Lots of pundits are suggesting this crash of the market is because people think if Obama wins and then has a Democratic House and Senate they will raise taxes causing a much worse recession and probably depression.
I have no idea if that’s true but it certainly makes sense to me.
I bet most of the pundits you listen to are not Democrats…
Comment by Daryl — Friday October 10, 2008 @ 9:03 pm
I don’t know, it was Fox Business News. Not sure if their business people are as conservative as their opinion people.
Comment by Don — Friday October 10, 2008 @ 10:50 pm
I’m usually a lot more conservative than many of your posters, but even I think that statement is nonsense. Of course, being a political season, the statements of most pundits are nonsense.
Comment by Richard — Saturday October 11, 2008 @ 8:35 am
I’m not sure which part of that statement you think is nonsense. Do you think the Democrats won’t raise taxes or do you think raising taxes won’t cause a worse recession?
I’m curious because I happen to believe both of those things. The part I don’t really believe is that the crash is because of that concern. I think the crash is due mainly because of the CRA, ACORN, and a lot of greed.
Comment by Don — Saturday October 11, 2008 @ 12:48 pm
The crux of your post was that the fear of electing Obama was the cause of the financial mess we are in. That is blatant nonsense.
Comment by Richard — Saturday October 11, 2008 @ 1:33 pm
I said what I think is the cause of the financial mess. What do you think is the cause?
Comment by Don — Saturday October 11, 2008 @ 2:19 pm
Just so you know it wasn’t me making the claim.
Here’s a link.
Comment by Don — Saturday October 11, 2008 @ 4:33 pm
Since you asked — the current market meltdown is being caused by panic selling that creates more panic selling. That in turn was caused by the fear that set in when many banks and mortgage companies failed. They failed because they had made loans to people who were relying on market appreciation of homes to make the balloon payments when they came due. But as it eventually had to, the home appreciation bubble burst over the last year or so (most prominently in California, but elsewhere to a lesser degree).
Why did the banks and mortgage companies make these loans to people who could not pay them off without selling the house?
Wall Street investment banks and insurance companies have gotten super-silly drunk on risk in the subprime mortgage market. They took on far too much risk, thinking that they were bulletproof and that the risk would never come back to haunt them. What we’re dealing with now is the hangover — you can’t get super drunk without feeling terrible the next morning.
Several years ago, the Federal Reserve kept lowering the target Fed Funds rate — the interest rate that banks charge each other for overnight loans. Commercial banks are required to keep a certain amount in reserve to back up their deposits, and these overnight loans help them meet these requirements. When the Fed lowers its target rate, that creates additional liquidity in the financial markets, which means banks have more cash available to lend to individuals and businesses.
Armed with lots of money to lend, the commercial banks set out to make lots of loans in hopes of turning a big profit. Some of the more lucrative loans were mortgages.
The investment banks discovered that they could purchase, slice, dice and repackage these mortgages into securities that could be sold on the open market. Seeing that these securities — also known as collateralized debt obligations (where many different pieces of mortgages are combined, or collateralized) — had the potential to be quite profitable, the investment banks created even higher demand for the mortgages.
To keep up with the demand, the commercial banks needed to write more mortgages. But the supply of traditionally qualified borrowers started to dry up, so the banks relaxed their lending standards. They found a fresh pool of borrowers, and sold riskier loans, which gave the investment banks more pieces to slice, dice and sell. Demand increased, so the commercial banks sold more loans to even less qualified borrowers, and you get the idea. Of course, all this also fed the unrealistic market appreciation of homes.
The investment banks figured that if they put enough of these high-risk loans together into securities, the risk would somehow mitigate. After all, they figured, there’s no way all these loans could go bad at the same time! Of course, they were wrong because the housing appreciation bubble burst. And the fallout began.
Add to this the problem of leverage. Banks and investment banking firms are highly leveraged. In the case of Lehman brothers, they would lend out $30 for every $1 they actually had in assets. As the subprime loans fell apart, they realized that the assets backing that dollar were worth less than they thought — again, this is the risk they took. Creditors and credit rating agencies demanded that they bring their capital structure in line, and when they couldn’t, the house of cards began to topple.
When any commercial bank was mentioned as having a large exposure in the mortgage industry, people panicked and began withdrawing their funds. That turned a high risk situation into a self fulfilling prophecy and banks like WAMU went under.
With nothing but bad financial news everywhere in the banking and housing industry, as well as the recent historically high oil prices, investing moods soured and everyone began looking for safer places than the stock market for their money. That led to the panic selling we have seen for the last couple weeks.
Who is ultimately responsible the situation we now find ourselves in? For allowing the banking industry to get itself so far out on a limb without proper regulation and oversight? I think there is plenty of blame to go around, but greed, stupidity and our political system all play a part.
