Go, Economy!

[Seik]

That was all really interesting info Gooch. Sincerely. I feel ashamed I don't know more about that kind of stuff, but then I look around and see that nobody really does.

[Razor Ramon]

Finance has become a huge beast that most people only have a small grasp on. That's like expecting everyone to know business laws when you just work in a mail room.

[Gooch]

Assume for a moment you invent a magical printing press. Your machine can print hundred dollar bills so good that the US Treasury cannot distinguish them them from the real thing. The bills are perfect in every way. Now assume you print $5 trillion worth of those bills and bury them in your back yard. Is this inflation? Surely not. Would it be inflation if $5 trillion in bills were spent and entered the economy? You bet. The key then is not how much the Fed prints, the key is how much of that money makes its way into the economy.

Please consider this audio with Austrian Economist Frank Shostak on Mises on September 30, 2008 discussing recent actions by the Fed.


"Will this printing create [price] inflation? This is dependent very much on what money will do next. If banks will not lend and banks sit on that cash forever and ever like the great depression because the risk is too high and the banks do not know if the lending will end up in good assets or bad assets, and because banks are in so many bad assets now they probably will not lend at all.

That is the observation that Murray Rothbard made, that during the Great Depression that banks have chosen not to lend because the risk of accumulating bad assets was far too high. So they were sitting on massive reserves. That is what is developing right now.

A good example is what happened in Japan in 2001-2002 where the Bank of Japan pumped 300% at one stage and lending continued to collapse. I expect similar things to happen here. If lending will not increase we can conclude this will not be inflationary."

I agree whole heartedly with Shostak and suggest we are following the Japanese model. This has been my thesis for years.

[Gooch]

That was all really interesting info Gooch. Sincerely. I feel ashamed I don't know more about that kind of stuff, but then I look around and see that nobody really does.

Very few people do and consequently very few people see the Fed's and the Government's actions as being pro-bank. The Fed Reserve was created by the wealthy (JP Morgan included) and it should be seen more as a cartel than anything. And what does a cartel do? It protects the interests of its members.

[Advocate]

Okay Gooch. Time to make a REAL thread and teach us Economics or LINK US to those blogs you are getting this from. Damn this shit is awesome.

[kingoffighters]

Gooch is the TNL financial meister. Time to legendize him.

[Advocate]

I think that's what he does for a living. Other than getting tickets to MMA fights in Chicago.

[Gooch]

I'd post the links but then less people would read them. It's human nature to be lazy so I'd rather quote the posts. If you want, however, just PM me.

I'll attempt to go piece-by-piece:

Even general news accounts presuppose an understanding of terms like “securitization,” “CDO,” and writedown.” So I thought I would provide my own translation.

Historically local banks took deposits from savings account customers and lent money to homebuyers. They paid 1% for the savings accounts and collected 6% on the mortgages, and the spread (5 percentage points in this case) was more than enough to compensate for any homebuyers who couldn’t pay their mortgages. (The numbers are illustrative only.)

Then, as any explanation of the subprime crisis says, banks started reselling and securitizing mortgages. But what does it mean to resell (let alone securitize) a mortgage?

To understand this, you have to look at it from the bank’s point of view. To them, a mortgage is a product. This product gives them a monthly stream of payments - about $1,000 per month for a 30-year, fixed-rate mortgage on a loan amount of $150,000 (numbers are very approximate), but that stream is not guaranteed; the homebuyer might not be able to pay (in which case they might have to renegotiate or foreclose, both of which are costly), or might pay the whole thing early. The price they pay for this product (this stream of payments) is just the loan amount; from their perspective, they are “buying” the stream of payments by paying you the loan amount. The lower the interest rate you get, the higher the price they are paying for your payments.

If Bank A resells your mortgage to Bank B, Bank B buys your payment stream from Bank A in exchange for a lump sum of money. Under stable market conditions, the lump sum that B gives A will be about the same as the lump sum you received from A (in which case A only makes money from various fees). You can also think of this as Bank B loaning you the money for your house, with Bank A acting as an intermediary.

Now, in practice, Bank B (or C, or D, …) is often an investment bank. And Bank B often securitizes your mortgage. This means they take your mortgage and combine it with many (thousands of) similar mortgages. If the mortgages are similar according to certain objective criteria - creditworthiness of borrowers, loan-to-value ratios, etc. - they can be treated as homogeneous. (Something similar happened with corn in the 19th century; certain standards were established for different grades of corn, and from that point bushels of corn from different farms didn’t have to be separately shipped and inspected by buyers, but could be poured together into huge vats.) Now you have a pool of, say, 10,000 mortgages, with about $10 million in payments coming in from borrowers every month. That pool as a whole has a price - the amount someone would pay to get all of those payment streams of that riskiness. In a securitization, the investment bank divides the pool up into many small slices - say 1,000 in this case. Each slice can be bought and sold separately, and each slice entitles the buyer to 1/1,000th of the payments streaming into that pool.

