Two somber anniversaries »« Yet another federal bailout for the rich

Ignoring the elephants

Presidential elections involve two distinct phases. In the first phase, the Villagers drive out of the race anyone who might even remotely threaten the power and privileges of the pro-business/pro-war single party oligarchy that runs the country. Once that is achieved, then the Villagers create major controversies over personal and social issues, so that the electorate gets really fired up and angry and think that important issues are at stake, and not notice that the game is already over. (See here and here for who the Villagers are and the role they play.)

We are now comfortably in that second phase of the process. There is little to choose from between Obama and Clinton in terms of policy differences and so we have this ridiculous amount of attention being paid to statements made by their supporters and other trivialities. When the Democratic nominee is finally determined, we will then see the same kind of intense attention on trivial issues between the two party nominees.

As I said in a 2006 post on election year politics:

As a result, the overture to familiar strains of election year sloganeering are being heard, following a similar pattern. In the months leading to November, one can expect to hear a lot about the following: gay marriage, abortion, immigrants, flag burning, English-only rhetoric, UN bashing, estate tax repeal, and assisted suicide.

All these issues (except for immigration and the estate tax) share the characteristic that they are largely symbolic and directly affect only a tiny minority of people. They have little relevance to the actual lives of most people, but they do aim straight at the emotional core of the base and provide many opportunities to push people’s buttons and make them angry. And expect to hear lots of talk about god and religion, perhaps involving those old faithfuls such as displaying the ten commandments in public places or the pledge of allegiance or prayer in schools and similar church-state separation issues.

However, I would not be surprised if a completely unexpected, but equally trivial, new issue emerges suddenly, since the ones I have listed are, like, so-o-o-o 2004, and the extremist base loves fresh raw meat.

That has happened. Look at the kinds of media coverage that the race now gets. The big issues that the country faces are the wars in Iraq and Afghanistan and the threat of a US attack on Iran; the hundreds of thousands of dead and injured in Iraq and the massive number of displaced people and refugees; the large and continuing budget and trade deficits; the rapid decline in the value of the dollar against other major currencies; the threat of an imminent recession; the crisis facing many homeowners due to the subprime debacle; the shakiness of the US banking system because of that same issue; and the spiraling cost of health care and the lack of coverage for over forty million people, a large fraction of whom are children.

These are all signs that the US has gotten itself into a tailspin. Paul Craig Roberts spells out the magnitude of the problems that have been created. All these issues affect each and every one of us, either directly or indirectly, and have major long-term consequences. Whoever becomes president in November will inherit a financial and military mess that will require very tough and unpopular decisions.

And yet, how much coverage do we have of the candidates’ views on these topics and what their priorities and plans are for dealing with them? Take for example the unprecedented actions by the Federal Reserve to bail out the big investment banks that made lots of money but now are in serious trouble. What are the candidates’ views on this situation? What would they do as president? Do they approve of this kind of government intervention in the financial sector?

We are clearly not going to get any kind of adult talk on this issue from the current president. Last Friday, when the Bear Stearns news was rocking global financial markets, Bush talked to a group of economists at the Economic Club of New York who, along with people around the world, were presumably anxious to hear what the government’s response would be. According to a reporter present, what they heard would have given them the impression of a president who was either in fantasyland, oblivious to what is going on around him or completely out of his depth.

[Y]ou had to wonder what the international financial community makes of a country whose president could show up to talk economics in the middle of a liquidity crisis and kind of flop around the stage as if he was emcee at the Iowa Republican Pig Roast.

We’re really past expecting anything much, but in times of crisis you would like to at least believe your leader has the capacity to pretend he’s in control.
. . .
Our credit markets are foundering, and all we’ve got is a guy who looks like he’s ready to kick back and start the weekend.
. . .
[T]his economic crisis has been going on for months, and all the president could come up with sounded as if it had been composed for a Rotary Club and then delivered by a guy who had never read it before.

