Irrational Exuberance again...?

[Lost User]

Will do. I'll just have to wait a short while as I check if my account has been credited with this [^] . . . . . . . . . . . Nope it's not there. Perhaps they sent it somewhere else :(( Wasn't sent to you in error was it?

[Oakman]

Richard A. Abbott wrote:

Nope it's not there. Perhaps they sent it somewhere else

Unfortunately mail from HSBC is being returned by the post office. It seems they are so broke they were cutting out the imprinted postage on letters being sent to them and gluing them onto the outgoing mail.

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to global warming.

[Ed Gadziemski]

You're leaving the multiplier effect and leverage out of your analysis. When banks take deposits, they can lend multiples of the deposits depending on their reserve ratio. So $1 deposited can fund $5 in loans. That is the multiplier effect. If you loan me a dollar and I invest in inventory for my business that costs a dollar and sells for three, I can pay you back your dollar, keep one for myself, and pay my supplier his dollar. That is leverage. Both the multiplier effect and leverage increase the power of capital.

[Oakman]

Ed Gadziemski wrote:

When banks take deposits, they can lend multiples of the deposits depending on their reserve ratio. So $1 deposited can fund $5 in loans

Actually I thought about mentioning that Oakman Savings and Loan could lend out $10 for every $1 that the Federal Reserve magicked into our account. But that just makes it worse, doesn't it? Oak is then loaning out 10 funny money for every 1 funny money he has. It looks good on paper, it feels good to Oak and to the people he's loaned all that money to . . . but Funny Money or not, they lost their job when Lehman Bros went belly up so they can't pay it back and they don't want to because now that Oak has come to his senses and isn't loaning out money for "liar's mortgages" nobody wants to buy their house and it's value has been cut in half. So Good Ol' Oak discovers that he lent out 50 million (based on the five mil he has on the books) and now he can foreclose on the houses he let people buy that, in aggregate, might be worth 25 million. When he announces that little factoid, his bank's stock emulates a rocket sled heading straight down and that starts a run on the bank and he's only kept one mil in cash on hand. . . :omg: So he tries to borrow money from other banks, but even though Bank of America can get dollars from the Fed at o% interest, they aren't as crazy as they used to be and they won't loan Oak any money, he's a fracking lousy credit risk! Then Congress sends him a subpoena. Seems they want to know about that corporate Concorde he bought. . . And the bill comes due. The one for his new Glock.

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to global warming.

[Ed Gadziemski]

Oakman wrote:

So Good Ol' Oak discovers that he lent out 50 million (based on the five mil he has on the books) and now he can foreclose on the houses he let people buy that, in aggregate, might be worth 25 million.

If that were the only problem. It would be very easy to cure. The bigger problem is that Bank of America took Oak's mortgages and bundled them with 950 million in other mortgages and sold them as derivatives. Ed's Hedge Fund & Car Wash took out insurance in the form of credit default swaps in anticipation of BofA's derivatives tanking. When they didn't tank fast enough, Ed jiggered the stock price of BofA through short selling which affected BofA's ability to raise capital and caused the government to tighten BofA's reserve ratio which forced BofA to default on the derivatives and other obligations, which caused Uncle Sam to step in and start throwing real money at what is effectively funny money (CDOs and CDSs). And before you knew it, 30 trillion dollars of phony wealth was destroyed and the world entered meltdown.

[Oakman]

Ed Gadziemski wrote:

which caused Uncle Sam to step in and start throwing real money at what is effectively funny money (CDOs and CDSs).

Don't you mean more funny money at what is effectively funny money? You do put your finger on something I hadn't been thinking about. How much of the wealth that has disappeared in the last six months never really existed? When people start noticing that the king has no clothes, his clothes don't disapear, because they weren't ever there.

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to global warming.

[Lost User]

The next chapter ... (tongue in cheek reply) Good old Oak, being a excellent businessman and investor took out CDS with AIG with Oakman Savings and Loan as the reference entity for 5 years. As Oakman Savings and Loan's position worsens, Oakman Savings and Loan defaults on its debts and Good old Oak makes claim for payments from AIG and the CDS is completed and terminated. FDIC steps in to administer Oakman Savings and Loan with BoA buying Oakman Savings and Loan for a nominal sum. Oak is a happy bloke - he's got no more worries with Oakman Savings and Loan and has made himself a few dollars because of a wise purchase of CDS's, AIG have laid-off some of the value of the CDS with external banks in China and London. AIG have also received taxpayers subsidies to help meet this CDS payment, Bank of America have another acquisition to prop up but they are not too worried as the taxpayer are subsidizing their bad debts. Foreclosures are placed on hold whilst the POTUS finalizes the plans. Oak attend Congress and pleads the 5th Amendment and is dismissed and sent on his happy way with no further questions to answer.

