldn't work because the property was too big. WTH?  Anyway, I am extrememly sympathetic to the small business and farm owner's and not to the people that took out 110% on their homes.  I just can't be - and I'm not sorry.  I am however, very angry that this is even happening.

I'm actually curious about what percentage of these crazy home loans were for people's primary residences and how many were for real estate speculators/flippers trying to make $50K in three months. I don't know how many people here own more than one home, but getting a mortgage for another house that isn't your primary residence, when you already have a mortgage on the place you live in, often requires some creative financing like no-doc loans.

And people buying flip houses, figuring they'd sell in under a year, had no reason to get a traditional 30-year mortgage when they could pay far less per month on a loan with a two or three year intro teaser rate.

In SoCal, you couldn't swing a dead cat without hitting a flipper. "Flipping a house" was the new "selling a screenplay." A person I know in Florida was doing the same, fixing up several houses at once. Everyone was making money, including mortgage brokers, most of whom seemed to be 22 year old guys who dropped out of college and shared a single tie.

It wasn't uncommon for people to be carrying three or four mortgages at the same time. People who didn't know a Craftsman from a Colonial were getting real estate licenses so they wouldn't have to pay commissions to agents.

So while I'm sure there are a lot of families who got into homes and lifestyles in the 'burbs they probably couldn't afford, I'm not as quick to blame people in this situation as I am greedy ba$tard$ who were taking big financial risks to get rich in real estate. And there are still people trying to flip, in my area at least, where some overpriced McMansions are sitting empty for six months or more.

That's my rant...