1) General Growth Properties (GGP) — another case of too much leverage, illiquid assets, and liquid liabilities. I live near Columbia and Baltimore, so I know of a lot of property owned by General Growth that was bought when they acquired the Rouse Corp. I can hear the Rouses in the distance congratulating themselves on a good sale.
For those that haven’t read me much, the deadly trio of too much leverage, illiquid assets, and liquid liabilities is what causes most corporate defaults of financial companies, not lesser issues like mark-to-market accounting.
2) The government thinks it is doing something good, and then it realizes that it is in over its head. Consider AIG and Fannie Mae (FNM). Where does the bailout end? The government does not have a team of financial analysts competent to dig into murky balance sheets, and they have the mistaken notion that they must act fast. Having worked on several takeovers of large financial firms, I can tell you that work done quickly destroys value. Either there is an underestimate that leads to losing the bid, or an overestimate that leads to overpaying, and an eventual writeoff of part of the investment.
With Fannie Mae and AIG (and probably Freddie (FRE) also), the government clearly did not know what it was doing. What were the main drivers of the loss, and how much worse could they get? Is this scenario self-reinforcing? The cursory work led to a bad result that is getting worse.
3) Amazing that we are almost to the end of the first $350 billion of bailout capital. The government is behaving like a person that just won the lottery, and is profligate with spending, because they’ve never had that much money to throw around with complete discretion until now. As it says in Proverbs 13:11, “Wealth gained by dishonesty will be diminished, but he who gathers by labor will increase. [NKJV]“ Easy come, easy go. I am not surprised in the slightest that the US Government has mis-estimated the loss exposures. They don’t have anyone with a concentrated interest (a profit motive) in the result.
4) Here’s another angle in the Fed refusing to disclose what assets they are financing. If we knew who they were buying from, and what they were buying, the markets would ask the question, “How much more firepower are they willing to expend?” If the judgment is “little”, market players would sell what the Treasury / Fed was buying, and if the judgment is “a lot”, market players would buy what the Treasury / Fed was buying.
That leads me to believe that the Treasury / Fed doesn’t want to commit a lot more resources to this fight. If they felt they had a lot more firepower, they would happily disclose their actions, because the private markets would aid their actions.
5) I’ve been talking about it for over a decade, so pardon me if I point at the great pensions disaster. We have had a lost decade where DB pension money needed to earn 8-9% / yr, and earned around 1% / year. That gap of 7-8% / yr over 10 years is enough to destroy most well-funded plans at the beginning of the period. The problem exists for DC plans as well, because as people age, they lose time to compound their money. Hey, think of this — the dumb guys that put all their money in the stable value fund did much better than those that put their money at risk. So much for the equity premium in hindsight, but now it’s time to begin committing funds to riskier assets. (Don’t do it all at once.)
6) At least Mr. Obama can make one market go up — muni bonds. Wait, that’s not good?! At least for healthy municipalities their borrowing rates improve as higher taxes lead the wealthy to shelter income from taxation.
7) Maybe Obama’s tax policy could have more bite. Close down tax havens. This is something I can get behind. I like low tax rates, but I don’t like the ability for some to lower their tax rates, and not others. Let there be a level playing field in the tax code, such that there is no advantage to moving profits offshore.
Now, could Obama enact real tax reform that would be fair, and cause Buffett (and others) to pay taxes on his unrealized capital gains? He could, but he won’t..
8) I understand why the Treasury did it. They wanted an opaque way of encouraging the purchase of weak banks by stronger banks. So, they let them absorb tax losses of the acquired bank. Too bad it is not legal, but legality doesn’t affect our government much these days.
9) Give Spain a round of applause — they managed to increase capital requirements on their banks during the good times. Things aren’t perfect now, but Spanish banks are in decent shape given all of the credit stress.
10) Why is the Fed funds rate so low? The 75 basis fee point forces the effective Fed funds rate from 1.00% to 0.25%. Though some see the Fed hemmed in here, I think that as they reduce the Fed funds rate, they will also reduce the 75 bp fee.
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This article has 18 comments:
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Herbert Hoover
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382 Comments
Nov 11 09:23 AM-
Smarty_Pants
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1108 Comments
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Nov 11 09:46 AMThat's gub'mint in a nutshell. You also forgot to mention that the taxpayers always wind up holding the bag.
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User 265350
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2 Comments
Nov 11 09:47 AMOr possibly, 'When does the bailout start'? For the GSEs haven't drawn upon their $100B as of yet. So far they still have the cash to lock away in their loan-loss reserves and their current operations are profitable. The future cost of projected loss weigh heavily upon their future outlook, but there is still hope to pull through. If you examine the numbers Fannie put out yesterday, you will see the bulk of their losses come from losing the ability to use their tax credits and from having to stock away more money into their loan loss reserve account as their projected future losses are adjusted higher. The GSEs are not quite the disaster that AIG is.
