The Crapper: Brother of Minus Does More Economic Explaining For Us Common Folk
I just got back from a three-day conference at my home office in Phoenix, where I learned that the state of our economy is a bit worse than I first thought. For this week, I wanted to let you know that, once again, the Dow Jones is not a direct indicator of actual reality (especially since AIG was kicked off the Dow Jones Industrial Average and replaced with Kraft). If the Dow was an indicator of actual reality, nobody would be trading anything…everything would be frozen in position, as it is with our economy.
One of the speakers at the conference came to tell us about the housing market and why the $700 billion “bailout” is necessary (note: I hate the word bailout, and I refuse to use it from this point onward. This whole thing is one giant investment, which I will explain later).
First, you need to understand a brief history of banking. At the beginning of the Great Depression, people began to realize that their money wasn’t safe in a bank, so they ran to the bank and took all of their money out. Unfortunately, most banks at the time kept a minimal amount of actual cash on hand. So when every one of their customers came to take their money back, they found that the bank was dry. Before the bank could get more cash, they collapsed. At the time, there was no FDIC (Federal Deposit Insurance Corporation), which now protects your money in case your bank fails (or at least $100,000 of it…but really, who has that kind of money in their checking account?). So, in the ‘20s and ‘30s, if your bank failed and you didn’t pull your cash out soon enough, you lost all your money. You may as well have set it on fire.
Today, banks are required to keep a certain proportion of their assets in cash (sometimes referred to as a bank’s “liquidity” or “liquid assets”). As a result of the latest crash in the housing market, a lot of banks do not have excess cash on hand. It’s all dry. They have the required amount of cash on hand, but nothing extra that they can lend to people. What does that mean? It means there’s no credit. No more loans. No more business ventures based on a person’s or corporation’s credit rating. The average credit rating today is higher than it was five years ago, but the banks don’t have excess cash to lend to people.
The $700 billion dollar investment is designed to do two things: (1) take the bad debt off the books of the banking industry, and (2) give excess cash to the banks that they can loan out. It’s a shaky proposition, but this is the best idea they can come up with. Really, there aren’t a whole lot of options at this point. If they don’t do this, the banks cannot lend any money. If the banks don’t lend money, the whole economic system (largely based on borrowed money in the United States) could come to a screeching halt, and ultimately collapse. Then we would see a spike in unemployment (perspective check: right now, unemployment is at about 6.2%, which is above the standard goal of 5.5%, but well below the 25% that it was during the Great Depression. So, yes, it’s bad, but it’s not Great Depression bad.).
The government isn’t giving $700 billion to the banks. They are buying an investment. Ultimately, the government intends to either collect on the failed mortgages, or sell them off at a substantial profit at some point in the future. If all works out as planned (or hoped, rather), this $700 billion could turn into a substantial profit of several trillion dollars at some point in the future (estimates range from 7-25 years, depending on who you listen to…other estimates range from “immediately” to “never”). It’s a risk, and the country is largely divided on whether or not it’s a good risk, or an appropriate risk to take with taxpayer money. But keep in mind, our taxes have paid for crazier things than this, and nobody complained. Taxpayers once unknowingly funded a $300,000 study to determine which brand of ketchup was thicker…I poop you not. I mean really, these are the same people who brought you the proposal for the “Bridge to Nowhere.” It shouldn’t surprise anyone that a $700,000,000,000 cash infusion is a viable option (THE viable option, I should say).
Along those same lines, the AIG deal is not an $85 billion loan. It’s not a gift. And it certainly is not a socialist tactic. The deal is this: the government is giving AIG $85 billion as an advance. AIG is flat broke and needs money to keep operating while they find people to buy their subsidiaries. Don’t worry if you have insurance with AIG; your insurance is covered under a different subsidiary and cannot default in case you need it (always remember: insurance is HEAVILY regulated, unlike the investing market at the moment). AIG is using the $85 billion to stay afloat and find people to buy their pieces. If they fail to do so in a reasonable amount of time (which is totally undefined at the moment, but we’ll find out soon enough), the government reserves the right to buy an 80% controlling interest in AIG, presumably to take it over and sell off the subsidiaries faster and recover their $85 billion advance. It’s not a loan, and it’s not socialism; it’s a loan shark deal. If AIG doesn’t act fast, the government is going to track them down and start cutting off their fingers.
With Feddie Mac and Fannie Mae (Ha! Her name is Fannie!), the government has assumed temporary ownership of the company, presumably to clean house and get them back on their feet. It’s like when a kid in his mid-twenties gets fired and has to go live with Mom and Dad for a while. It’s not a fun idea. Nobody is enjoying themselves. But Mom and Dad let the kid run wild, and he screwed up, so now he has to live with the ‘rents and stop drinking and smoking for a while until he can get a new job and get back on his feet. It sucks, but what can you do?
So, basically, it seems that a lot of these problems are institutionalized a lot more than I originally thought. It’s obviously going to take a while for us to fully recover, although I do think we will start to see the beginning of a turnaround after the first 100 days of the next president. It would happen a lot quicker and a lot less painfully if people would stop using words like “socialism” and “worse than the Great Depression” when those terms obviously don’t apply.
Also, it might help if we didn’t use the same name for large companies that two-year-olds use for various parts of their anatomy. But that’s just my thought.
UPDATE: As of Monday, September 29, 2008, Congress decided the $700 billion deal wasn’t such a good idea in its current form. They’d like to talk about it for a bit longer. It’s somewhat like an opera: they can’t do anything until they sing about it for a long time first. As I said last week, I wouldn’t expect anything to happen until after the election. Everyone is too fragile right now in their campaigns, and the average voter doesn’t understand what this bill means. All the average voter hears is “Giant corporate thieves are stealing your taxpayer money because they can’t handle their own.” So they call Congress and say, “I ain’t payin’ no taxes to bail out no corporate thieves.” And then the congressperson has to vote “no” because every single constituent has called in to explain that if the bill gets passed, the congressperson is likely to lose the race. And progress moves forward (or not) in a fully functional democracy (or not) full of educated citizens (or not) where we’re out of options and out of time, but still continue to piddle around because we enjoy the opera.
Love, Michael
P.S. As a result of congress’ inaction today, the Dow Jones dropped over 770 points. To keep this in perspective, it’s important to remember that as a result of the events of September 11, 2001, the Dow dropped over 680 points. In short, this is bad. This is really very bad. A lot of people are going to lose their jobs over this. And not just at jacked up financial institutions like Wachovia (Hurray for more buyouts!). A lot of telecommunications and energy companies are now talking layoffs. I think it’s fair to say that we might be in a recession.
P.P.S. I would be willing to bet that opportunistic investors will drive the market back up soon (perhaps by the end of the week, like they did two weeks ago). However, I could be wrong. It happens sometimes.