The lack of regulation and oversight that allowed this situation to develop has been a long time coming. There has been monumental failure on the part of both Republican and Democrat administrations, as well as congress, to monitor the banking industry and maintain appropriate regulations. But of course, we all know those industries have tremendous lobby power and can pretty much do as they wish.
I don’t blame Republicans or Democrats. I blame them both for failing the American people; the people who are going to be most hurt in this mess, and the ones who are ultimately going to get stuck with paying the bill. I’m quickly becoming one of those who think “None of the above” is the correct vote. I don’t think either of the two choices we have this year are worthy of my vote. It’s more a matter of holding you nose and voting for the least objectionable, and frankly, I’m not sure who that is.
*** Some of the comments were cut and paste from other sources I tend to agree with. Sure hope you don’t have a limit on comment length!
Comment by Richard — Saturday October 11, 2008 @ 6:56 pm
I don’t know about this. It seems like too politically neutral a position for this blog, stated in too casual a manner.
Who let this guy comment here, anyway?
Comment by Daryl — Saturday October 11, 2008 @ 8:26 pm
Joking aside, Richard, it sounds like a pretty fair, comprehensive analysis, without going deeper into what particular regulations and policies allowed it to happen (which would surely exceed any reasonable comment length!)
Comment by Daryl — Saturday October 11, 2008 @ 8:30 pm
Right, Daryl. I tried to keep it simple.
Comment by Richard — Saturday October 11, 2008 @ 8:47 pm
O.k. I do agree with most of what Richard stated. Except about how banks are not heavily regulated. We are, You can go to FDIC.gov and read pages and pages of regulations. The problem with most of those are the focus of the regulations. As soon as 9/11 happened the people demanded something be done to protect our country. So, we got new regulations. the majority of these have been focused on tracking money. CTR’s, SAR’s and MICL’s all became part of our daily vocabulary. I’m sure that this new economic threat will bring on even more regulations. Luckily for me, that’s what I love. Maybe this could end up opening up a new position for me at work.
Comment by Jocelyn — Saturday October 11, 2008 @ 9:09 pm
Yeah, no neutral comments allowed!
Seriously though very good analysis imo. I do think you glossed over the fact the CRA and ACORN had in the issue. I’ve read people who seem a lot smarter than all of us who suggest they had a part in it.
Of course I don’t think the crash was due to Obama but I have to say that to keep Daryl on his toes. 😉
Comment by Don — Saturday October 11, 2008 @ 9:12 pm
Richard, could you please explain the $700B bailout package as comprehensively as you did the reasons for the meltdown? I’m not sure anyone understands that!
Comment by Donna — Saturday October 11, 2008 @ 9:21 pm
Joce — Your are certainly correct that banks have a lot of regulations. Unfortunately, not enough. The current situation is proof of that.
Don — I’m sure you can find people smarter than us who will both defend and support CAR and ACORN with equally cogent arguments. Problem is, no one knows who is right. I personally think CAR is a good program. Redlining was a bad practice. As long as the borrower meets the same credit standards as everyone else, where they live should not prevent them from obtaining a loan. The problem is that the “same credit standards” were relaxed for everyone and that’s what got us into this mess. ACORN is a different issue. There is a lot of “welfare style” feel good stuff in it that does not sit well with me. I understand the idea that owning a home is part of the American Dream, and wanting to assist low income people in obtaining one sounds appealing to many people. I just don’t know that that is the proper role of government. I think way too much importance is placed on owning a home. I don’t think I will ever own another one. JMO.
Together these two programs may have had some effect on the current situation, but I doubt if it was out of proportion to the overall failures. I have not seen the data but I also suspect most of homes affected by both those programs were likely of lower value and less at risk of default on the basis of obscene cost. I think the biggest risk was all the high priced homes that had huge mortgages. Average home prices in Orange County rose from $300K to $750K between 2000 and 2007. That insanity was driven by cheap mortgages and lowered credit requirements, and those big guys were more likely the ones who couldn’t make the payments, and who’s default had a more deleterious effect on the overall situation.
Like I said, no one knows for sure. What we do know for sure is that there were not enough safeguards built into our banking systems to prevent the current market collapse. Millions of people’s retirement savings have been almost wiped out, ours included. Anybody know if McDonald’s is hiring?
Comment by Richard — Saturday October 11, 2008 @ 10:06 pm
Hmm, no but I’m retiring in a few months.
Comment by Don — Saturday October 11, 2008 @ 10:50 pm
Now the only question I have Richard is why you didn’t bother to tell anyone this was going to happen. You obviously know all the reasons it went south. 😉
Comment by Don — Saturday October 11, 2008 @ 11:28 pm
Donna — I’ll try, but I’m not sure anyone really understands it completely.