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joepublic
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49 Comments
Nov 11 09:51 AM-
Mr. Cynical
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15 Comments
Nov 11 11:10 AMAnother good article, David, keep em coming.
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gabe borenstein
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192 Comments
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Nov 11 11:36 AMThe error committed by the Treasury was tho allow Lehman to fail allowing speculators to test the tolerance limits.The error committed by the various components of the industry was diverse but the subprime lending enhanced by the Micky Mouse AAA rating on the subprime paper ,is the culprit of the financial sector's derailment.
The articles like this one have no value as the problems,issues are identified and remedies are applied .
The results may take some more time(lag),but major market and economic rebound is on the way.
It seems to me that the imposition of no naked short rule shoud be reinstituted untill broad confidence is restored .
Shorting thestock has no economic value -you don't like public company A ,don't buy the stock or buy the stock in company B.
For myself ,I have issued the warnings about impending Armageddon in an interview with Mark Gilbert (Bloomberg London) in June of 2005 and again on September 18 /2007 (Bloomberg TV -Brian Sullivan).
Now ,I am not going to discuss the sincere and measures implemented by the Administration,Congres... ,Treasury and the FED aimed at addressing serious issues-but I know they are very effective.
Spain?-it is about to implode and the higher reserve requirements will only enhance the degree of implosion.
U.S stock market is in the midst of solidifying the base for unprecedented rally .Volatility will continue.
Global cooperation on the key financial /economic issues makes the constructive outcome a certainty.
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Socialism cannot compete!
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484 Comments
Nov 11 11:43 AMThe REAL analysis is that ONLY we the people know our own personal budgets and what needs we have -- no two families with the same income have the same cost structures -- some have tuition to pay, some not; some have high medical expenses, some not. Instead of this cobbled system, we should realize that the government HAS NO preemptive claim on our income!! The REAL solution is to abolish income taxes and fund government by consumptive taxes alone. THAT means that we pay when we buy. And WE DECIDE what and when we buy...so therefore we are able to allocate our income according to our needs in that system!!
This would lead to a MUCH SIMPLER tax system, with power back to the people to decide where BEST to spend their OWN MONEY!! We currently have a 66,000+ page tax code trying to do it for us -- to account for all the possible situations that are deemed worthy of a tax credit because they constitute genuine needs! But that also has led to tremendous complexity, and an onerous IRS!! That's not "serving the people"!! Ditch it!!!
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waf76
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66 Comments
Nov 11 12:10 PM-
RCA
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53 Comments
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Nov 11 12:42 PM> The REAL solution is to abolish income taxes...
Amen!
> This would lead to a MUCH SIMPLER tax system, with power back to
> the people...
Unfortunately our government has a very powerful vested interest in making sure that doesn't happen.
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moonbat1775
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705 Comments
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Nov 11 12:45 PMThere is Biblical precedent for this in the Bible ala the Jubilee which was to occur every 49 years in Israel for the forgiveness of debts and the freeing of slaves.
If this would help prevent a depression, then let the bloody fractional reserve bankers be wiped out. Let their depositors be made whole by the FDIC.
Then, a NEW honest banking system, not like the one we have now.
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Smarty_Pants
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1108 Comments
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Nov 11 09:11 PMI think the banks need to offset the phantom liability on their balance sheet with the foreclosure. Otherwise their balance sheet liabilities would grow without end and without offsetting assets. Seems like that must violate some sort of accounting rule.
Not sure I'm 100% on all the technicalities on this, but here's a stab at it.
1) Banks 'create' money to lend for a mortgage.
2) Bank balance sheet adds the IOU (mortgage) as asset, cash issued as a liability.
3) Mortgage defaults, bank forecloses, house replaces IOU as asset
4) Bank sells house at market price (less than mortgage amount)
5) Bank must take a loss on balance sheet so the numbers come out even, thereby eroding their equity capital.
Two things I can think of on this issue:
If the bank forecloses on enough underwater properties their capital base (reserves) will erode to nothing and put them out of business.
The money originally loaned out and spent to buy the house is still circulating, but the bank has received less money in settlement via foreclosure. Doesn't this increase the money supply?
It seems to me that the foreclosure process, when done with underwater mortgages, removes capital from a bank's balance sheet and puts it into circulation, though it doesn't "create" any new money after everything is settled.
Am I missing something?
Still, the issuing of the loan did increase the money supply and that's (temporarily) inflationary, just as the foreclosure and offsetting of the loan is deflationary.
