Are you changing your behavior in response to current events? - Page 5

Re: Are you changing your behavior in response to current events?

The bottom line is this:

(1) If you want to buy something and it costs more than you've got, you either save up and buy it or get a loan to cover the difference.

(2) For most folks, the only way they'll be able to buy property is through a loan.

(3) Taking out a loan is generally a safe thing to do, provided you meet several criteria:

(a) you have a secure income
(b) you can afford the size of repayments required and have factored in a safety margin so that if e.g. interest rates go up, you can still afford the repayments; in other words, don't have champagne tastes on a soda pop income
(c) you don't treat your proprty as a speculative investment; yes, houses generally increase in value over time, but in the medium and short term they can plummet in price

(4) Now I thought point a - c above were pretty self-evident, and indeed forty or so years ago, financial regulations in most countries made you stick to these rules. Quite simply, financial institutions wouldn't lend to people unless they'd demonstrated they were long term savers [e.g. my parents, both professional people in solid jobs, had to save with their building society for several years before they were granted an interview with the manager to discuss their getting a mortgage]. Plus, people weren't as obsessed with property back then.

(5) But that was then, and this is now. Several factors have wrecked this secure state of affairs:

(a) A world wide loss of prudence or removing of restrictive shackles (depending on your viewpoint) meant that credit became far easier to gain. Debt skyrocketed, but people were able to buy, buy, buy on the back of loans that would never have been granted under the old system.

(b) Even this system might have worked if it had been restricted to folks on sensible incomes. But when that market became saturated, the so called 'lemons' (people with low unreliable incomes) who'd previously been shunned by banks, were targetted. Quite simply, other than kids and the institutionalised, they were the only market left to exploit (and without growth, no more fat bonuses for the top bank executives).

(c) Do the math - the only way someone on a low unreliable income can get a loan is either by outright fraud or clever accountancy (some might argue the latter is the same as the former ).

(d) So all sorts of deals were thought up, and this led to a lot of very dodgy debtors and a further heating up of the housing market.

(e) Then those on decent incomes started to get aspirations for ever more expensive properties and they too started to invest way beyond their means on the expectation that they could make a financial killing.

(f) But this is all predicated on the assumption that a high enough proportion of the sub prime market would remain good debtors and that the richer debtors would be able to realise profits on the houses they'd bought. Of course neither came true. An uncomfortable proportion of the lemons proved to be bad debtors, and the richer debtors got screwed when the housing market cooled (that's the strange thing about increasing the price of houses - do it enough, and eventually nobody can afford to buy them). The banks were now stuck with an uncomfortably large percentage of debtors who could no longer pay their loans and furthermore, repossessing the properties served little function as the houses had plummetted in value making them practically worthless.

(6) When you reduce things to this simplistic a level, the main culprits become clear:

(a) those who decided to enter the sub-prime market. If anyone can explain why lending large sums of money to someone on a low insecure income makes financial sense, please tell me. If the motive had been philanthropic, there might have been a moral justification for this, but the motive seems to have been greed, pure and simple. For many, I suspect that the need for those bonuses just outweighed everything. Frankly, if you can't have a great lifestyle on 500k per year, you don't deserve that money in the first place, let alone bonuses.

(b) The debtors bear some responsibility as well. I accept that some of them probably got in way over their heads and in others, the promise of being able to afford a nice home may well have outweighed a nagging small voice of reason. But surely some of them saw what a huge risk they were taking?

(c) Our governments and financial authorities should have stepped in way sooner. I know there's a response of 'it's easy to be wise after the event' to this, but at least in the european media, there have been warnings of the precarious nature of the western economy for years.

Re: Are you changing your behavior in response to current events?

I hear what you're saying, but consider the following quotation:

That's from the last letter our family received from some Jewish relatives living in Berlin in the 1930s.

The fact is that although we should concentrate on what really matters (which generally has zilch to do with money) for the source of our feelings of comfort and wellbeing, we can't ignore large problems like this because inevitably things of this magnitude will affect us all.

Re: Are you changing your behavior in response to current events?

Here is another overly simplified question: If the market lost 1.2 trillion dollars yesterday, wouldn't have been cheaper for the market to have invested only 700 billion to fix the issue?

Re: Are you changing your behavior in response to current events?

The trouble now isn't easy credit - it is essentially NO credit. This will have enormous consequences if it isn't resolved. It is amazing to me how few people realize that they are in the line of fire. How hasty they are to say "let the banks suffer - muhahahaha!".

We've seen what can happen when a banking crisis is left to resolve itself almost 90 years ago. It wasn't pretty. (but hey - we sure stuck it to those 'fat cats' back then!)

