Tuesday, November 6, 2007

So You Want To Better Understand the American Economy?

You can start here - this site, itulip.com has become one of my favorite sources for analysis and irreverent background on economic issues.

The above link seeks to explain just what the nature of the American Economy really is: is it an industrial economy, a finance economy, or what?

I came across the above discussion while reading about the rapidly devaluing dollar. It seems that, like Warren Buffet, I am making a sound decision to receive my pay in the form of Yen rather than U.S. Dollars. When Karen went to present at Oxford this summer her dollar was worth half Pound Sterling (meaning she had half the purchasing ability). Contrast that with when I was in Ghana several years ago and my dollar was worth something on the order of 8,000 Cedis - I was living it up on about $250 for three months.

Why does any of this matter, Paul? Let's consider recent developments:
1) Bank of America reported losses of several billion dollars in the third quarter (that's the end of September)
2) Merril Lynch reported billions of dollars in losses and fired their CEO
3) today Citi announced they, too, lost billions of dollars
4) oil is being traded at nearly $100 a barrel (this will be the higest ever)
5) the housing market is collapsing

Number 4) first:
Oil is expected to be expensive during the Summer because more people
(read: Americans) are driving their cars for vaction spots and in the winter more people (meaning us, again) are supposed to be using oil to heat their homes. Thus, usually the spring and fall are times for cheaper oil because there is less demand on the supply. When oil trades high it means that ultimately gas prices are high and so the cost of goods rises (because the higher gas prices paid by companies to ship your groceries the average 500 miles they now travel has to be absorbed by someone - that someone is you and me). When the cost of goods rises we get something called inflation. So long as the cost of oil rises, expect that you will need to pay more to get your average needs met - unless the government prints more money (this is why the Weimar Republic was in such a bad way at the beginning of WWI - you literally paid for bread with wheelbarrows of money). What is really screwing the pooch for us right now are numbers 1-3 and 5, read below.
How did these firms lose billions and billions of dollars? They invested in real estate. More specifically, in the wake of the dot com bubble bursting (The Market Correction, as it was labeled by Bush & Co. and also one of the puns of Jonathon Franzen's fine novel, The Corrections) the U.S. government allowed for deregulation of how banks could structure debt.
It used to be, before the Great Depression, that a mortgage lasted 10 years and so the down payment had to be much, much harder to collect. If you didn't pay off the loan (mortgages are loans) in those 10 years, the bank repossessed your home. In the wake of the Great Depression the Fed initiated a number of sweeping changes to the banking industry. Among them the Fed made it possible for more Americans to have the ability to own a home by making 30 years the standard amount of time in which to settle the mortgage (it's a debt). For decades, then, the reigning opinion has been, "Homeownership is the best way for low-income families to generate wealth." How is that done, Paul? I thought these people were in debt?
You're absolutely right, these people are in debt, and here's the heart of where our financial woes begin as a nation. When the dotcom bubble burst (mid- to late-90's) there were a number of folks (call them investors) involved in making money in the stock market. Now the rule of the stock market is buy cheap stocks and sell them when there is a strong demand for them, that's when the price is high.

The executives and financial officers of many, many firms had invested their fellow employees' retirements into stocks that were sold as sure-fire quick money making machines, for some reason these hacks felt that every single tech company would be Google and Amazon.com. They weren't and all those retirements were lost when people realized that everyone was investing in the same stocks and the only value these stocks had were that everyone else thought they knew something no one else knew.

Here's a visual: there's a stream of happy-go-luck lemmings heading in a herd in a direction and slowly word started spreading that the lemmings up front were tumbling to their doom. Word got around on our 24 hours a day, gotta have a story media that the very same stocks that were being touted as sure-fire on the finance program earlier that week (hey, why not, finance can be newsy too!) were actually going to lead to massive poverty. So all the inverstors, the very ones that had driven the price up for so long, were now taking their money out as soon as they possibly could; hopefully before all the money was gone.

