Some financial musings

So, the bailout bill failed and the Dow dropped 780 points.  Egads!  There are some things I would encourage people to think about:

1. It is not all gloomy.  Notice the price of gold.  I have written previously that gold is a good refuge investment for people in this crisis.  When the markets crashed in the Great Depression, we saw a very different pattern.  The price of gold tanked in 1931, from $20.69 in 1930 to $17.06 in 1931.  What this means is that wealth was destroyed in the crash.  The fact that gold is rising DURING our current crash means that at least some of the wealth is just moving elsewhere.  That is moderately good news.
   
2. Why is it that we are bailing out investment banks in the first place?  If the problem we are facing is a lack of liquidity (nobody wanting to LOAN money), then why bail out the people who BORROW money?  Goldman Sachs et al. do not loan money, they borrow it!  We should be adding liquidity to the commercial banks instead.
   
3. It is interesting that every time we have one of these bailouts, it seems that Goldman Sachs is the primary beneficiary.  This was true with the Mexican bailout in 1994 when Robert Rubin was CEO of GS (GS was Mexico's investment bank), when AIG was bailed out a couple of weeks ago, and again if this bailout plan goes forward.  Is it any coincidence that Paulsen is the former CEO of GS?  Now that all of the other investment banks have been bought up by commercial banks, they are all held to reserve requirements for commercial banks.  GS is the only true investment bank left (as far as I know).  
   

Just sayin...

Good riddance, bad bailout

Thank God that pig of a bailout bill did not pass.  The last thing we needed was another bill passed in a panic, without careful thought, and with more attention paid to the political calculus than the economic needs of the country.  This was a bad bill because:

1. It was funded by borrowed money, as I discussed in my last entry.  Borrowing this amount of money would have driven down the value of the dollar, thereby spiking inflation.
   
2. It rewarded the people who risked our money by reducing their exposure to risk.  Fat cats who gamble on the economy should be allowed to go broke, just like the thousands of people facing bankruptcy and foreclosure.
   
3. It gave unprecedented power to the Secretary of the Treasury.
   
4. Though Republicans claimed the government could turn a profit on the bad debts purchased by these funds, that is clearly rubbish.  If these were good investments, chances are they would not be considered worthless today.  That is why we are in this mess.
   
5. The provisions that attempted to reduce executive salaries and golden parachutes were so full of loopholes, you could drive a truck through them.  For example, it said that companies couldn't write off salaries above $500,000.  Whoop dee doo!  It also did not prevent multimillion dollar golden parachutes as long as they were part of an existing contract.
6. Remember that the Bush administration has a history of choosing not to enforce parts of bills it doesn't like using signing statements.  So, we have no reason to trust they would uphold any of the provisions in the first place.

This is not to say that nothing should be done.  I like Thom Hartmann's idea to re-institute a transaction fee.  Until 2007, there was a 0.25% fee for stock transactions.  This was a miniscule amount for retail investors such as myself (in comparison to my brokerage fees), but was enough to curb speculation by investment banks and day traders.  It also generated enough revenue to fully fund the activities of the SEC, which used to actually ENFORCE the law.  Thus let the speculators pay for the bailout, not taxpayers who are the victims of this fiasco.

I would also support a bailout for resident mortgage holders.  People who actually live in a property could apply for some kind of refinance package on better terms than their sub-prime rates.  This would put millions of Americans back on their feet, and fuel a true recovery.  This is what FDR did after the Great Depression.

We'll see how this plays out.  I am afraid that Congress will eventually fold on this, just as they did on FISA, torture, etc.  I predict that they will pass a revised bill before the recess.  Too bad. In 1931, Herbert Hoover tried to end the Depression by bailing out the banks.  It failed, and the banks failed a year later anyway.  I predict that this will happen again.  The Bush Administration is just trying to buy a few months so that the big crash will happen after the election.  Then the Republicans will try to blame Obama....

Here is a Hoover flashback:

Sound familiar?  

Bad idea from left field

I was sipping my first coffee this morning with bleary eyes after my son had us up at 3am due to a nasty cold, and I found an email from my cousin with an interesting idea.  The Fed had just bailed out AIG, an insurance company that insures investment risk, for $85 Billion.  The email proposed that instead of bailing out anybody (including the $700 billion for the banks this week), the government should just divide it up between all of the voting aged population, and send it out.  It is called the "We Deserve It Dividend."  

Now, the email invalidated itself right off the bat with some atrocious math.  It claimed that dividing the $85 Billion between roughly 200 million people would give each of us $425,000.  I did a little double take, but my morning brain gave it a temporary pass.  Of course, it would really be only $425.  Snopes has already put this one to bed.

