Tuesday, September 23, 2008

New Territory For Our Economy

The history of what got the United States in its current financial mess has been written about on this blog, Moneythoughts, numerous times, but let us review the story briefly once more.

The housing and the mortgage market are tied together. Builders can build houses, but without buyers that process soon stops. My example: the early 1970’s before there where mortgage bonds and the whole process of the securitization of mortgages. Taking mortgages and putting a giant rubber band around them and selling them as a mortgage bonds is a great idea, but was not around in the early 1970’s.. The problem is that unless the mortgages, their quality and that means their ability to pay principal and interest on time, are properly graded and given the correct bond rating, then eventually the market looses confidence in the mortgage bonds and the bonds stop trading because no one knows what is in them and you have a mortgage bond market melt down. There are billions and possibly trillions of dollars in mortgage bonds that no one knows what is there ability to pay. The US Government is about to buy all these bad mortgages and give the banks fresh cash to replace them.

At the same time that the mortgage bond market is being abused by the underwriters and the rating agencies, the domestic economy receives a jolt in the sudden rise in the price of gas and diesel. This takes money out of the system at a time when the people in mortgages they can not afford are trying to hold onto their homes. Then the continuous drain as the American consumer continues to buy everything under the sun from China and other countries. Add to this the amount of debt being created by the US Government to pay for the “war” in Iraq. The debt issuance by the US Treasury weakens the US dollar in the foreign currency markets forcing up the price of oil that is traded around the world in US dollars (oil prices are quoted in US dollars). As the US dollar weakens the price of oil continues to go up taking more money out of the system. Remember the story about the basketball and you can not take the air out of it and expect it to have the same bounce?

OK, now that and a series of bank and investment house bail outs and we are up to present day. What now? Well, we are with our collective backs against the wall. There is literally no where for us to go. The US Government and the US Treasury and Henry Paulson will now be the bank. That is right, just like when you play Monopoly, the board game, someone is the bank. Well, Mr. Paulson is the bank and the US Government is going to give him $700 billion to start the next round of the game. Where is this money going to come from? Well, the Federal Reserve Bank can create demand deposits with each bank that sells the US Treasury its bad mortgage bonds and other bad debt and whatever crap they might have hanging around their balance sheets.

Oh, there are a lot of politicians and talking heads on TV acting like they know what they are talking about, but until you see a real economist on TV talking, the safe thing to think is that we are in uncharted waters and no one really knows what is going to happen. This much I can tell you. The next round of inflation is going to further erode the value, spell that purchasing power, of the US dollar for all of us. And that includes those that accept US dollars for payment overseas.

I want to come back to the idea of regulation, oversight and auditing. These three things right now must replace Father, Son and Holy Ghost. That is how important regulation, oversight and auditing are to the survival of our domestic economy today and in the future. The idea that the conservatives have been espousing for many years now that the markets will regulate themselves is plan unadulterated CRAP!!! I hope you understand that I am understating its importance for the sake of brevity. Think air traffic controllers, would you want to fly without any air traffic controllers on a commercial jet and try and land in New York, Chicago, Atlanta or Los Angeles? Think about all those planes picking their own time to land and the runway they want to land on. What kind of commercial air business do you think we would have with that layout?

Stay tuned.


LceeL said...

Just so the story is perfectly clear - this move to de-regulation which gave rise to the feeding frenzy of greed and avarice which have toppled our financial markets and institutions, arose out of the teaching of Milton Friedman, of the University of Chicago. His laissez-faire attitudes regarding the banking business and the markets became the anthem of the Conservatives and then the Neo-Cons. The lack of effective leadership in Washington further exacerbated the problem. Thus our currnet state of affairs. That about it, Fred?

moneythoughts said...

You are absolutely correct, and I have nothing to add.

Some ideas sound good or they look good on paper, but the real world is much different than the academic world that Milton Friedman was a part of his whole life.

Robert said...

Yes, the deregulation has created a mess.

Still a lot of middle class people bought it, partially because middle class benefited also. I'm amazed how large and nice looking most of today's houses are compared to the smaller and more spartan homes that were common when I grew up in the 1960s.

Consumption, consumption and the yuppifying of America.

Along with that came many bad things for the environment, like along with larger house and lot size came sprawl and longer commutes. I think the average commute is longer than in the 1960s. Burning more oil, per person; even with more fuel efficient cars.

The super wealthy corporate executives played the fiddle and average middle class folks danced to the tune.

Now middle class has split into upper middle class and the rest going into poverty. Many cities have become unaffordable for large portions of the population due to land and housing costs.

The house of cards looks like it's tumbling so some of this extreme "free market as God" rhetoric ought to fall out of favor.

moneythoughts said...


I sure hope so! Your comments are right on target. Well said.