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Thomas J. Gordon
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63 Comments
Nov 11 09:27 PM... Flash
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moonbat1775
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705 Comments
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Nov 12 03:10 AMI will have to think about what you said. I assumed that with a massive, simultaneous default the foreclosure system would seize up. But now I have to think about what foreclosure and selling of the house would do to the money supply. My initial thoughts are that the sale of the foreclosed house will be a wash with regard to deflation since a FRB loan will likely be created to buy it.
Ouch, this case gives me a headache. But I will get back to you with new grooves in my brain I hope.
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Smarty_Pants
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1108 Comments
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Nov 12 12:01 PMTrue enough. Perhaps modestly deflationary then, as the new loan will be for less than the old loan.
I still believe that an underwater foreclosure puts some of the bank's capital into other hands (original seller of the house), but that doesn't increase or decrease the money supply, simply change ownership for that amount.
However, enough underwater foreclosures will bankrupt the lender eventually (without a bailout that is) as all their operating capital will be transferred to other hands.
'Tis a very tangley subject to analyze. Difficult to say if any line of thought is heading the right direction.
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moonbat1775
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705 Comments
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Nov 12 01:20 PMThanks. It is hard for me to wrap my head around banking. At first the dishonesty of it appalled me, it was literally unbelievable. Then I thought about the justifications and that confused me for a while. <A href="mises.org/Books/myster...;>The Mystery of Banking</A> did and is doing wonders.
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moonbat1775
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705 Comments
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Nov 12 01:22 PMmises.org/Books/myster...
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Socialism cannot compete!
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484 Comments
Nov 12 02:09 PM[quote]
that works well for those who are well off but that is a regressive tax that would not help the middle class.
[end quote]
Regressive?? No. Sales taxes need not and should not apply to necessities such as food. There's no reason this would be regressive!! If anything, it's the most progressive tax possible, because YOU, the consumer, decide IF and WHEN you get taxed, if AT ALL!! Please, tell me how that is not the best? This isn't my own opinion either -- the Founders of this nation had this to say:
“Taxes on consumption are always least burdensome, because they are least felt, and are borne too by those who are both willing and able to pay them; that of all taxes on consumption, those on foreign commerce are most compatible with the genius and policy of free States.” (James Madison, “Address to the States”, 1783)
[quote]
The middle class is the root of the problem. They are the engine of the economy. I think its high time we start taking care of our neighbors instead of only looking out for numero uno.
[end quote]
No. Wrong. THAT is what the root of the mortgage problem is: the push for more lending to those less-qualified! Rather, it is time to stop the notion that government can and ought to provide for everyone, and instead allow us to TAKE CARE OF OURSELVES!! If you are truly worried about taxation on the middle class, you should look at the tax rates paid by the middle class and question why you think those amounts currently taxed are acceptable!! We ALL pay far too much!!
[quote]
B/C those with less will have to spend money on consumption as a higher percentage of their income. So you are basically reinforcing the current quagmire we are in with the same old solution of giving tax cuts to the rich.
[end quote]
No. I think you are fundamentally misunderstanding -- sales taxes would NOT apply to necessities -- food, housing, or energy. They would apply ONLY to discretionary items: jewelry, stereos, computers, etc.!!
[quote]
VAT is already applied throughout Europe and most European countries still tax income so VAT would not be enough to fund the government.
[end quote]
You are assuming the government keeps its current corpulent size!! That is not the intention. The intention is to shrink it back to the level the Founders intended. The federal government should be providing only those very fundamental, necessary needs: national defense, roads, bridges, food & drug safety...perhaps a few other really necessary regulatory/oversight agencies. The rest are designated to the States *by the Constitution*!! Do we even realize how much duplication we have between levels? There is far too much bloat and waste. Keep in mind that European governments are even more socialist than we are -- with government-paid healthcare, etc. -- and those programs are NOT working. They are slowly failing. European countries have 10 to 12% unemployment during *normal* times...and slow growth as well. Productivity is lower due to job immobility. They are *not* the model of competition and efficiency.
There's no reason we can't fund essential government functions with solely consumptive taxes, and there's no need for it to be regressive -- that depends simply on what we decide to include/exclude from the sales tax.
Some good reading for ya:
www.fairtax.org/site/N...
To finish: yes, it sounds radical...i can see why you balk at first glance. But consider looking back at the history of the income tax, and how huge it has become, both the code and the *amount* that most are taxed...and ask yourself if *that* is not the truly radical thing, which never would have been tolerated prior to the 20th century!!
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waf76
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66 Comments
Nov 13 01:59 PMyou make a compelling argument and have swayed me to see it the way you're looking at it. If there are no taxes on necessity items then I would have to agree with you. Having said that can you picture a scenario where the government actually shrinks?