As an amateur/n00b at economics

[Jerk]

It doesn't make sense to me that we will have a long-term recovery unless several things change:

1. prices are allowed to set at their market value.
2. we increase production of real goods and increase exports.
3. banks will loan money....to people who have jobs and will pay their debts.

If the Fed and the Gov't pump enough money into the system and we have what looks to be a recovery, but with out any real increase in exports, production, revenue, etc, then it is a fake rebound that is only pushing the consequences further down the road.

The common thing I hear is that 'we've got to get the banks lending again'? To whom? The same people who defaulted on their mortgage last year? What has changed recently that shows we have the production going on which creates wealth and the ability to pay back these loans?

If there is no production of goods, no exporting, no creation of wealth, then we continue to watch all these various institutions and individuals play ping-pong with each other until someone is left holding the ball.

Just my thoughts...it may be stupid but I have very little formal education on this subject. It really is interesting to me. I believe the David Schiff theory that our economy is in the middle of a huge transformation from one of debt service to one of production and savings.

[OUHOMER]

I watch most of the youtube the other day. I know we are trying not to buy a damn thing unless we can pay cash.

I never understood, why large companys would not have a rainy day fund. Seems like they all made big profits either from their product but from idiots buying their inflated stocks.

i know they borrow to buy raw material and make payroll, but why? Seems they would have put money back for it.

I am idiot, I dont have a clue, I assume things should be done, like I do at home. Dont spend what I don't have or at least know where the cash flow is coming from.

[Frozen Sooner]

Cash-only floor planning is not now nor has it ever really been the way industrialized countries work. In fact, one of the biggest indicators that a company is about to go under is that it's on a cash-only basis with all of its suppliers.

[royalfan5]

I watch most of the youtube the other day. I know we are trying not to buy a damn thing unless we can pay cash.

I never understood, why large companys would not have a rainy day fund. Seems like they all made big profits either from their product but from idiots buying their inflated stocks.

i know they borrow to buy raw material and make payroll, but why? Seems they would have put money back for it.

I am idiot, I dont have a clue, I assume things should be done, like I do at home. Dont spend what I don't have or at least know where the cash flow is coming from.

Borrowing tends to provide capital cheaper than equity. In addition, leverage allows you to grow at a much quicker rate. Also, your interest is tax deductable. You don't expect your household to deliver a return on your investment, a business has to do that, and in most businesses that simply isn't possible without leverage.

[Frozen Sooner]

Borrowing tends to provide capital cheaper than equity. In addition, leverage allows you to grow at a much quicker rate. Also, your interest is tax deductable. You don't expect your household to deliver a return on your investment, a business has to do that, and in most businesses that simply isn't possible without leverage.

There's also the reduced risk factor of leverage vs. cash reserves. A business that's divided it's cash reserves then fails can BK out of the business debt. The business that uses cash reserves is out the money.

Not saying that's necessarily good, but there's a bunch of argument out there that the US's relatively liberal business BK laws have been one of the impetuses for sustained economic growth. How many times has Donald Trump filed for bankruptcy in his various ventures?

[royalfan5]

There's also the reduced risk factor of leverage vs. cash reserves. A business that's divided it's cash reserves then fails can BK out of the business debt. The business that uses cash reserves is out the money.

Not saying that's necessarily good, but there's a bunch of argument out there that the US's relatively liberal business BK laws have been one of the impetuses for sustained economic growth. How many times has Donald Trump filed for bankruptcy in his various ventures?

The ability to have a second(or third for that matter) acts is one of the great strength's American business/society. Many great American firms have been insolvent at least once in their history.

[Frozen Sooner]

Yep, it is.

Heh. Two bankers chatting about what a good thing bankruptcy is...:D

There's a really good post on www.creditslips.org questioning why we're not allowing AIG and others to simply file bankruptcy and reorg rather than take on their toxic debt instruments. Interesting read.

[royalfan5]

Yep, it is.

Heh. Two bankers chatting about what a good thing bankruptcy is...:D

There's a really good post on www.creditslips.org questioning why we're not allowing AIG and others to simply file bankruptcy and reorg rather than take on their toxic debt instruments. Interesting read.

