The Economic Crisis Explained
What happened?
The news says poor people buying houses and corrupt politicians caused the financial crisis. The news is wrong.
I wrote this mainly for srhadden, but I hope most of you will read it.
What really happened?
America has a lot of debt. There are three kinda of debt. Private debt, which is what you owe on your credit cards/car/house/student loans. Public debt, which the government owes (which is to say you pay for it). Corporate debt, which corporations owe.
Lending and borrowing have to match. Savings and debt have to match. The only way around that is to commit fraud. (Fraud was rampant in the Enron and S&L scandals, but fraud wasn't the big problem this time.)
Since the Eighties the government, corporations, and citizens have all been borrowing a lot and saving very little. This is a problem.
American has a lot of debt. The people we owe money to figured out that we probably couldn't pay it back. Everybody panicked.
Is my bank broke (insolvent)?
I don't know. The sad truth is your bank probably doesn't know either. The best guess is a statistic called the Texas Ratio. If your bank's Texas Ratio is greater than 50, then you should move your money to another bank. Here's a lsit.
How much debt is there?
This chart shows the public debt as a percentage of GDP. Think of it like you credit card bills as a percentage of your pay check.
This chart shows all debt (public, private, and corporate).
If you were a credit card company and your customer's owed you 3.2 times as much as they make, would you panic?
Also notice, that private and corporate debt are 2.5 times GDP, which is a lot more than public debt.
Ok, the debt has to balance, so where did the savings come from?
We exported out debt to other countries, like China.
What is the deal with China?
China sells us stuff. We pay them in dollars. But they don't want to buy American stuff with those dollars. Instead, China loans America the dollars to buy more Chinese stuff.
Does this sound like a bad idea? For 25 years, the President's Council of Economic Advisers have said this is good policy.
I heard that nobody knows what is going on. I also heard that some guy totally predicted all this. What gives?
Truth be told, it was pretty obvious that this was going to happen.
Here is a small list of people who predicted the collapse:
When the Glass-Stegall Act was repealed in 1999 Senator Byron L. Dorgan said, "I think we will look back in 10 years' time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930's is true in 2010...I wasn't around during the 1930's for the debate over Glass-Steagall. But I was here in the early 1980's when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness."
And going waaay back:
Adam Smith said "[A house] contributes nothing to the revenue of its inhabitant...If [the house is rented]... the tenant must always pay the rent out of some other revenue...the revenue of the whole body of the people can never be in the smallest degree increased by [a housing boom]."
Karl Marx said, "Owners of capital will stimulate working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism."
If this is a depression, how come there aren't dust bowls and soup lines?
There are, but because of globalization, the dust bowls and soup lines are in other countries. I am no expert on the rest of the world, but from what I can tell, the economies of Iceland and Spain have collapsed. Italy and Greece are close. China is laying off millions of people every month.
What is with the bailout?
The goal is to capitalize banks.
Banks all borrow from each other. For the most part, it's big banks borrowing from small banks. Typically, big banks can afford more risk--their size allows them to spread the risk around and mix several losses with lots of wins. When things started collapsing, the banks stopped lending to each other. The solvent (not broke) banks wanted to stay liquid (hold on to cash). The insolvent banks didn't have cash to lend. Credit between banks froze and this spread across all the financial industry.
Can you explain that again, with more conspiracy?
Big financial institutions have bough off congress and the president, and they are using the crisis to launder stolen taxpayer money.
The Treasury loans $1 to Bank A at 1% interest. Bank A writes the Treasury a warrant for $.67. So Bank A got $.33 for free. Now Bank A can loan the money to another bank at 4-6% interest, a consumer at 8-20% interest, or Bank A can pay off a creditor.
Here is where it gets interesting, Bank A can pay off it's creditors and then declare bankruptcy. In this case, the creditors have been paid in taxpayer money for bad debts written by the bank and the public get absolutely not benefit from it. Awesome huh!?
