The Secret Villain Behind Our Economic Collapse 30 comments
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"EMBARRASSING"
That's the word our Treasury Secretary used to describe how he felt begging Congress for money to bail out America. Around him were seated our Federal Reserve Chairman and our Securities & Exchange Commission Chairman.
And that's what happened in front of the camera. Behind the scenes, God knows how many foreign governments we've gone begging to. Don't sell our paper to us and hit the market. Please. Please. Please. Okay, we'll agree to include you in the bailout and buy it back from you.
Paulson had it right. Embarrassing.
Lot's of folks are looking for people to blame. People on the left want to blame Republicans. People on the right want to blame Democrats. Even reasonable, normally level-headed people feel that their government has let them down.
Our government is a Republic. The premise is that we elect "responsible" people who won't be swayed by a "mob mentality" to guide the rest of us who can be swayed in our feelings from day to day. That's why many folks are upset and are blaming government. The people we put in charge of taking care of us were asleep on the job.
Fair enough...
But whether you have a Republican government like ours, a pure citizen democracy, a king, or a dictatorship they all have one thing in common - they are all run by humans. One, few or many.
And there is one thing we as investors must never forget about human nature - at certain times, it is prone to excessive optimism. At other times it is prone to excessive pessimism.
So let other people point fingers and look for people to blame. As investors we must know that being mad at humans for being human would be like being mad at two people for falling in love. Or like being mad at myself for having dark hair. It was a bull market of the greatest magnitude, and many folks got caught up in it. It's our nature to do this and every once in a while it happens in excess.
And unless human nature itself changes, you can bet it will happen again. And as investors we can't afford to be angry about it or we won't be able to profit from it.
Let's study it together...
I think what made this bubble more powerful than most was the sheer magnitude of the people who benefited from it. In my judgment, that made the positive, reinforcing feedback loop much more powerful than the "dot com" bubble.
Rising home prices made existing homeowners very happy. They were able to take home equity loans which made the credit card and home improvement and restaurant companies happy.
New homeowners were happy because they were able to afford new homes. That made Congress happy because constituents would send in letters thanking them for creating legislation that helped Jack and Diane get their "dream home." And of course builders were really happy because they were able to charge high prices and sell a lot of homes at the same time.
Wall Street was happy because they had something to sell to fund managers starving for yield. Subprime bonds are GREAT in a low interest environment. And that meant a lot of fees and big bonuses for Wall Street. And the fund managers were thrilled because they were never quite sure how they were going to fulfill their retirement obligations to millions of baby boomers in the first place. But getting higher yields is a good place to start, so why not invest in private equity!
Insurance companies were happy because that tired industry finally had some growth. At 83 years old, Maurice "Hank" Greenberg has a stronger pulse than AIG (AIG), so let's give it some growth. We can write a policy covering the trade between Lehman Bros. (LEH) and Merrill Lynch (MER) because "they ain't going anywhere."
Even the village idiot got in on the act. He went from flipping burgers to flipping houses in two years and was well on his way to becoming the next Harry Helmsley. And that made television producers happy because if the village idiot could do it anyone could do it, and that makes for great TV.
The home improvement business was happy which made shareholders of all these companies happy because of rising stock prices. And of course government on every level was happy because big tax revenues means money to improve schools and roads.
The list goes on and on and on and on...
That's a lot of "shiny happy people." Thrilled actually. Who wants to turn off the music and shut down the bar when the party is raging? The few people who did sound the alarm sounded like party poopers. Who cares if the neighbors are complaining about the noise? Tell 'em to loosen up and join the party!
(Antiquated Regulation Strong Economic Growth Excess Liquidity = Excessive Optimism squared (or credit/asset bubble))
This ecstasy feedback loop was particularly powerful because people weren't just making money. They were underwriting "the American Dream". Isn't that what it's all about? In that way, this bubble was stronger than the "dot com" bubble or the Tulip bubble. It was almost as powerful as a gravitational black hole. Every person who felt it paid it forward, and every person who received it felt good about themselves (wouldn't it be nice to get thank you letters from first-time homeowners thanking you for making their dream possible?) and paid it forward twice as much. Once you get sucked in, you're in.
And like all bubbles, this one had an official mascot, a single reference highlighting the level of absurdity. Whereas the "dot com" bubble had the "sock puppet," the credit bubble had the "no income mortgage."
And like all bubbles this one had an official peak. It's the corporate version of an overdose. When a company does something so dumb that it shocks the other drunk party goers. I'm talking total destruction of shareholder value. In 2001 it was AOL buying Time Warner (TWX). This time it was Wachovia Bank (WB) buying Golden West Financial. Wachovia was like the guy at the party who gets taken away by the ambulance - you know he won't ever be the same.