Once I had gotten past the voodoo economics, I thought about it a bit.  It does have some persuasive power as an idea.  If we reject the foolishness of supply-side trickle down economics, we could conclude that the exact opposite is preferable.  "Trickle-UP" economics would contend that giving the poor and middle classes money would drive up demand, stimulate production, produce jobs, and create economic utopia.  This is why this email has gone viral, and I received it from my cousin.

The problem is that both forms of trickling are equally oversimplified and wrong.  In the case of this "dividend," or Bush's "Economic Stimulus Check" for that matter, it just can't work out long-term.  Here's why:

1) Where is the money coming from?  

China mainly.  China holds about $1.5 Trillion of our debt, and continues to be our biggest foreign customer of US Treasuries.  In return for buying our debt, they expect a modest rate of interest in return.  However, it adds up when you are talking about such large sums.  So, it is not that the US government has money bursting from its coffers, and we can just ask for it back.  Taking this dividend would indebt our children and our children's children for generations.

2) Where would it go?

What would people do with the money?  Would they go shopping, and drive up consumption as it is hoped, and drag us joyfully from ruin?  I don't think so.  First of all, any sensible person would first use the money to pay off debt.  The average American has $9800 in credit card debt, and would be foolish to do anything but pay that down first.  Then there are back mortgage and car payments to make.  So, in essence, the vast majority of the dividend would just go right back to the banks, stimulating nothing.  

3) What would people buy?

Assuming some people were in good enough financial condition, or were stupid enough to go shopping while in debt, what are they likely to buy?  Since our manufacturing base has been destroyed by Reaganomics and free trade, buying things in the US has little overall impact on the US economy.  This is especially true for consumer electronics, which are nearly universally manufactured in Asia.  Therefore, much of the benefit from consumption fueld by this dividend would end up overseas.

So, though the government sending out money would probably prove popular (or populist), it would be a very bad idea.  Many of the people who received this email probably figured that out halfway down the page.  It is my misfortune to require a two-page research paper to work through it...

Looking into the abyss

Several months ago, I was listening to the podcast of the Thom Hartmann radio show on Air America Radio and became exceedingly anxious.  His guest was Dr. Ravi Batra, the (in)famous economist from SMU, who is known for making doom and gloom predictions, AND BEING RIGHT.  Dr. Batra was predicting that the economy was going to go to Hell in a handbasket in July or August, and made such a logical case that I started doing some research. I read two of Batra's books--Greenspan's Fraud, and The New Golden Age.

Here is an audio YouTube of the interview. Listen to the other parts, too.

I am a politics and economics junkie by nature, and already had some background in the subject, but I delved deeper into his case.  When I was finished, I called all of my friends and relatives and told them I was getting out of the stock market, and into gold, Euros, Short-term US Treasuries, FDIC- insured CDs, and inflation-adjusted bonds (TIPS).  They thought I was a bit crazy at the time, but after Black Monday they paid a bit more attention.

How did we get here?
Under the mantle of "free trade" and deregulation, the Republicans in power since the Reagan administration have been dismantling the structures, regulation and oversight that created the middle class after WW2, and kept our economy productive and wages high.  Reagan began a war on labor when he broke up the air traffic control union, and with only a slight pause under Clinton, the Dept. of Labor has served corporate interests, NOT the interests of workers.  As a result, we have seen real wages decline, tax incentives for corporations to ship jobs overseas, a decline in union membership, and the erosion of our manufacturing base.

The current mortgage and bank crisis is down to the Gramm-Leach-Bliley Act, which destroyed the firewall between commercial and investment banks set in place by the Glass-Steagall Act in 1933.  Phil Gramm (McCain's main economic advisor) also wrote the Commodity Futures Modernization Act.  This allowed banks to gamble with bank deposits, and led directly to the disasterous invention of mortgage-backed securities.  Poor oversight also allowed banks to pursue sub-prime mortgages, naked shorting of stocks, and speculation in oil commodity markets, etc.
http://losangeles.injuryboard.com/miscellaneous/the-subprime-mess-and-phil-gramm-an-experiment-in-deregulation.aspx
and
http://www.zimbio.com/Finance/articles/20/History+Repeating+America+Gilded+Age+Past

What's happening now?
Bush's military adventures and profligate spending have turned a $200+ billion surplus under Clinton into a $800 billion deficit. The debt is now close to $9 Trillion, up $5 trillion from 2000. The bailout of investment banks is essentially mitigating the risk the fattest fat cats in the world took with our money, while doing nothing to fortify the foundation of the economy--the demand fed by a healthy working middle class.  These bailouts will come in the form of further borrowing, mainly from China and the Middle East, further driving up our debt.