He then spoke about his Big Plan: sending checks of $600 to everyone! Oh yes, that should definitely turn things around. Oh, and he’s also totally against congressional earmarks now, though he was fine with them while the Republicans controlled Congress. That was pretty much it. One wonders if there are any adults in this administration.

Here is Jon Stewart on the economic mess and Bush’s speech:

Meanwhile, on Friday itself Wall Street investors started a steady drumbeat demanding that the Fed cut interest rates once again at its regular meeting on Tuesday, by another huge amount, perhaps even as high as one percentage point. The Fed duly obliged cutting rates by a quarter point on Sunday, itself a highly unusual action, and then followed with a further cut of ¾ point on Tuesday. The stock markets duly soared upwards again.

Cutting interest rates by large amounts might please Wall Street investors, at least in the short run, but it has consequences for the long term. Doing so while European rates stay high results in the dollar, already at record lows, sinking even further. This will raise the price of oil and other imports, increasing the rate of inflation and aggravating the trade deficit. All this makes foreign investors even more wary of dollar-based investments, which may make it harder to sell them US treasury bonds to finance the deficits.

The investments made by investment banks like Bear Stearns are highly leveraged, meaning that they buy securities with just a small amount as down payment and finance the rest, just like the way we buy houses with a small down payment and finance the rest with a mortgage. The difference is that when buying a house (in normal times) the down payment is usually 10 to 20% and the value of the collateral (the house) is worth more than the loan, so that if the borrower can’t repay the loan, the lender can still recover the money by selling that asset.

In the case of Bear Stearns, it is estimated that the size of its purchases outnumbered its actual assets by a ratio of 28-to 1, meaning that it bought securities for 28 times the value of the actual cash it put into the purchase. The balance was borrowed. Usually these banks sell these highly leveraged securities long before the loan is due to be repaid and thus are able to repay the debt. But in this case, nobody wants to buy their securities. When the bills came due, the banks could not sell and thus had no money, which is why the bank had a liquidity crisis. When the Fed came to the rescue by guaranteeing these securities, it was essentially saying that they would pay up if the value of the securities did not rise again and creditors came for their money.

Hanging over everyone is the uncertainty. How many other big banks are holding on to how much mortgage backed securities? How much did they leverage? How far is the Federal Reserve willing to go in using taxpayer money to prop up these banks?

On Monday the biggest commercial bank in Cleveland, National City Bank, lost 43% of its value in one day, fueled by suspicions that it was holding a large amount of now worthless mortgage-backed securities. Before 1999, commercial banks were restricted by the Glass-Steagall Act from taking the kinds of risks that investment banks take, because the government insured the deposits of those banks and did not want to underwrite excessive risk taking. That act was passed in 1933 in the wake of the Great Depression because banks had been making highly speculative investments and thus caused the crash. But in 1999 Congress and Bill Clinton removed that barrier and now the rot that has infected the investment banks has spread into the commercial banking sector also.

As the days go by, watch for more volatility, fueled by rumors.

POST SCRIPT: The God Delusion Index

Answer this series of questions and calculate the extent of your own God Delusion.

Comments

  1. A Nonny Mouse says

    Minor quibbles only, but:
    1) The estate tax, while perhaps not just symbolic, does affect only a tiny minority of people.

    2) In your discussion of leverage by investment banks and the comparison to homes, you hit a (meaningless) pet peeve of mine. I prefer to see that compared numbers are expressed in the same method for quick review. As such, 28:1 leverage by investment banks would be compared against 9:1 or 4:1 for 10% and 20% down on mortgages, respectively. Personally I’d say the bigger problem with those investment banks in this comparison is the pretense of knowledge of underlying asset value. A home and land’s value is very unlikely to drop to zero, though a particular stock equity or financial obligation / contract might.

    While one might quibble that the pool of assets would not then be zero, I’d answer that the premium loss of any significant number of assets losing value makes the colletive pool far less valuable to the investors who are their target market.

  2. says

    Buying house is not easy task, it involves lot of thinking and reasoning should be done before buying a house. The first decision one should take is whether to buy a house or rent it owning a house gives a sense of pride and we can furnish according to our choice.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>