To be fair, I'm more of a trader now, but I doubt that is a long term deal.

[jkjsooner]

You guys strayed quite a ways off-topic in your discussion about companies borrowing and using leverage.

Jerk's point is that as a country we are consuming more than we produce and that hardly seems sustainable to me either. It may work as long as China is funding our excesses and maybe that could continue for years but at some point it just has to end.

He also is pointing out that the economic fix seems to be doing the same thing that got us in this mess. That doesn't make sense to me either.


As for Donald Trump, he seems to be very skilled at organizing his businesses so that he gets the upside without the downside risk. He sells his name more than anything else which I find puzzling. He's ruined so many investors that I just don't understand why so many people think doing business with him is such a sure thing. He is the last person I would ever do business with...

I'm now accepting money for my Trump lawsuit defense fund ...

[yermom]

There's also the reduced risk factor of leverage vs. cash reserves. A business that's divided it's cash reserves then fails can BK out of the business debt. The business that uses cash reserves is out the money.

Not saying that's necessarily good, but there's a bunch of argument out there that the US's relatively liberal business BK laws have been one of the impetuses for sustained economic growth. How many times has Donald Trump filed for bankruptcy in his various ventures?

therein lies the problem. your business fails, so what? you lost someone else's money.

without any backing what keeps this from happening again?

i guess the bottom just falls out every 50-60 years...

[Frozen Sooner]

therein lies the problem. your business fails, so what? you lost someone else's money.

without any backing what keeps this from happening again?

i guess the bottom just falls out every 50-60 years...

So what should be the penalty for someone who's business fails and leaves them in insurmountable debt?

Debtor's prison?

The converse of the entrepreneur walking away is the investor who didn't do their due diligence.

[Frozen Sooner]

You guys strayed quite a ways off-topic in your discussion about companies borrowing and using leverage.





i know they borrow to buy raw material and make payroll, but why? Seems they would have put money back for it.

Looks to me like we were doing a pretty good job of answering this question.

[yermom]

it just doesn't seem productive. i'm not a business guy. i don't have a solution. but getting more debt to constantly expand more as a business model sounds just like any other ponzi scheme to me. eventually it stops working while whoever started the thing is long gone with lots of cash

[Frozen Sooner]

it just doesn't seem productive. i'm not a business guy. i don't have a solution. but getting more debt to constantly expand more as a business model sounds just like any other ponzi scheme to me. eventually it stops working while whoever started the thing is long gone with lots of cash

Careful. You're sounding a lot like Marx and Engles there...

[yermom]

i'm all for private business and profit, but i don't get the constant need for expansion and bowing to shareholders to raise stock prices half a point this quarter instead of worrying about what's going to happen in 5-10 years

i mean i get it that your competitors are doing it, so business practices have to evolve like anything else to stay competitive, but when you step back and look at things, nothing is based on anything.

you have a bunch of businesses trying to sell services and Chinese junk to people that don't have money because there are no real jobs anymore. obviously that is overstating a bit, but that is where the trends seem to have been going lately

[Vaevictis]

i know they borrow to buy raw material and make payroll, but why?

Basically, debt is grease for the economy. It makes things run smoother.

The interest you pay on debt is to compensate the lender for (1) the time value of their money and (2) the risk that the lender will never get the money back.

That's it. From a business point of view, debt is very often a good thing provided you can fulfill your obligations and you make efficient use of the money the debt provides you.

-----------------------

Let's say you're a small manufacturer that just received the biggest order you've ever had. You don't have enough cash on hand because the order is simply unprecedented. If you fill this order, it's a sure thing the customer will pay -- they'll even put the money in escrow.

In a cash-only situation, your only choice is to refuse the order. Is that really the best thing here? No -- taking on a little short term debt would allow you to fill the order. Your customer gets their order filled, you get paid, and the bank gets paid too. Everybody goes home happy.

The problem with debt is when (1) borrowers assume more than they can handle and (2) lenders let them. Note that there are two parts to this; you can't have one without the other.