It get's worse. Now the banks will sell the bad mortgages to hedge funds. The federal government will pay half the cost. And if the mortgage is non-performing (a bad mortgage) then the government will absorb all the losses.
When you consider the alternatives (investing in American industry, income tax refunds, extending unemployment benefits, national health care, grants for higher education) it seems really hard to believe that congress and the president are not thoroughly corrupt. Though, there is some reason to believe this is all a brilliant strategy, but that is a long story for another post.
Is the Federal Reserve to blame?
Somewhat. The Federal Reserve kept interest rates low when they should have raised them. This made loans easy to get. So bad loans were written. They should have known better.
On the other hand, the banking system almost melted down in September and the Federal Reserve was 90% responsible for stopping that. Had the Federal Reserve not taken the actions it did, the finical crisis would be a super depression. You would have lost all the money except the cash in your pocket, which wouldn't be worth anything anyway. Your boss wouldn't have any money to pay you, so you would lose your job. Your utilities would have been shut off. The US government would have collapsed, along with all of Europe and much of Asia. Cats and dog living together, etc.
Ok, now what?
It looks like the downward slide is slowing. The TED Spread is about where it was a year ago. The Baltic Dry Index is climbing. Inflation is erratic, but basically not yet a concern (1 dollar = 100 yen or .75 euros). We may be in a recovery as soon as fall, but housing prices have to fall another 30% and the banks may be much worse off than we are lead to believe.
Nobody in government is pushing to reinstate Glass-Stegall or seriously limit derivatives. It may be too soon to fix these problems. George Soros said, "What you have to do in the short run is the opposite of what you have to do in the long run. You get control of a skid by turning into it." But I am worried that corporate and political leadership have no intention to fix this ever. In which case, we will be back in this mess in 5 to 10 years.
So far, we have followed the same path that Japan did when it's stock and real estate bubbles collapsed. Japan's recovery came after a Lost Decade.
The news says poor people buying houses and corrupt politicians caused the financial crisis. The news is wrong.
I wrote this mainly for srhadden, but I hope most of you will read it.
What really happened?
America has a lot of debt. There are three kinda of debt. Private debt, which is what you owe on your credit cards/car/house/student loans. Public debt, which the government owes (which is to say you pay for it). Corporate debt, which corporations owe.
Lending and borrowing have to match. Savings and debt have to match. The only way around that is to commit fraud. (Fraud was rampant in the Enron and S&L scandals, but fraud wasn't the big problem this time.)
Since the Eighties the government, corporations, and citizens have all been borrowing a lot and saving very little. This is a problem.
American has a lot of debt. The people we owe money to figured out that we probably couldn't pay it back. Everybody panicked.
Is my bank broke (insolvent)?
I don't know. The sad truth is your bank probably doesn't know either. The best guess is a statistic called the Texas Ratio. If your bank's Texas Ratio is greater than 50, then you should move your money to another bank. Here's a lsit.
How much debt is there?
This chart shows the public debt as a percentage of GDP. Think of it like you credit card bills as a percentage of your pay check.
This chart shows all debt (public, private, and corporate).
If you were a credit card company and your customer's owed you 3.2 times as much as they make, would you panic?
Also notice, that private and corporate debt are 2.5 times GDP, which is a lot more than public debt.
Ok, the debt has to balance, so where did the savings come from?
We exported out debt to other countries, like China.
What is the deal with China?
China sells us stuff. We pay them in dollars. But they don't want to buy American stuff with those dollars. Instead, China loans America the dollars to buy more Chinese stuff.
Does this sound like a bad idea? For 25 years, the President's Council of Economic Advisers have said this is good policy.
I heard that nobody knows what is going on. I also heard that some guy totally predicted all this. What gives?
Truth be told, it was pretty obvious that this was going to happen.