The role of government is to maintain an orderly marketplace - from the creation of a common currency to the standards for banking. I think of their role as being sorta like traffic lights of the economy. You own the car - you buy the gas - you steer the wheel - but the lights prevent chaos at the intersection.

Right now traffic is stuck. Every driver is shouting out their window how frustrated they are with the other driver - but traffic is not moving - it is backing up and affecting more people every day.

Some people watching on TV say it is the fault of the people driving, the car builders, or the traffic lights - then say 'it doesn't affect me - so let them work it out themselves"... However it is spreading - from intersection to intersection - highway to highway - city to city. Not only could they find themselves stuck in traffic soon - their groceries, gas, medicine, pension checks, tools of trade, DVDs, coffee, clothing, etc. are all on those roads and soon may also be getting stuck...

The correct response people should be making is; "I am lucky it hasn't affected me YET... who can resolve this in the fastest and most orderly way before it gets any worse? " The answer is obvious. After the dust settles we'll figure out the details of who is responsible, liable and how to avoid it in the future. For now - we need to get traffic moving. Fast.

Re: Are you changing your behavior in response to current events?

For many of us still having a hard time grasping how this stuff can bring down the entire economy, this was very helpful: The Week America's Economy Almost Died : NPR

You should listen to it rather than read it if you can. I did last week on the radio, and it scared the bejesus out of me...

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H

Re: Are you changing your behavior in response to current events?

Andrew, that's an excellent summary, but there's a big gap in it, which results in an important omission from the list of culprits.

It's also the hardest thing to explain. I've tried, and I can't do it. Even the people who work with these things for a living can't explain them clearly:

Fifteen years ago, under much different circumstances and on a comparatively tiny scale, mortgage-backed securities took down a couple of mutual funds that had loaded up on them without really understanding what they were buying. My former law firm represented some of the funds, and the one thing I took from the experience was that these things were like a financial virus that could infect an otherwise healthy institution. That's why the collapse of the subprime mortgage market has had such a huge impact.

M.

Re: Are you changing your behavior in response to current events?

Daily reading : Commentary: Bankruptcy, not bailout, is the right answer - CNN.com

Let the private institutions that make bad decisions FAIL. Don't bail them out. If you run a business and make terrible decisions, there are consequences. In the future these private companies are not going to listen when a certain partisan group tries to talk them into making bad loans. But, they knew the risk, and only wanted the dollars, so it's not just governments fault. Let them fail. Let new lenders come into the market. Don't listen to the media, they turn a profit by scare mongering, the more sensational and scary their news, the better the ratings, the more money they make.

Re: Are you changing your behavior in response to current events?

Bah. I guess it comes down to:

(1) Are we on the brink of systemic failure?

(2) If so, is this bailout the right solution?

It appears that even #1 remains controversial... Not to me, though. The link I provided does give credence to the hyperboles of last week. NPR is not in the business of fear mongering.

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H

Re: Are you changing your behavior in response to current events?

Look, I'll be really blunt.. since about June, I've seen something like this coming. We've had more and more clients call our offices who simply have no ability to pay, and can't get ability to pay. And we're in a B2B enterprise. Right now, the number of people who have paid (and then later had payment removed, if you understand) is skyrocketing. The number of clients who simply fold... yeah, that's on the high rise too.

This is a major problem; because it makes it where a business has no idea how much their inflow/outflow is monthly, and when inflow screeches, it's significantly bad.

For the first time in years, I worry daily about whether or not everyone at our office has a job tomorrow.

Re: Are you changing your behavior in response to current events?

It remains an ongoing threat. That's what spooked Paulson and Bernanke to back down from their "tough" position, when they let Lehman Brothers fail, and propose the bailout.

Commentators like the Harvard lecturer at the CNN link above would prefer a return to the tough stance, and they have some decent arguments on their side. Notably missing from that particular commentary, though, is any appreciation for the fact that this situation has now spread far beyond institutions that issued questionable mortgages. (See my post about derivatives above.)

That's the big question, and it's probably unanswerable. At this juncture, any plan involves a leap of faith, and no matter how it's designed, there will be vocal critics on all sides, because you can't design a plan without making choices that are socially and politically controversial.

What's needed is a person or organization who can inspire sufficient confidence from enough people to get them to join in that leap of faith. Unfortunately, we don't have that now. None of our public persons or institutions have the necessary credibility. It wouldn't even have to be an elected official; there was a time when Alan Greenspan commanded enough respect that he might have been able to make a difference, but that day is gone.

M.

Re: Are you changing your behavior in response to current events?

Absolutely, but there never has been and never will be a shortage of people wanting access to others money at reasonable rates. Our current crisis is the result of rampant abuse of this system on both sides of the fence.

As for me, I've spent my time as a borrower, but as I've grown older, I've also changed my habits and goals. Not to worry though, bankers. Others will be more than happy to step in and borrow the money.