[Vaevictis]

If the Fed and the Gov't pump enough money into the system and we have what looks to be a recovery, but with out any real increase in exports, production, revenue, etc, then it is a fake rebound that is only pushing the consequences further down the road.

I was saying this back in 2001-2002. Usually, I would agree with you, but I think that we've pushed it back far enough that there's true hell to pay.

I think that if we let this thing free-fall, it could become politically destabilizing, so our choices may only be between a protracted but politically stable contraction, or a sharp, short and politically unstable one.

I'll take 10 years of moderate economic hurt over even the smallest possibility of food riots in every city or civil war.

(Note that I think that this was essentially the choice presented the country during the Great Depression and FDR's policies reflected the country's choice to endure the former.)



The common thing I hear is that 'we've got to get the banks lending again'? To whom?

To each other and to large corporations, actually. You heard this the loudest at the end of the last year. An informative indicator about this issue is the TED spread, which is the spread between the LIBOR and T-Bill rates.

It basically indicates the differential in interest rates between what is generally accepted as a risk free security (US short term debt) and a nominally riskier security (short term bank-to-bank debt) which is itself nearly risk free.

Towards the end of last year, the TED spread was as high as around 4.6% when the historical norm is more like 0.5%. That indicates some severe stress in the system. It's much better today at around 1%, but it's still pretty unpleasant.

[jkjsooner]

Looks to me like we were doing a pretty good job of answering this question.

I didn't realize OUHOMER started this thread. My fault. I don't care if you guys have side debates but I sure would like for someone to address Jerk's questions because I think they're valid.

[Frozen Sooner]

I didn't realize OUHOMER started this thread. My fault. I don't care if you guys have side debates but I sure would like for someone to address Jerk's questions because I think they're valid.

I didn't realize I needed your dispensation to answer people other than the OP.

Oh, wait. I don't.

[NYC Poke]

It doesn't make sense to me that we will have a long-term recovery unless several things change:

1. prices are allowed to set at their market value.

Prices are always at market value, by definition. Even during the housing bubble, where asset values were inflated, there were willing buyers and sellers at those prices. I'm not sure what you're suggesting here. Should the government set prices, and if so, how?

A good argument can be made that the Fed was playing loose with money supply for the last several years in order to avoid a recession, and that contributed to inflated asset values. Money supply was kept so loose for so long that now that the economy is in serious trouble, we don't have any wiggle room (interbank interest rates are near zero). That's why many economists feel that the only response to the present crisis is to increase government spending. It's basically the only response left to increase aggregate demand.


2. we increase production of real goods and increase exports.

This is not unimportant. But there is a U-shaped profit curve in the supply chain. Everybody all over the world can make stuff. The margins are in the conceptualization, on one side of the U, and in marketing and sales on the other. Think of the iPod; the money is made by the people at Apple who conceived the idea, and also by the people who market and sell the iPod. They make more money than the firm in Shanghai (or wherever) that actually manufacturs the physical good. I'd rather work for Dell in Round Rock than the factory in Malaysia that puts that crap together.


3. banks will loan money....to people who have jobs and will pay their debts.

From what I understand, banks who received TARP money used it to build their depleted reserves back up. As unpalatable as the concept seems, it is possible that we didn't go far enough with the bailout. We gave the banks enough money to straighten out their balance sheets, but not enough to get them to start lending again.

To the extent they made bad loans, see my comment to your first point. As long as money supply was loose, there was the expectation that asset values (e.g., houses) would keep increasing, making the perceived risk in writing loans less. Couple that with the lack of reserve requirements in the largely unregulated credit derivatives market, and you get the perfect storm we're experiencing now.

[badger]

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[jkjsooner]

I didn't realize I needed your dispensation to answer people other than the OP.

Oh, wait. I don't.

You're taking this way to personally.

[jkjsooner]

Prices are always at market value, by definition. Even during the housing bubble, where asset values were inflated, there were willing buyers and sellers at those prices. I'm not sure what you're suggesting here. Should the government set prices, and if so, how?
derivatives market, and you get the perfect storm we're experiencing now.

I think it's pretty clear what he's suggesting. The prices of assets are distorted by certain actions of the government. Call that market value or whatever.