[Oakman]

Richard A. Abbott wrote:

Oak attend Congress and pleads the 5th Amendment and is dismissed and sent on his happy way with no further questions to answer.

Until he realises that the fifty million he cleared from the CDS has been converted into the price of a few night's lodgings and meals at a medium priced hotel by Uncle Ben who has been sending funny money to all and sundry as fast as he can authorise the credits.

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to global warming.

[Ed Gadziemski]

Oakman wrote:

How much of the wealth that has disappeared in the last six months never really existed?

I'd guess 90%. Bernie Madoff wasn't the only one running a Ponzi scheme.

[Oakman]

Ed Gadziemski wrote:

I'd guess 90%

But then the questions simply becomes how much real capital was traded for the monopoly money, convinced they were making a good trade?

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to global warming.

[Ed Gadziemski]

Oakman wrote:

how much real capital was traded for the monopoly money, convinced they were making a good trade?

Good question. The total value of every single U.S. mortgage is $10.4 trillion. The real capital required to fund those U.S. mortgages was probably less than $3 trillion. The estimated total value of all financial "products" based on U.S. mortgages is $62 trillion, giving a multiplier of at least 20 and possibly more.

[Oakman]

Ed Gadziemski wrote:

The real capital required to fund those U.S. mortgages was probably less than $3 trillion.

Sure, but the builder and possibly the guy who financed him (although unlikely) used real capital during the construction phase. Those who did put down 10 - 20 - 30% are seeing their values drop just as fast as if they'd used a liar's loan.

Ed Gadziemski wrote:

The estimated total value of all financial "products" based on U.S. mortgages is $62 trillion, giving a multiplier of at least 20 and possibly more.

And we are supposed to fix this, how? Keep giving AIG money until it's paid off on all its bad bets? Get the banks to admit that they are not only broke, they owe so much money they can't see daylight? Have uncle Ben work his wizardry with Treasury notes until China realises that their vast supply of U.S. currency has been debased so much all they can buy one extra bowl of rice and a pair of chopsticks?

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to global warming.

[Ed Gadziemski]

Oakman wrote:

Get the banks to admit that they are not only broke, they owe so much money they can't see daylight?

That would be a good start. If you know anything about AA, the first step is admitting that you have a problem.

[73Zeppelin]

Oakman wrote:

And we are supposed to fix this, how? Keep giving AIG money until it's paid off on all its bad bets?

Temporary nationalization. Afterwards, returned to the private sector with mandatory scalable default insurance policies. The higher the leverage, the higher the premium the bank has to pay and in the case of default, payment goes to the SEC or gets injected into the market. We also need "fair" CEO compensation schemes that are tied strongly to company performance and the elimination of golden parachutes.

[Oakman]

73Zeppelin wrote:

Temporary nationalization. Afterwards, returned to the private sector with mandatory scalable default insurance policies. The higher the leverage, the higher the premium the bank has to pay and in the case of default, payment goes to the SEC or gets injected into the market.

Zep, with great respect - this sound like a bandaid, followed by classical fascism. Now fascism got a bad name because it was intertwined with racism (and Stan hates it because its other name is state socialism) but I am not trying to put your idea down via guilt by association. I guess I am asking the question: when does regulation become a defacto ownership - or at least partnership? If so, is that what we either want to do or need to do?

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to global warming.

[73Zeppelin]

I'm not trying to suggest nationalization as a remedy for lax regulation. I meant temporary nationalization to make sure that lending takes place and a return of the nationalized institution to the private sector once the economy has recovered. Stocks in most banks are incredibly devalued. Shareholders, who are in some sense part owners of the company, have lost large amounts of wealth as a result. It is in their interest that banks don't lend and instead hoarde capital. That is not what the market needs right now. Banks need to lend, but shareholders have every reason to not want banks to lend. The immediate problem then, is not so much regulation, as it is to get the economy back on track. After that happens, the discussion on regulation can take place. I don't expect there to be any consensus on regulation for quite some time. And besides, it worked for Sweden. The major obstacle for the U.S. is that, unlike Sweden, there are a larger number of distressed banks in the States - that puts even more of a burden on the government to nationalize banks. I can always take the cheap argument and ask: if dumping billions into the banks isn't working, why not at least try nationalizing one bank and see what happens?