John

PS - Gotta love that Tuco!

Re: Are you changing your behavior in response to current events?

If I were stuck in a traffic jam, and nobody came to direct traffic, I would get out and do it my self. If a tree fell across my street & I couldn't get to work, I would cut it up myself or go around.

The fact that WallSt is not trying to fix this themselves is making me wonder about the validity of it all. They obviously either don't think it is necessary, or don't want to take the risk themselves. Warren Buffet seems too be the only one willing to put his money on the line.

If the sky is falling, why are the lawmakers taking 2 days off for a holiday that is not a national holiday. I am sure that they will still be active, but I don't see any urgency there either. If my house was on fire on Christmas morning, I would still fight it.

I am sorry, but the longer this goes on, the less I am believing in the crisis long term impact. I have lost faith in both our government to do whats right and our media to keep them in line and tell the truth. Then again, as I am typing this, our sales forecast has been revised down again.

Re: Are you changing your behavior in response to current events?

Well said!

Re: Are you changing your behavior in response to current events?

That works for your block. Now all you have to worry about is the rest of your town and state, and the other 49. See the problem?

One possible (and obvious) answer is that they're doing a lousy job.

There's that credibility issue I was talking about. And your point is very well taken.

M.

Re: Are you changing your behavior in response to current events?

Yes I do. There is no way one person could clear all the trees. But Warren Buffet is the only one getting out to remove the tree. Evidently investors in the other "49" are either too greedy, or they don't think the tree needs to be dealt with. Just as a tree blocking me and many like me from making a living would not be enough to stop me, WallSt evidently doesn't think this will stop them from earning a profit.

Re: Are you changing your behavior in response to current events?

I don't think that's it. I think it's that most investors don't have anything to match the scale of Buffett's "tree removal" gear.

Wait, I thought you were talking about investors. How did you suddenly switch to "Wall Street"?

Wall Street -- what's left of it -- is running scared and knows that the days of immense profits are over, at least for the foreseeable future. That was made clear when Morgan and Goldman voluntarily converted to bank holding companies. By doing so, they voluntarily submitted themselves to regulation by the Fed, and my guess is that they did it to head off even tougher regulation by someone out to make an example of them.

M.

Re: Are you changing your behavior in response to current events?

Philosophically you are correct -- firms making bad decisions should fail and the remaining firms should be stronger as there are fewer competitors.

The problem is the nature of the over-the-counter business of derivatives that most of these firms are engaged in. When you make a stock trade on the NYSE, or trade an option on the CBOE, or buy/sell a futures contract at the CME, those contracts are guaranteed by a central clearinghouse that removes the counterparty risk. In other words, when you buy a stock you are not paying the seller -- you are paying the clearinghouse (through your brokerage firm) and the clearinghouse is paying the seller. At the end of the trading day, all of the trades are settled and the clearinghouse debits/credits each firm's bank. It is a zero-sum process. It doesn't matter to you if the person who sold you the stock went bankrupt during the day, as the clearinghouse acts as the middleman.

In the OTC markets there is no clearinghouse and thus when a trade is made you need to gauge whether the other side of the trade is going to be around to make good on it. Therein lies the problem called counterparty risk. Even if a firm such as Goldman had a spotless portfolio of winning trades on its books, if the counterparties all go under, that means their trades are essentially voided.

That is why most of us in the regulated securities and derivatives markets have been pushing for years to have OTC products clear through normal exchanges. This crisis may now bring that closer to reality.

Re: Are you changing your behavior in response to current events?

Michael, absolutely right (about the omission, not the praise, though that was nice ). There are other problems as well, like computerised share index watching systems that seem to be set at 'panic', and some stunningly bad math. On the latter point, there's an excellent article in New Scientist this week about this.

Re: Are you changing your behavior in response to current events?

I didn't know I was switching. I thought they were one and the same.

Re: Are you changing your behavior in response to current events?

Another question, how will success or failure be measured say a year or two from now? Everyone seems to agree that regardless of a bailout, we are in for some rough times. What will determine if we are saying "yea we did/didn't do this and things were not so bad" or "Boo we did/didn't do this and things are terrible"?

Re: Are you changing your behavior in response to current events?

"Investors" is a much bigger group. It includes big pension funds, many of them operated by city and state governments under strict guidelines (at least theoretically). It also includes anyone who participates in a 401(k) plan or has an IRA or invests in a mutual fund or even a money market fund. Most of us are investors in one capacity or another, just on a small scale.

This is not to say that Wall Street firms are not also investors. Indeed, a number of major scandals of the past 25 years grew out of their dual roles as investors and investment advisors, especially during the tech bubble. But as far as I know, that isn't a major issue in the current situation.

It's a damn good question, but I don't think anyone can answer it.