[NYC Poke]

I think it's pretty clear what he's suggesting. The prices of assets are distorted by certain actions of the government. Call that market value or whatever.

I went to OSU. Some things are more opaque to me. ;)

[jkjsooner]

I went to OSU. Some things are more opaque to me. ;)

:-)

Using housing as an example, the government keeps talking about solving the housing crisis by halting house price declines. They're doing whatever they can to lower mortgage rates, give tax credits (which must be paid back BTW), etc.

The fact is, housing costs exceeded (by a large amount) our ability to afford the house. Call it market price or whatever but the housing crisis will not end until affordability is reached. There is no sustainable program that will avoid that. Anything else is just rearranging the deck chairs on the Titanic.

[yermom]

house prices ballooned because of shady lending. if you only have to pay interest for a few years then you can live in way more house than you can afford for those few years. if you haven't gained as much equity as you think you were gonna, you are in trouble

places like California are tight on land for all the people that want to live in the area, so prices were already pretty ridiculous to start with

[NYC Poke]

:-)

Using housing as an example, the government keeps talking about solving the housing crisis by halting house price declines. They're doing whatever they can to lower mortgage rates, give tax credits (which must be paid back BTW), etc.

The fact is, housing costs exceeded (by a large amount) our ability to afford the house. Call it market price or whatever but the housing crisis will not end until affordability is reached. There is no sustainable program that will avoid that. Anything else is just rearranging the deck chairs on the Titanic.


That truly is a conundrum. I don't see how we stabilize housing prices while we continue shedding jobs. And while housing prices continue to decline, more people will be inclined to simply walk away from their houses when their mortgage far exceeds the value of the underlying asset. And if you were a bank, would you be inclined to loan money that is secured by an asset declining in value?

Now I'm like our economy. Depressed.

[Frozen Sooner]

You're taking this way to personally.

I'm not taking it personally at all. I'm amused that you seem to think you can dictate which questions posters in a thread are allowed to answer. Mind your own muttons.

[TopDawg]

I like this thread.

[badger]

I'm not taking it personally at all. I'm amused that you seem to think you can dictate which questions posters in a thread are allowed to answer. Mind your own muttons.

You let the brainteaser thread die because you couldn't solve the final puzzle ;)

See, I put a winky after that statement so that you know that I am joking and that you don't have to take it personally.

[jkjsooner]

I'm not taking it personally at all. I'm amused that you seem to think you can dictate which questions posters in a thread are allowed to answer. Mind your own muttons.

Actually, I kind of got the impression that people were thinking that they were addressing Jerk's question when in fact you guys were on a side topic. I think my incorrect impression (which is obvious once I re-read the posts) spurred my first comment. That was my confusion and my fault.

I've learned a lot from your posts so I'm sorry about being critical (but it wasn't specifically you - not that it matters).

[Frozen Sooner]

Ah. Then I apologize for my mistaken impression of what you were getting at.

[Vaevictis]

As long as money supply was loose, there was the expectation that asset values (e.g., houses) would keep increasing, making the perceived risk in writing loans less.

I personally think it's more than just that.

I think that the Fed keeping rates so low for so long pushed people into riskier asset classes in pursuit of a reasonable return above inflation. The longer this lasted, the more debt had to be generated to feed this demand -- and so the brokers pursued lower and lower quality debtors.

Add to this the fact that the ratings companies worked for the brokers and thus were happy to stamp AAA on garbage, and you have where we are now.

(Obviously, there's more to it than that, but I'm just focusing on the Fed at this point.)

[Chuck Bao]

It doesn't make sense to me that we will have a long-term recovery unless several things change:

1. prices are allowed to set at their market value.
2. we increase production of real goods and increase exports.
3. banks will loan money....to people who have jobs and will pay their debts.

You are right in assuming that #1 and #2 won't work until #3 does. But, it is much more complicated than that. We have a global economy and the solution has to be approached internationally. There was a shocking 20-50% decline in international trade starting in October of last year and the main reason was not the slowing global economy, but the lack of confidence amongst banks and the sudden shut-down in trade financing. I wrote about this back in September when the Thai banks had black lists on European and US banks and were trying to get the attention of their clients in the import/export trade to tell them they would no longer discount letters of credit from those black listed banks.