[Lost User]

73Zeppelin wrote:

why not at least try nationalizing one bank and see what happens?

Weren't the dealers somewhat relieved that by the statement by the Fed's Chairman [^] of the no intentions for banks to be nationalized which had an immediate upwards effect at the Stock Exchanges. Is it not time to consider researching a new system as the current system is probably irrevocably broken. Scrapping it might be the kindest thing to do.

[73Zeppelin]

Richard A. Abbott wrote:

Weren't the dealers somewhat relieved that by the statement by the Fed's Chairman [^] of the no intentions for banks to be nationalized which had an immediate upwards effect at the Stock Exchanges.

Which is actually one of my arguments in favour of nationalization. If the sole aim of shareholders is to preserve their wealth by having banks hoard liquidity rather than lend, then we do indeed need to consider nationalization under the current economic climate. The DOW is currently at levels not seen since the 1990's. I don't think a small upswing in the market accurately reflects the current fundamentals of the economy.

Richard A. Abbott wrote:

Is it not time to consider researching a new system as the current system is probably irrevocably broken. Scrapping it might be the kindest thing to do.

I'm not convinced that the system is completely broken. I think that financial regulation simply needs to keep up with financial innovation. And, further to that, compensation schemes must be "fair", in the sense that there should be a downside risk for executives if company performance is poor. Under the current system, this is not true (i.e. golden parachutes, free options). This means that there must be appropriate levels of regulation along with appropriate levels of capital requirements. A complete redesign is, in my opinion, unnecessary.

[Oakman]

73Zeppelin wrote:

I meant temporary nationalization to make sure that lending takes place and a return of the nationalized institution to the private sector once the economy has recovered.

I did understand that. I guess the solution beg the question: If it works, why would we go back? (Maybe that's simply another way of asking the question you asked at the end of your post?)

73Zeppelin wrote:

Banks need to lend, but shareholders have every reason to not want banks to lend.

But this takes us back to: what banks are lending is funny money, created with a stroke of Bernake's magic pen. He, by the way, said this morning that there could come a day when no-one would want to buy America's 10 year notes. Of course the way he said it, it had nothing to do with his actions, only with Obama's budget. I keep coming back to my sneaking suspicion that banks have to have capital in order to lend capital - anything else is simply sleight of hand that makes people feel good - and is really more of the same type of behavior that got us into the mess we're in. I'm not saying that we don't need to keep people productive and I don't posit a return to the soup kitchens and breadlines of the thirties. But I am trying to understand why we are not talking about stimulating capital aquisition instead of "the economy." Is it just a dirty word these days? I keep thinking that banks will lend when: A. they have enough people loaning them money via bank accounts; B. When people who are credit worthy have enough capital to pledge some as collateral. Understand that, as near as I can tell, Obama's tax plans will not directly affect me, so I am not simply spouting off out of self-interest. Whether we suddenly return to trickle-down economics or put a bonnet on Uncle Sam and call him "nanny," should not make much of a difference to my lifestyle. It may be that until we start having currency based on something (and won't that changeover be fun!) be it gold, latinum (from StarTrek), energy, or production as you suggest, any and or every solution is simply playing the little dutch boy with a leakier and leakier dike. Do you have any suggested rweadings on the idea of production-backed currency?

Jon Smith & Wesson: The original point and click interface Algoraphobia: An exaggerated fear of the outside world rooted in the belief that one might spontaneously combust due to globa

[73Zeppelin]

Jon, I couldn't agree with you more. What you are addressing is a much deeper topic, whether you realize it or not (and I think you do realize it). The real issue is, indeed, fractional reserve banking. The current system of fiat money is not supported by anything and that is truly the source of not just the current problem, but other, deeper issues like the true causes of inflation. The problem with backing a currency with something like gold is that there isn't enough physical gold to go around. Furthermore, the value of gold is affected by supply, extraction costs, purity, etc.. etc... Even the kings of ancient history (e.g. Croesus) knew that diluting the metal content of coins was a nice way to manipulate the economy. So returning to Bretton Woods isn't an option. Do you receive emails if I send you a link from the "send email" thingy in the message window of CP? I'll send you a link, but it will contain things that hit a little too close to home for me if I post it in public here.