I know economics bores most of us, but Gilby and maybe someone else may read this.
It’s an economic-legal definition question, sorta. Here goes.
I Kinda understand how the fannie may type "take over the real estate holdings of a bankrupt bank ", Fed take over might work. At least the tax payer gets a ton of real estate for the $ spent. Potentially, there is value there that could appreciate during the coming inflation period.
Isn’t AIG an insurer ? This puzzles me a lot. Don’t insurers need deep pockets ? They are the ones who have collected the money already, and now have a basket of potentially enormous liabilities.
I will not pretend to understand this well, but did the USA taxpayer just give 85 billion $ to an insurer ? To buy a trillion or so $ of insurance liability ?
This is probably one of Billy’s most thoughtful and thorough explanations. Billy blames his toe fungus on the birth of Bush. He discounts the fact that disgruntled Wal-Mart employees are entirely responsible for the fiscal fiascos that this country is presently experiencing. Wal-Mart constitutes a mammoth economy in and of itself. It is constantly being undermined by employees motivated by their distorted self worth determined to sabotage it financially. Shame on you for this omission, Billy.
Appreciate? In dollar terms, maybe, but in real terms, it’s not going to happen. The fed caused housing boom resulted in a lot of malinvestment in the housing market. This created more supply than there was enough demand to sustain it. Resources were incorrectly pulled into the housing market which could’ve been used on other things that could improve our well being, but instead we have too many houses.
The cause of the housing bubble should be pretty easy to understand. Basically, the government backed Fannie & Freddie which signaled to investors that there was little risk in investing in them. This along with artificially low interest rates allowed them to buy up mortgages from banks. The banks, knowing that they always had a buyer for their mortgages, did not concern themselves with making sure the borrower was able to continue to pay their loan, as they would not be holding the loan, so they were only concerned with selling as many mortgages as possible to get the commissions. Further, the government had laws requiring banks to sell loans to poorer people and neighborhoods.
The solution to what we have now is to get government out of the way and just let the market readjust. Bailing out the banks only adds fuel to the fire.
End the fed and we no longer have the lender of last resort that creates these bubbles.
It sounds like they bought 80% of the company for 85 billion. Do we really need to bail out the investors that made bad investments? It’s going to be paid for by the taxpayers. Pretty sick that we have a system where an entity steals money from us, uses it to manipulate and cause problems and then steal from us again to pay for their mistakes.
Once they crashed, their boards were dismissed. The gov cut the cords to their golden parachutes and the stock holders lost every cent. Overall, a rough time for anyone who worked or invested there. Lehman stock is now as worthless as Bear Stearn’s shares. There may be somewhere to point the finger, but surely there is no champagne parties in the banking industry now. Basically, they went bankrupt and the gov has to deal with the trillions of dollars in outstanding mortgages, because no one else has the $ to do the job. They would have preferred to find a buyer, such as how Morgan Lynch was sold.
Were the gov to do absolutely nothing, this might lead to a rolling cascade of bankruptcies and foreclosures, with millions of abandoned homes of dubious ownership. That much I sorta understand.
The AIG thing is harder to grasp. What were they insuring ? The bonds that were backed by mortgage derivatives ? Does the taxpayer now have to insure the value of these devalued derivatives ?
I don’t see the Fed as a villain in this. I am not saying their policy played no roll. It’s just that the member banks of the Fed and their investors have lost way to much $ in this disaster to be accused of causing it deliberately.
No buyer? At the right price, there would be a buyer. Those mortgages have value. The holders of the mortgages have the choice of foreclosing and then selling the homes on the market, or trying to get some sort of payment plan set up with the borrowers that would make it more valuable to not foreclose.
What’s wrong with cascading cross defaults? Anything you do is going to be painful, as the damage has already been done, but it’d be quick and the market can then recover. Whereas with the government taking these, it’s going to be painful over a longer period. Should it be the investors that lose money, or should it be the taxpayers? By bailing out these organizations, does it encourage more malinvestment in the future with the government implicitly there to bail them out again on someone else’s dime?
The government owns AIG, along with most of Wall St. now, so yeah, they insure it at the expense of whoever they feel like stealing from.
Not really. They were making a lot of profits during the boom. They may have even expected a bust, but they didn’t care cause of the implied backing the government made.
Fannie Mae is an interesting situation, as they would buy mortgages to repackage them, and with the line of credit from the US Treasury, the repackaged mortgages had a lower risk, so they ended up being the big buyer of those repackaged mortgages, which attracted a lot of artificially cheap capital. I wouldn’t say it’s deliberate on the fed’s part, it’s just simply the result of the fed manipulating the money supply.
This is a very interesting debate for me, because I have an extensive collection of facts and half truths, and I am really sure I have a very poor idea of what is going on.
