Saturday, August 13, 2011

Deregulation and greed

With the tumultuous market we've seen over the last couple of weeks, the conversations have turned to the root of all of this. Was it 2008? What caused that? It's no secret that I'm a super conservative, capitalist, anti-liberal, pro-big business, greedy, dollar chaser. However, I can't begin to agree with the deregulation that began 30 years ago. To say "leave the market alone. It will take care of itself." is totally insane. Why would anyone stop doing what they are doing if it is making them money? Because it's the right thing? Since when do for profit businesses and people care about the right thing. Their right thing is their pocket. Truth be told, if I was in any of their shoes, I'd have probably done the same thing though. The temptation to make hundreds of millions of dollars would be greater than considering the consequences for strangers.

In any event, people are wondering how this all happened and I believe it began when banks began trading for themselves. Once they had the ability to make money on investing their money rather than making money on the interest and investments of their clients, we entered a whole new world. Take the ability to do that and mix it in with the lack of oversight from regulatory agencies and sprinkle in the lack of knowledge on the part of the average American and you've got a real recipe for disaster.

The subprime mortgage insanity is based on the banks giving away home loans to people who don't nearly qualify for starters. It's all predicated on the fact that housing prices always go up. It doesn't matter if they can afford the house. They're gonna keep it a couple of years then sell it and make money for a downpayment that makes the next, more expensive house actually cheaper because the loan is less. All they have to do is not default for a couple of years. So home loans went berserk. After a couple of years, there was some equity in the house and banks started leveraging that dollar to the max. Let's throw a line of credit on that baby so you can have a bunch of cash - send the kids to college and buy a boat. Now the homeowner's dollar is paying for three things. That's leveraged debt in simple terms. Debt that can't be paid off dollar for dollar because 1 dollar is needed in 3 places. Borrowing against your borrow based in equity which is all believed and not measured.

So this happens over and over and over and over. House prices go up and up to insane levels and more houses are built. We've got more houses for sale than people that need them with prices inflated because of this demand we created. The demand isn't for the house; it's built on the idea that you should sell and move because your house value is higher than when you started. Make money and go bigger. This was the American dream sold to the average American that never thought they'd be able to own a home and it was done by the bankers so every average Joe bought into it. The bubble grew. People couldn't afford the mortgages so they sold and moved and just inflated the bubble. House prices weren't related to anything anymore and became over-valued assets.

People defaulted on their loans and lost their houses, but the banks didn't care because they didn't lose money. They had been selling the mortgages, in part, to outside investors (local and abroad). So the bank held the mortgage to pay back the investors and the bank assumed no risk. The investors didn't care because the mortgage was also insured by AIG, for example so the investors would be covered on the back end as well. AIG was like the FDIC for people buying slices of mortgages. With every party covered, except the homeowner, there was no reason to quit. Everyone was making money.

AIG doesn't back just mortgages though. Things like medical insurance are covered by them as well. When houses are realized to not be even close to what they're valued at people are paying on nothing, which is like me financing a Kia for $80,000 and finding out it's worth only $20,000. I still owe the $80k but I'm throwing money away.  That's $60,000 of waste. So these homes aren't worth shit, nobody wants to invest in something that over inflated, homeowners can't afford it in the first place (because of the leverage) and it's a losing proposition that nobody wants to touch. Now we have tons and tons of toxic debt. Things we owe on, but nobody wants to cover that spread. Not to mention, AIG runs out of cash because they owe more in covering the claims than they have so they're in the hole. And so much rides on them.

Meanwhile, Russia is trying to get China to conspire and sell every single share of Fannie Mae and Freddie Mac which would devalue them to almost nothing which deflates our entire government and every bank is about 5 days from having all the customers make a run on it. Everyone feels their money is safer under the mattress. That means they can't get anyone to do new business and they're not worth anything and can't generate revenue. They collapse and everything comes crashing down with them.

All of our European investors lost they money they've invested, homeowner have no banks to get loans, and the market and commerce in the US stops on a dime. Trucks stop moving, gas stops pumping, store are empty and ATMs stop spitting out bills. It's the 1500s again. Broke and bedlam in less than a week.

Two things happened that prevented that. First, the Chinese are business people and they declined the Russians spiteful invitation. They need us as much as we need them. We pump a ton of money into China, part of why our debt is the way it is. Had they called in those debts and we went down, they lose an influx of money. Second, the $700B bailout program. It got loaned to all the banks, whether they needed it or not (the not being people like Wells Fargo). Everyone took it to help avoid isolating the weaker banks and were supposed to lend it out and stimulate things. Some did, some didn't. Some paid it back nearly immediately.

The folks that did go down like Dick Fuld of Lehman Brothers lost millions but walked away with many millions more so he's not hurting. Neither are any of the other individuals, as individuals. However, their companies, like Lehman Brothers, which were institutions and not just companies are now gone. I can't believe how many names are missing from the roster. Bear Stearns, for example.

The ones that remain have been deemed "too big to fail." All that means is that if they fail, too much goes down in the process and we can't let that happen. So, the government has no choice but to do this again, if need be.

The nice thing is that there's only one way to go from the bottom. You buy on bears and sell on bulls. Buy low, sell high. Now is the time to invest because everything is cheap while they struggle. The money spent invigorates the companies and the markets. Things are based on real numbers instead of emotion and speculation. It's a little Ponzi-esque, I guess, in the sense that we are building on nothing to get more people to do the same until these companies produce real results.

I guess you just can't cut your way out of a recession. You have to spend your way out of one. We got out bailout and saved the country, now we have to bring it back up. Europe, on the other hand, has a bigger problem, some of which is due to the money they had invested in our debt and some is brought on by the formation of the EU, while keeping countries politically separate.

So that's how it happened. All greed and nobody was watching. It's obviously much more complex. I don't understand derivatives really well and I'm not sure that anyone does. Credit swaps and leveraged debts nearly brought about the end of the world though. Now to see what happens next.

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