The way we have recently gotten out of recessions is by lowering interest rates.  This is what Greenspan did in 1982, 1991, and 2001. That will not work this time.  Lower interest rates are designed to encourage people to borrow money to spend, thereby stimulating consumption, production, jobs, etc.  The problem now is that people are tapped out. They have little or no collateral for further debt. I read that the AVERAGE credit card debt in the US is more than $9800. They are using credit to buy food and pay off other debt. People are upside down on their mortgages, and are losing their jobs.  Without the stimulus normally caused by rate cuts, these will just lead to more inflation.
http://www.forbes.com/finance/2008/09/12/credit-card-debt-pf-ii-in_jl_0911creditcards_inl.html

The statistics seem to show that inflation is still historically low, but that is because the Bush Administration has been monkeying around with definitions and methodology, and reducing the information fed to the public.  Here is a great article on that:
http://www.marketoracle.co.uk/Article3135.html

The Political angle
I believe that Bush, Paulsen, and Bernanke are now attempting to kick the can down the road.  They know that the economy is crashing down around us, and hope that they can prop it up long enough so they can blame it on the Democrats after the election.  Notice that oil prices have mysteriously dropped, just two months from the election. This despite depreciation of the dollar, two damaging Gulf hurricanes, the threat of war with Iran and Russia, sabre rattling by Hugo Chavez, and potentially devastating revelations about oil reserves in the Middle East and elsewhere (Peak Oil).

I am not convinced that they really want McCain to win.  Conservatives hate McCain, and I do not find their feigned enthusiasm for Palin convincing.  The alternative view, which I don't find persuasive, is that they think they can get richer if McCain continues the current policies.  No, I think they secretly want Obama to win this time, even though it will hurt their short-term interests.

What's coming?
I think that we are in for a real catastrophe.  I fear that this might be WORSE than the Great Depression.  Now, before you accuse me of wearing a tinfoil hat, think about this.  The conditions that lead to the Depression were VERY similar to those today.
http://www.reuters.com/article/domesticNews/idUSN1741285420080418

The problem is that we do not have the manufacturing base we had in the 1930s to backstop the slide.  We also have FAR more debt, which means that we have less capacity to borrow money to fund public works
and infrastructure improvements, which were FDR's primary tools for ending the Depression last time.

My opinion is that the bailouts being discussed this week will only buy a few weeks or months, and then the doodoo is really going to hit the fan.  Consumption will drop precipitously, which will cost jobs. Lost tax revenues will kill state and local government budgets, forcing them to reduce expenditures on services like fire, police, etc.  If foreign governments decide to stop buying our debt, or if oil-producing countries start denominating oil in Euros instead of dollars, we are SCREWED.

By the way, I am not convinced that Americans will be willing to stand in long lines for jobs and soup, and live in Hoovervilles, as they did in the 1930's.  I think there will be lots more violence and crime this time.

What to do?
I am writing because I think it is important to batten down the hatches. This coming depression will probably last several years. Dr. Batra's advice is to downsize your life as much as possible.  Get out of debt as much as possible. Stay far far away from the stock market.  Buy "refuge" assets, like gold.  Buy Euro-based assets, because the EU is more fundamentally sound, and the Euro should hold up if the dollar crashes further (I own FXE--an ETF that invests in Euros).

Batra also recommended selling your house and renting before the mortgage crisis hit.  I don't know if this is still good advice, but I am not going to do it.  I think we got our house for a good price, and that our area of London was lightly touched by the bubble here.  Our interest rate is 5.24%, and we will be able to make payments as long as I keep my job and the variable rate doesn't go above 10%.

Silver linings?
If you are in a position to maintain cash during this catastrophe, you may be able to profit handsomely on the other side.  Real estate should become very cheap.  You can bet that whomever wins the election in November will try to stimulate growth by investing in infrastructure.   So, there may be buying opportunities for infrastructure companies. Better to go for the picks and shovels companies, rather than the gold mines, to borrow a CA Gold Rush
analogy.  I have some shares in Mueller Industries (MWA), which sells water pipes and valves. It seems that both McCain and Obama will invest in alternative energies, so look there as well.  Energy efficiency will also be big.

That is enough for one post. Looks like a Kos post!  There is much more to be said. If you have any persuasive arguments to the contrary, I would be happy to hear about them.  Things are pretty grim from where I am sitting, and I am feeling increasingly anxious about my ability to provide for my family.