Stuff I am pretty sure of :
1 The Fed is actually just a group of hundreds of privately owned banks with 12 governors from the 12 regions of the USA, and a chairman that is confirmed by the senate. They serve for 14 year terms, and are most loyal to their banks, only a little worried about politics. The Fed itself turns any profit it earns over to the USA treasury. The member banks made money by borrowing it from the Fed at 4 %, and loaning it out at 6 %, on 20 year property backed loans, as an example.
2 Each member was given a credit line. If they owned a billion in USA gov bonds, they could borrow (and have to pay interest on) , 10 billion dollars, or there about (the rules are varied), at a very low interest rate, Prime rate.
3 This system worked well, as long as property values remained stable or rose. I remember a serious dip in property values in the late 80’s, after that, there was a very sharp rise. For instance, I bought my place for 50 K, with 5K down at 8 % interest in 1994. In 2004 the property next door (of similar size and value) sold for 350, 000 borrowed at 5 % with some adjustable rate thing. So you get half the buyers are young and have never experienced declining values. All they have known is watching their friends that bought become rich, while they were renting.
4 Banks are not being bailed out. They are being foreclosed on. Because of declining property values, people stopped paying on their loans. The banks still must pay that 4 % on every dollar they ow the Fed. When they can’t, their shareholders loose every penny. This isn’t a bail out. Because some member banks can’t pay the interest they ow the Fed, they are history, and the Fed takes over their equity. A bailout would be if the Fed let them “slide” on the interest, or forgave some of the debt. Which they can’t do.
You’re missing the fractional reserve aspect. If they loan out $100,000 whch they just created, they only have to borrow $10,000 from the Fed or another back, or have $10,000 in deposits.
I don’t understand what you are saying here. In any case, it’s not the Prime rate. The Prime rate is a rate set by the Wall Street Journal that is used as an index for many loans to their customers.
What concerns the banks and the fed are the discount rate and the federal funds rate. The federal funds rate is the one we hear about when the fed lowers rates. It’s actually a target rate the fed sets. Banks lend their excess “reserves” to other banks overnight at this rate. The Fed buys and sells bonds to push this rate up or down. The discount rate is the rate at which the Fed will loan out money to banks.
If success is bubble after bubble after bubble after… then yeah, very successful. I’d say success is a market without the false signals that cause malinvestment and create these bubbles.
House prices going up 7 times, in dollar terms, does not mean it’s successful. When we hit hyperinflation, are we successful because prices are going up?
Uh huh, so what is that $700 billion bailout they are talking about this weekend? It’s to buy up bad debt at book value, not market value. It’s a bailout where the banks will be able to sell their debt for many times it’s actual value.
Taking over Fannie and Freddie guaranteed the debt owed to other banks and investors. Buyout deals, where one bank buys another, are backed by the Fed where there is a guarantee on the value of the debt.
It’s all at the cost of inflation and taxpayers.
What is happening is a form of price fixing where the fed and the government are propping up prices of things that are overvalued. This hurts the economy. These assets need to be liquidated and allowed to reach their market value.
You’re missing the fractional reserve aspect. If they loan out $100,000 which they just created, they only have to borrow $10,000 from the Fed or another bank, or have $10,000 in deposits. - Gilby
I am quite sure you are off by $90,000, for the the amount a bank would have to pay interest to the Fed. $ 10,000 in bonds will give them a credit line at the Fed for $ 100.000. So when they "create money out of thin air ", to give the buyer a mortgage, remember they must also cut a check for $ 100,000 to the seller. They must pay interest to the Fed on $ 90,000 , not $10,000 as you suggest. If they only had to pay interest on about 1/10 the money they lended, property values would have to drop to 1/10 of the mortgage value, before the bank could loose any money, and obviously that hasn’t happened.
I agree with much of the rest you wrote. Except that to many houses were built. There is still a strong demand for housing, but speculators drove the price to high. Once the prices drop to where you can pay for the purchase by renting the house, people will start buying again.
The 700 billion $ thing does sound like a bailout.
Perhaps it would be better to take that 700 B and pump it into Fannie and Freddie, that the gov totally owns now. This would allow F and F to make new loans, with better oversight and larger down payments.
It would also allow the banks to fail, and people who speculated on property to lose, instead of the taxpayer.
I understand it poorly, but the gist of the bailout logic seems to be that once mortgage credit dries up completely (with all the banks closed ), houses and businesses will be impossible to finance, and plunge in value as a result. Consumer spending would tank, and the lay offs would begin. No new jobs until a very long rebuilding of credit institutions is able to fiance new factories, that no one wants to build anyway because demand is so low because people don’t have jobs to buy anything. With the commercial banks gone, it wouldn’t matter if you invented a better solar panel, that was in high demand. There is simply no one to lend you the money to build the factory, hence no jobs etc.
It’s to bad this is happening a month before the election. Now, the motivation of the politicians will be to do something fast, so nothing bad happens that could jeopardize their election.