Paulson was right to be embarrassed on behalf of the American people. We lost our cool. We couldn't handle our buzz. We didn't know when to stop. The cops had to break up our party.
But I have a feeling this is going to be good for us. What makes America great is our incredible ability to self-correct. That's really our secret sauce. We know when we have to change course. Clean up. Get our act together.
We will analyze these problems honestly and openly. And after much self-reflection, we'll improve. We will come out of this with better regulation and a much stronger and stable capital markets system. We will come out of this with more fiscal discipline.
But most importantly, we will come out of this remembering how good we've had it and how close we came to losing it. Sometimes liver disease is the only way to get someone to sober up.
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Nobody saves anymore. It's all MINE MINE MINE! NOW NOW NOW! GIMME GIMME GIMME! Nobody wanted to hear "save 10% of the home's down payment" or "flipping condos is no different than flipping POS.com on its IPO day" or "the balloon payment can't hurt me!" Our country sold its soul to an easy fast buck in this real estate bubble and now nobody wants to take any blame or responsibility.
May Providence protect drunkards, fools and the United States of America.
"Even the village idiot got in on the act. He went from flipping burgers to flipping houses"
Nostradamus predicted that in the year 2000 the Village Idiot would be elected President. Some people claim that prediction came true.
President Bush has publicly boasted that he was a C grade student. When voters elect a C grade student to be President one can only expect F grade as the result for the nation. It is a pity that this nation has so many Scientists, Engineers , Nobel Laureates but they have close to zero representation in the Congress/Senate. Instead we have lawyers and financial types running this country and ruining it for future generations.
What else can you blame Bush for before he leaves office? Pile on. It will make you feel good.
You know less than one third of iceberg remains above water. current problem is like that.
Every one is talking about the problem above the surface. I think very have addressed the root of the problem. What is the epic center of this financial earthquake?
Grreedy financial people tried to squeeze the people who were already squeezed in to low income group, without even thinking what will happen if more than a few fails to pay their installment. More than a few failed and other who are not deserved joined them downhill game.
Basic problem is going to get worst. There will be to classes, rich and poor. Income per capita will go down and lots of people will not be able to afford the sweet home for the current price. Even the funds and investors will be reduced and more gamblers will be out.
Our economy is based on medium and low income people and the fate of the economy will be the fate of this people.
It's the bed you made, America...now lie in it.
I think Paulson's "embarrassment" is rather shallow...
Last summer, we all remember Paulson's assurances that the upheaval in the Financials (he refused to admit to a crisis) was limited to the subprime and was and would continue to be contained.
We now know that this was false.
Now, it's very had for me to believe that the Secretary of the Treasury of the United States had such a dismally poor grasp of what was really going on, and the true depth of the problem.
If in fact Paulson did not know, then he has no business being the Secretary of the Treasury.
If in fact he did know, then he was guilty of lying to Congress and all Americans.
Either way, Paulson and Bernanke have lost the confidence of the American people, and have betrayed their trust.
It is time for them to go.
It is silly and ridiculous to expect those who were, at least in part, the architects of the current financial disaster to play key roles in the rescue and reconstruction. As Kevin Phillips remarked, the arsonists now want to be applauded as firemen!
ROCJ - you say china has done well. the history of china for 2300 yrs has been continuous civil war. the only surviving institution in china has been the family unit..
> jack
NOT TRUE. Some of us millions, in fact, were working hard, saving money, taking care of our families, buying homes we could afford, investing wisely and we thought we were doing the right thing. Now, the drunks are sobering up and they want US to pay for their stupid party. I'm not mad, I'm furious.
Worse, the scoundrels who got and kept jobs that paid multi-million dollar salaries, plus bonuses, and drove their companies into insolvency either get golden parachutes or get to keep the jobs they proved they were unable to do.
I, and millions of responsible Americans like me want payback. We want the overpaid idiots that ran their companies into the ground fired or jailed. We want them to pay back their undeserved bonuses into the bailout fund. And we want them barred from ever again working in any financial institution at any job higher than janitor.
Hank Paulson was running Goldman when they changed course . He took them toward the edge and the competition followed. Under his leadership, the entire financial industry went from mostly responsible to casino gambling. Putting Paulson in charge of the bailout is like making the arsonist Fire Chief.