The price of these slices is based on current assumptions about the riskiness of those payments - the riskier those payments are perceived to be, the lower the price anyone will pay for a slice of them. The problem is that at the time those mortgages were securitized, the buyers assumed that housing prices could only go up, and therefore the payments were not very risky; when housing prices began to fall, many more borrowers became delinquent than had been expected. As a result, if you own a slice of that pool, you still own 1/1,000th of the payments coming in, but your expectations of how many payments will come in are much lower than they were when you bought the slice.

(A collaterized debt obligation is a securitization where the slices are not created equal. Some slices are entitled to the first payments that come in each month, and hence are the safest; some slices only get the last payments that come in each month, so when people start defaulting, those are the slides that lose money first.)

This brings us to writedowns and, eventually, to the subject of banking capital. Let’s say you are an investment bank and you paid $1 million for a slice of a securities offering (a pool). You put that on your books as an asset (in the world of finance, a stream of payments coming to you is an asset) valued at $1 million. However, a year later, that slice is only worth $200,000 (you know this because other people selling similar slices of similar pools are only getting 20 cents on the dollar). You generally have to mark your holding to market (account for its current market value), which means now that asset is valued at $200,000 on your balance sheet. This is an $800,000 writedown, and it counts as a loss on your income (profit and loss) statement. And that is what has been going on over the last year, to the tune of over $100 billion at publicly traded banks alone.

The next problem is that, over the last two decades, most of our banks have become giant proprietary trading rooms, meaning that they buy and sell securities for profit. Let’s say you start a bank with $10 million of your own money. That’s your “capital.” You go out and borrow $90 million from other people, typically by selling bonds, which are promises to pay back the money at some interest rate. Then you take the $100 million and buy some stuff (like slices of mortgage pools), which pays you a higher interest rate than you are paying on your bonds. Suddenly you are making money hand over fist. But then let’s say that housing prices start falling, securitized subprime mortgages start plummeting in value, and your $100 million in assets are now only worth $80 million. Since the value of your debt ($90 million) hasn’t changed, you are technically insolvent at this point, because your losses exceed your capital; put another way, the money coming in from your slices of mortgage pools isn’t enough to pay your bondholders.

According to some observers, this is where Fannie and Freddie were until they were bailed out by the U.S. government; by certain accounting rules, they had negative capital.

When you make a deposit in a bank, you are essentially buying a bond (cash flow stream of interest payments, with eventual principal collection). The bank is doing the same when it makes you a loan. Many banks then sold off those loans for a fee (their profit) thus ridding them of the credit risk associated with the borrower.

[Melf]

So....

- the government here is about to lay off 40,00 workers.
- the government's bond rating is about to be degraded to the lowest possible level.
- PR has a 1.2 billion dollar deficit (it has a $9 billion budget)
- the unemployment rate here (pre-mass lay off) is at 13.7%

GO ECONOMY!

[Gooch]

RUH-ROH!

Feb. 28 (Bloomberg) -- Warren Buffett’s Berkshire Hathaway Inc. posted a fifth-straight profit drop, the longest streak of quarterly declines in at least 17 years, on losses from derivative bets tied to stock markets.

Fourth-quarter net income fell 96 percent to $117 million, or $76 a share, from $2.95 billion, or $1,904 a share, in the same period a year earlier, the Omaha, Nebraska-based firm said in its annual report. Book value per share, a measure of assets minus liabilities that Buffett highlights in his yearly letter to shareholders, slipped 9.6 percent for all of 2008, the worst performance since Buffett took control in 1965.

“The credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country” at the end of 2008, Buffett in his letter to shareholders today. “A freefall in business activity ensued, accelerating at a pace that I have never before witnessed.”

Berkshire, where Buffett serves as chairman, chief executive officer and head of investing, suffered as the benchmark Standard & Poor’s 500 Index turned in its worst year since 1937. Liabilities on derivatives linked to world equity markets widened by 49 percent to $10 billion in the three months ended Dec. 31, though the contracts don’t require Berkshire to pay out until at least 2019, if at all.

Berkshire shares have fallen 44 percent in the past year as the value of the firm’s top equity holdings dropped and losses increased on the derivatives. Nineteen of the top 20 stocks in Berkshire’s U.S. portfolio declined last year.

‘Major Mistake’

Coca-Cola Co., Berkshire’s top holding, dropped 26 percent. American Express Co. plunged 64 percent. Oil producer ConocoPhillips fell 41 percent, and Buffett said in his shareholder letter that he made a “major mistake” in buying shares when oil and gas prices were near their peak.