Here is a small list of people who predicted the collapse:
- George Soros
- Peter Schiff
- Warren Buffet
- Paul Volcker
- Nassim Taleb
- Nouriel Roubini
- Nikolai Kondratiev
- Ron Paul
When the Glass-Stegall Act was repealed in 1999 Senator Byron L. Dorgan said, "I think we will look back in 10 years' time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930's is true in 2010...I wasn't around during the 1930's for the debate over Glass-Steagall. But I was here in the early 1980's when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness."
And going waaay back:
Adam Smith said "[A house] contributes nothing to the revenue of its inhabitant...If [the house is rented]... the tenant must always pay the rent out of some other revenue...the revenue of the whole body of the people can never be in the smallest degree increased by [a housing boom]."
Karl Marx said, "Owners of capital will stimulate working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism."
If this is a depression, how come there aren't dust bowls and soup lines?
There are, but because of globalization, the dust bowls and soup lines are in other countries. I am no expert on the rest of the world, but from what I can tell, the economies of Iceland and Spain have collapsed. Italy and Greece are close. China is laying off millions of people every month.
What is with the bailout?
The goal is to capitalize banks.
Banks all borrow from each other. For the most part, it's big banks borrowing from small banks. Typically, big banks can afford more risk--their size allows them to spread the risk around and mix several losses with lots of wins. When things started collapsing, the banks stopped lending to each other. The solvent (not broke) banks wanted to stay liquid (hold on to cash). The insolvent banks didn't have cash to lend. Credit between banks froze and this spread across all the financial industry.
Can you explain that again, with more conspiracy?
Big financial institutions have bough off congress and the president, and they are using the crisis to launder stolen taxpayer money.
The Treasury loans $1 to Bank A at 1% interest. Bank A writes the Treasury a warrant for $.67. So Bank A got $.33 for free. Now Bank A can loan the money to another bank at 4-6% interest, a consumer at 8-20% interest, or Bank A can pay off a creditor.
Here is where it gets interesting, Bank A can pay off it's creditors and then declare bankruptcy. In this case, the creditors have been paid in taxpayer money for bad debts written by the bank and the public get absolutely not benefit from it. Awesome huh!?
It get's worse. Now the banks will sell the bad mortgages to hedge funds. The federal government will pay half the cost. And if the mortgage is non-performing (a bad mortgage) then the government will absorb all the losses.
When you consider the alternatives (investing in American industry, income tax refunds, extending unemployment benefits, national health care, grants for higher education) it seems really hard to believe that congress and the president are not thoroughly corrupt. Though, there is some reason to believe this is all a brilliant strategy, but that is a long story for another post.
Is the Federal Reserve to blame?
Somewhat. The Federal Reserve kept interest rates low when they should have raised them. This made loans easy to get. So bad loans were written. They should have known better.
On the other hand, the banking system almost melted down in September and the Federal Reserve was 90% responsible for stopping that. Had the Federal Reserve not taken the actions it did, the finical crisis would be a super depression. You would have lost all the money except the cash in your pocket, which wouldn't be worth anything anyway. Your boss wouldn't have any money to pay you, so you would lose your job. Your utilities would have been shut off. The US government would have collapsed, along with all of Europe and much of Asia. Cats and dog living together, etc.
Ok, now what?
It looks like the downward slide is slowing. The TED Spread is about where it was a year ago. The Baltic Dry Index is climbing. Inflation is erratic, but basically not yet a concern (1 dollar = 100 yen or .75 euros). We may be in a recovery as soon as fall, but housing prices have to fall another 30% and the banks may be much worse off than we are lead to believe.
Nobody in government is pushing to reinstate Glass-Stegall or seriously limit derivatives. It may be too soon to fix these problems. George Soros said, "What you have to do in the short run is the opposite of what you have to do in the long run. You get control of a skid by turning into it." But I am worried that corporate and political leadership have no intention to fix this ever. In which case, we will be back in this mess in 5 to 10 years.
So far, we have followed the same path that Japan did when it's stock and real estate bubbles collapsed. Japan's recovery came after a Lost Decade.