I'm still trying to figure this out. Thai banks quickly returned to discounting L/Cs. But, I'm left wondering whether the state-owned banks in China were excessively playing the good bureaucrat role and that played a big part in the sharp slowdown in global trade over the last five months. This is just my theory and I haven't seen anyone else write about it or comment on it.

Yeah, my theory is to blame China. What's new?

But back on point, trade financing is one of the first things that the US government should ensure. And, if the US banks can't or won't do it, I say nationalize them or set up the "good" bank that will.

[Jerk]

Prices are always at market value, by definition. Even during the housing bubble, where asset values were inflated, there were willing buyers and sellers at those prices. I'm not sure what you're suggesting here. Should the government set prices, and if so, how?



If many people who should be unqualified to get a home loan somehow get one anyway, then it is going to create an artificial rise in home prices above where it should be.

JMHO

As for your second point, when I say 'production of real goods' I should have meant production of anything that can be made and sold to in exchange for wealth - including intellectual property.

This is so complicated that I don't even have the smarts to understand it, much less explain it. What I am trying to say is that we are a society that borrows and consumes, borrows and consumes, etc. Which is fine. We could get into a 100 trillion debt, but it would never hurt us so long as we make the payments.

Where does the money we get to make the payments come from? If it comes from another guy who borrowed money, and he got payed by someone who burrowed their money, and so on and so forth forever, then it is just a giant pyramid scheme. But it still works if there is wealth creation by the production of stuff...stuff that has value and can be exported. Without that last piece, it is a circle jerk. If we have that last peice (and enough of it), then we're fine. If not, we're screwed.

[NYC Poke]

I agree with what Vae an Chuck wrote, and obviously my explanation was a gross oversimplification. When the history is finally written on this, the explanations will fill volumes.

As to the ratings agencies, they've made this same mistake before. Because the ratings agencies are not in the business of derivatives trading (if they were good at it, they'd be doing it because the money was better), they had to rely on the derivatives traders to assess their risk themselves. They have dropped the ball this way in the past, notably with a company I used to work for, Enron.

Jerk, you can make the case that housing prices were artificially inflated, and I would agree with you. Cheap borrowing increased demand for housing, not only in the number of units sold, but also in how much people were willing to spend on housing. The Fed played a large role in distorting the market, but prices were still market-based.

Crap lending practices played a role, but that's only one side of the equation. If it was just crap lending, we could have gotten out of this relatively cheaply. The other side of the equation is the demand for the crap loans. I have read interviews with the derivatives traders who admitted that they knew they were bundling crap loans. They didn't care as long as they knew they could bundle them, securitize them, and sell them. Their counterparties didn't mind because they bought credit default swaps which were supposed to protect them from credit risks. And the banks and insurance companies writing the credit default swaps didn't care because as long as asset values kept rising, they'd be more or less protected, so they were in essence writing insurance policies without reserving for the risk like they would for, say, auto insurance. This all goes to the regulatory side of the coin, and both political parties are at fault because the vote to leave the derivatives market unregulated was nearly unanimous.

eta: It looks like the regulation issue is being discussed here: http://www.soonerfans.com/forums/showthread.php?t=130181

As for the "true" value of assets, Andrew Sullivan posted a couple of interesting graphs yesterday on his blog in The Atlantic.

http://andrewsullivan.theatlantic.com/the_daily_dish/images/2009/03/23/homesales.jpg


This meme is beginning to sound like an orgy, but Calculated Risk looks at the latest housing numbers:

...a significant percentage of recent sales were foreclosure resales, and although these are real sales, I think existing home sales could fall even further when foreclosure resales start to decline sometime in the future.

http://andrewsullivan.theatlantic.com/the_daily_dish/images/2009/03/24/united_states.jpg


No Empty Wallets counters Drum on the housing market:

If prices were to fall another 20% to $132k as Drum suggests, or $124k when adjusted for the tax credit, we would be at the same inflation adjusted median price as the early 80s (when mortgage rates were a whopping 18.5%).