M.

Re: Are you changing your behavior in response to current events?

This has been an good thread for me and I am glad it did not get out of hand. Thanks for the info Michael.

Edit:
Young Chuck, moved to Texas and bought a Donkey from a farmer for $100.00.

The farmer agreed to deliver the Donkey the next day.

The next day he drove up and said,
'Sorry son, but I have some bad news, the donkey died.'

Chuck replied,
'Well, then just give me my money back.'

The farmer said ,
'Can't do that. I went and spent it already.'

Chuck said,
'Ok, then, just bring me the dead donkey.'

The farmer asked,
'What ya gonna do with him?'

Chuck said,
'I'm going to raffle him off.'

The farmer said,
'You can't raffle off a dead donkey!'

Chuck said,
'Sure I can. Watch me, I just won't tell anybody he's dead.'

A month later, the farmer met up with Chuck and asked,
'What happened with that dead donkey?'

Chuck said,
'I raffled him off. I sold 500 tickets at two dollars a
piece and made a
profit of $898.00.'

The farmer said,
'Didn't anyone complain?'

Chuck said,
'Just the guy who won. So I gave him his two dollars
back.'


Chuck now works for an investment bank.

Re: Are you changing your behavior in response to current events?

From an email I received earlier today:

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes,
it would go something like this:

* The first four men (the poorest) would pay nothing.
* The fifth would pay $1.
* The sixth would pay $3.
* The seventh would pay $7.
* The eighth would pay $12.
* The ninth would pay $18.
* The tenth man (the richest) would pay $59.

So, that's what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. 'Since you are all such good customers,' he said, 'I'm going to reduce the cost of your daily beer by $20.' Drinks for the ten now cost just $80.

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?'

They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:

* The fifth man, like the first four, now paid nothing (100% savings).
* The sixth now paid $2 instead of $3 (33%savings).
* The seventh now pay $5 instead of $7 (28%savings).
* The eighth now paid $9 instead of $12 (25% savings).
* The ninth now paid $14 instead of $18 (22% savings).
* The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

'I only got a dollar out of the $20,' declared the sixth man. He pointed to the tenth man, 'but he got $10!' 'Yeah, that's right,' exclaimed the fifth man. 'I only saved a dollar, too. It's unfair that he got ten times more than I!' 'That's true!!' shouted the seventh man. 'Why should he get $10 back when I got only two? The wealthy get all the breaks!''Wait a minute,' yelled the first four men in unison. 'We didn't get anything at all. The system exploits the poor!'

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!

And that, ladies and gentlemen, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore.

Re: Are you changing your behavior in response to current events?

No, it's not how our tax system works. It's one of those grossly oversimplified parables that people tell when they're lobbying for a particular change.

In truth, the tax system is so complicated that no such story could adequately capture it, and the very choice of how to construct such a story is highly loaded. Take this example: If these guys truly paid their bill the way we pay our taxes, all of them would pay something, because even the lowest earners pay FICA and Medicare. Only the highest earners earn enough for FICA to kick out, and only those whose income derives from sources other than wages escape payments for Medicare. Somehow, whenever you see one of those calculations about how the rich pay the biggest share of tax, that part of the equation is always left out.

It sounds good in the parables. In reality it doesn't happen.

However, this is not a tax debate. This thread is about the current economic crisis (if it is one, a subject about which questions have been raised). Tax-cutting or -raising diatribes are not the issue (not yet).

M.

Re: Are you changing your behavior in response to current events?

Michael. I think this is an excellent [but necessarily over-simplified] example of how our tax system works. Would you have responded the same had he said "income" tax? His over-simplification also left out the EITC, which would have allowed some of guys to actually be paid to drink their beer.



That's true.

John

Re: Are you changing your behavior in response to current events?

This would only happen if all nine men are as selfish as the one that wrote that parable.

Re: Are you changing your behavior in response to current events?

And yet we hear people making these same complaints every day.

Re: Are you changing your behavior in response to current events?

All that parable proves is that the majority of the benefits from tax breaks accrues to the wealthy.

Re: Are you changing your behavior in response to current events?

As opposed to what -- "estate" tax? The FICA and Medicare examples I gave should have made it clear that I was talking about "income".

It also left out the AMT, which would require the sixth through ninth guys to recalculate their shares and, in many instances, pay more. Unless, of course, the League of Tavern Owners intervened for that particular week and passed a special exemption, which then they'd have to revisit the following week.

Look, the tax system in this country, with its complex interaction between federal and state taxing jurisdictions, is just too sophisticated to be reduced to the type of "excellent [but necessarily over-simplified] example" set forth above. Trying to reduce the system to such terms is the surest way to get screwed by people who really do understand the intricacies of the machine. And that's about as far as I can take this here.

M.