To avoid losing an election year, the mortgage industry was allowed to deregulate in such a way that banks and hedgefunds could take debts and sell portions of the debts to others. Basically what's being sold here is the promise that a debt will one day be collected and with interest. Two problems arose here:
1) If I lend you $100 and Roper sees this, he cannot say that there are now $200 present in the system. You have my $100 and I have the promise that you will give it back next year with an additional $15 (this is called interest, the amount you pay for the convenience of using my money now to be paid back later). People (read: Chief Financial Officers and other important financial analysts) nonetheless began investing into these hedgefunds with the belief that there was now $200 present to be shared among whomever was smart enough to invest in this great scheme. This is the fallacy of mistaking credit for money. Money is not the same thing as credit. Why not? If I lend you the $100 and you no longer value honoring this debt not only am I out $100 dollars, but you done spent the money too. Now there's no dollars. This is what happened with the subprime mortgage industry this summer.
Subprime means that the borrower cannot get credit extended to him at the prime rate (the rate that the Wall Street Journal prints each week). Why can't he? Because the credit reporting bureaus (Equifax, Experian, and TransUnion) came up with an algorhythm (that's your credit score) that is supposed to predict when a person will pay his debt on time. His score says he ain't paying on time no time soon.

It doesn't work, they announced this year. Turns out that people realized you could sell the ability to be an "authorized user" on someone's credit accounts and in so doing everyone's credit score rises. The higher your credit score the lower the interest you should pay to borrow money.

Because of deregulation, many people that should not have been extended credit were nonetheless extended a ludicrous amount of credit. How? The rules were changed so that a person that could only afford a $1,000 monthly mortgage payment was able to qualify for a mortgage payment of nearly three times that. How is that possible, Paul? The magic of deregulation allowed it so now you could qualify for this much too large mortgage based on this initially lower interest rate, a teaser rate. You pay the low, low interest rate for the first 2 years and then every year for the next 28 years your interest rate will vary - more than likely it will be significantly higher (this is a 2/28 mortgage).

Why would anyone encourage this practice? There are two immediate benificiaries: the people selling the mortgages ('cause they get a commission on these loans), and the people (banks and hedgefunds) that lost their money in the dotcom bust. Run from the frying pan into the fire. During this time there was a constant lowering of interest from the Federal Reserve Bank (my student loans were carrying, like, 1% interest I had too borrow at those terms!), remember? Why were the rates dropped? Because the dotcom bubble had just burst all over ouf faces and the freedom haters attacked us; we had to stimulate the economy. Bush, in his initial statements after 9/11 said what? He said, go out and buy, America. He said that specifically.

But how will we do that, W? We offer interest rates so low that no one feels afraid of the actual cost of borrowing. Now the chickens are coming home to roost. In October an estimated $30 billion dollars of adjustable rate mortgages (ARMs) were adjusted and every month for the next 12 months a further $1 bn will be adjusted. In Carroll County, west of Atlanta, one in 27 homes is in foreclosure as of this month. What's fueling this? HGTV and there exciting reality programs about flipping properties.

People were reading books about investing in real estate and this would be the way to secure a retirement. Buy a house cheap, use a second mortgage (a Home Equity Line of Credit) to cover the cost of fixing the property up and sell it for more than it's really worth. All of a sudden there is this spike in the Labor numbers - everyone's employed in housing, whether supplies or construction or whathaveyou. In Carroll County there has been 1 request for a building permit for an apartment complex this year, last year there had been a significantly larger number.

So: less people are employed, more people are facing foreclosure than since the Great Depression, the average American before last year was carrying an average credit card debt balance in excess of $8,000; the median student loan debt was $35,000; the war on terror continues to cost hundreds of billions of dollars (we're literally dropping billions of dollars onto our enemies, shooting bullets of excess capital into their bodies - we're that rich); and investors are artificially driving the cost of oil up because their real estate money's all gone (optimistically), or, we've reached the peak oil moment - where the cost of oil continues to rise until we are finally forced to innovate a new way to make groceries travel an average of 500 miles before it reaches your dinner table.

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