Remember those sub-prime loans I mentioned? Remember how I explained that the banks had loaned out more money than they had assets to cover now that the housing market has devalued and many poor loans have defaulted, and that their creditors demanded that they bring their capital structure back in line?
Basically, they had made bad loans and the value of the underlying assets that were supposed to secure these loans no longer covered the amount outstanding. As a result, no one was willing to lend them any more money to keep their businesses afloat, nor could they raise operating capital by selling those risky loans because no one would buy them. When you don’t have enough money to pay your employees and your bills, and no one will loan you any more, and you can’t sell off any of your assets, your business fails.
The idea of the “bailout” was for the government to buy those bad loans from the banks. That would reduce the bank’s risk and bring their capital structure back in line. They would no longer hold risky loans that were not covered by assets of equal worth, and which were a poor ongoing risk in a falling housing market. With their capital structure back in line, their creditors would once again be willing to lend them money to operate.
That was the original theory. Of course, the bill to approve the plan failed. It then had about $100 billion of pork barrel garbage (that had absolutely nothing to do with the banking crisis) added in order to buy the votes of reluctant congressmen. That’s how our congressional system works. Bribe them with $100 billion in pork and they will spend another $700 billion for something important.
Of course, the real tab for the “bailout” was not expected to be $700 billion when all was said and done, but that much might be needed to deal with the issue initially. The argument was that not all the loans the government bought from the banks would be bad, and that the value of the underlying assets (property) securing the loans was not zero. However, they needed that much money to fund the program and get the loans off the banks books. Sometime down the road, the expectation is that the housing market will recover to some extent, and much of the $700 billion will be recovered when the homes are sold at forclosure or as they are paid off. No one could put a handle on when that might be or how much it might be.
Confused yet? Feel right at home. We all are.
Of course, this “bailout” should have settled things down, and in terms of the investment banks and commercial banks failing, it has. What we are dealing with now is a loss of confidence in the whole banking industry and in government’s ability to regulate it properly. That in turn has led to the stock sell off and an irrational panic that feeds on itself. There is no reason for the sell down other than that people are scared and are selling stock for whatever they can get for it out of fear it will go lower. Of course, that causes it to go lower and then more people decide to sell, and so on. Eventually it will stabilize, but no one knows for sure when that will be. I suspect we are getting close to the bottom, but who knows. Of one thing we can be sure; the market will not go up as fast as it went down. It will take several years to rebound completely.
I don’t know if any of this helps or even makes sense, but it’s the best I can do.
Comment by Richard — Saturday October 11, 2008 @ 11:30 pm
Don — I’m a historian, not a prophet.
Comment by Richard — Saturday October 11, 2008 @ 11:32 pm
Rats! I was hoping you could tell us what to do next.
I agree completely about why the market kept falling once the bailout had been signed. I kept thinking of a shark feeding frenzy every time I looked at the DOW. Of course Boeing and Intel are 2 of the 30 so Donna, Daryl and I are all looking at huge drops.
The one thing that saves me is my pension doesn’t use the markets to determine value. It uses the 21 years I put in and the GATT. I’m really hoping the 30 year Treasury rate will drop down around 4%. That would raise my pension by close to 10%.
Comment by Don — Saturday October 11, 2008 @ 11:48 pm
Thanks, Richard. Good recap. I did have a general idea of the mortgage buyout intention. I just didn’t understand why it had so much “pork” added to it, and why, when it failed the first vote, adding MORE pork got it the votes it needed to pass. I should have remembered who was doing the voting … Congress! In the end, it seems every vote hinges on what’s in it for “me” rather than what’s in it for the good of the nation, doesn’t it?
Comment by Donna — Sunday October 12, 2008 @ 8:01 am
So Mr. Historian, what caused the 930+ point rise today and why didn’t you tell me it was going to do that? 😉
Comment by Don — Monday October 13, 2008 @ 2:01 pm
Oh wait, you’re a historian and not a prophet. Isn’t that another way of saying hindsight is always better than foresight?
Comment by Don — Monday October 13, 2008 @ 2:02 pm
Quoting myself, “Eventually it will stabilize, but no one knows for sure when that will be. I suspect we are getting close to the bottom, but who knows. Of one thing we can be sure; the market will not go up as fast as it went down. It will take several years to rebound completely.”
I stand by my statement. In fact, there is a good chance it will be down some tomorrow as a little profit taking sets in. But again, who knows. Maybe it will rise again some more. If anyone could predict the short term changes in the stock market they would be unbelievably wealthy. No one can do that.
And yes, I though that was obvious. Hindsight is always better than foresight. In fact, I’m not sure there is such a thing as foresight. People can make educated guesses about the future, but time makes fools of most prophets.
Comment by Richard — Monday October 13, 2008 @ 10:15 pm
Well, you can never go wrong predicting the past. 😉
Comment by Don — Tuesday October 14, 2008 @ 5:21 am