Personally, I'd like to see the government sieze all the assets of the financial companies' officers and directors and use that as the bailout fund to start. Instead, they will sieze the assets (taxes) of people like me and the millions of other responsible Americans and give it to the folks who created the mess in the first place.
This is the opposite of Robin Hood.
In this case, the experiment was that low income and middle class income people who ordinarily would not have the opportunity to own a home perhaps through risk management (CDS's, etc.) can have that opportunity. For a time it worked because most of the folks who were subprimers paid their mortgage. Then the defaults started growing which were mainly the people who abused the system with multiple homes they couldn't afford and couldn't flip fast enough and the rent would not pay the mortgage.
The experiment was a good one and hopefully we don't throw out the baby with the bathwater. The problem was that greed got the better of the loan originators and the flippers and everyone up the chain to the loan bundlers who pedaled these exotic mortgage instruments on wall st.
The problem now is trying to see how to fix the system. My sense is that although these exotic packages became toxic, it was the fact that there was no institutionalized market for determining the value as distressed as it may be that was the culprit in caiuse log-jams that froze up liquidity. So IMHO, the cure is to create a CDS or similar type Derivative Instrument Exchange specializing in trading these exotic products so the means of valuing them is institututionized and there is always a market regardless if the instruments are in or out of favor.
As a starter, although it's being called a government bailout, in essence what the government is doing in buying up these troubled assets to unclog the system is setting up an exchange mechanism which it is funding as the first buyer. If seen in this light, others perhaps will see that buying these distressed assets at ridiculously cheap prices will be a good investment and a few years down the road can return 100% or more.
You'v taken the words right outa my head. Your right , don't blame all of us and i don't want to pay for a damned scheme i didn't participate in . Let the bare ass dancers pay.
Well written so i will quit for now.
"Worse, the scoundrels who got and kept jobs that paid multi-million dollar salaries, plus bonuses, and drove their companies into insolvency either get golden parachutes or get to keep the jobs they proved they were unable to do."
That's just envy talking there. The fact of the matter is that business has a job to seek profits. Its not in the business of social engineering. There's no doubt about it, the root of this current crisis is in social engineering.
The real scoundrels who now appear to be getting off scot-free are those bumbling public servants that pursued a policy, actually an ideology, that incorporated governmental incentives and disincentives to see lower income class Americans rise up to a new middle class status. On its face it sounds wonderful, but the devil as always was in the details. In 1977, Pres. Carter signed the community reinvestment act which pushed Fannie and Freddie to aggressively lend to low income minority communities. In 1993, Pres. Clinton started feeding the CRA an ever-increasing diet of anabolic steroids. Through out his 8 years in office the Clinton Administration constantly rewrote the rules for Fannie Mae and Freddie Mac. In 1995, they made getting a satisfactory CRA rating much more difficult. A good CRA is critical for a bank that has any designs on expansion. With a good CRA rating banks received expedited approval procedures for opening new branches or banks could self-certify their compliance with the CRA and avoid routine examination. They could establish branches across state lines, or engage in new expanded powers, or enjoy a "safe harbor" from protests.Banks were given strict new numerical quotas and measures for the level of "diversity" in their loan portfolios. They actually started making loans based on race and little else. Bank examiners would use federal home-loan data, broken down by neighborhood, income group and race, to rate banks on performance. In 1997, Clinton got the Department of Housing and Urban Development to double-team the issue.
Clinton's HUD secretary, Andrew Cuomo, "made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis. Specific changes made to Fannie and Freddie included extraordinary leverage, allowing them to hold just 2.5% of capital to back their investments, vs. 10% for bank. The crowning blow was allowing Fannie and Freddie to get into the sub-prime loan business in a big way. All of this set the stage for what unfolded in the last 8 years. Congress could have stopped it. They knew what was going on. Instead, Fannie and Freddie lobbied Congress to the tune of $200 million over the last 10 years. Those same Congressmen who today say the problem was the lack of regulation and point their fingers at others, just happened to be those that blocked any reform bill or even talk about it. There are plenty of newspaper quotes from years past of guys like Barney Frank saying, "''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,' and "''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''
During another of the 17 different attempts to get reform Barney Frank called the president's suggestion for a strong, independent regulator of Fannie and Freddie as being "inane." Barney isn't the only guilty party. There's plenty of players both Democrat and Republican. But tagging scoundrel to those with the biggest payday is misguided, and evidence of an uninformed general public that is more likely to believe what their favorite politicians and the media spoon feed them, thus guaranteeing many repeats of this same misguided policy.
duude: you're confusing talent and expertise with luck and timing
just to shut up some of the media people, at least 18 million will be happy !!