Nope. If I go deposit $10,000 in the bank. The bank can then loan out $100,000 without ever borrowing more money. Their cost is the interest they pay me. Another example is if they write a loan out for $100,000 without ever having deposits to cover that $10,000 reserve, they would have to borrow $10,000 from another bank or from the fed.
There was artificial demand before which drove the building of lots of new houses. The artificial demand was due to the low interest rates. The low interest rates gravitated towards homes instead of elsewhere because of the backing of Fannie and Freddie by the government.
In other words, when the fed has low interest rates, it sends a signal to the market that there is an abundance of resources available, which there isn’t, and that drives overinvestment into whatever sector is looking best. The creation of money does not create more resources, it simply transfers the resources from the rest of the market, to the speculators.
I understand your claim that there is not too many houses, as people want bigger and more luxurious houses, and therefore the ones that exist will simply be filled based on affordability once the market corrects, which government action is trying to prevent from happening.
That’s just more of the same that caused this problem to begin with. If there were no connection between the government and the mortgage market we would not have this problem. Individual banks would assess the risk of mortgages they sold, charge the appropriate interest rates according to the risk, and then the people looking for homes will have to buy a home that allows them to live within their means.
Yeah, it’d be nice if everyone could own their own dream home, but let’s be realistic. There is a limited amount of resources. Giving everyone a dream home uses those resources and takes resources away from other worthy projects. You simply can’t have it all. If the market is just allowed to be a free market, then prices will allocate the resources according to need.
Huh? Giving money to F&F? That money comes from the taxpayer or through inflation.
[quote=“feel the light”]
I understand it poorly, but the gist of the bailout logic seems to be that once mortgage credit dries up completely (with all the banks closed ), houses and businesses will be impossible to finance, and plunge in value as a result. Consumer spending would tank, and the lay offs would begin. No new jobs until a very long rebuilding of credit institutions is able to fiance new factories, that no one wants to build anyway because demand is so low because people don’t have jobs to buy anything. With the commercial banks gone, it wouldn’t matter if you invented a better solar panel, that was in high demand. There is simply no one to lend you the money to build the factory, hence no jobs etc.
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By bailing them out, you are propping up the prices and pushing resources into these bloated sectors, pulling resources away from more useful industries. If they let them fail, prices will adjust and the market will then have real signals to use again, and the rebuilding will occur. It may take a year or two, but it will be much quicker to recover than to drag it out by continuing to push resources into these failed sectors.
If you want to understand this, you may want to read this book about the Great Depression: America's Great Depression
It explains that it was not the 1929 stock market crash that caused the Great Depression, but it was the interventions by the government that created it and prolonged it.
Speaking of the $700,000,000,000 bailout, the Secretary of the Treasury and former CEO of Goldman Sachs (a company that will make a killing on this bailout) is asking for dictatorial powers in his proposed bill:
“Nope. If I go deposit $10,000 in the bank. The bank can then loan out $100,000 without ever borrowing more money. Their cost is the interest they pay me. Another example is if they write a loan out for $100,000 without ever having deposits to cover that $10,000 reserve, they would have to borrow $10,000 from another bank or from the fed.”- Gilby
Nope, just do the math Giby. Someone deposits 10,000, this allows my bank the right a write check for 100,000 $ that the Fed will cash and wait 20 years interest free to get their money back ? You can’t seriously believe that.
So I pay 400 $ / yr. interest to my depositor ( 4 % x 10,000 ) , and collect 6,000 dollars a year from my mortgage holder (6 % x 100,000). If this were how it worked, I would recoup 100 % of my original investment in 18 months. After that, I earn 60 % annually on said original investment for the next 18 1/2 years, with none of my original investment at risk.
You are off by a factor of 10 in your vision of how profitable banking is. Were that true, how could any bank lose any money ?, with the present default rate of less then 10 %? If 90 % of my loans are in default, I still have an income of 6000 $ to pay interest obligations of only 4,000 $/ yr. Even if 9 out of 10 of my outstanding loans aren’t paying interest. Do you understand, writing a mortgage is the easy part. You must give the seller a check for 100, 000 $ today. That check won’t clear unless I have money at the Fed today to pay for it, or borrow the cash from the Fed, paying interest. The Fed will not loan money for free, or cash checks for you on your empty account.
Here is a link to the Fed web site for this quote.
“QUESTION How is the Federal Reserve funded?
ANSWER The Federal Reserve’s income is derived primarily from the interest on U.S. government securities that it trades through open market operations. Other sources of income are the interest on foreign currency investments held by the System; fees received for services provided to depository institutions, such as check clearing, funds transfers, and automated clearinghouse operations; and interest on loans to depository institutions (the rate on which is the so-called discount rate). After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.” - The Fed web site Please note the part about interest on loans to depository institutions.
If you want to insist banks pay interest on only 1/10 of the money they borrow from the Fed, explain why a default rate in the single digits is destroying them.
I’m not following everything you’re trying to claim, but…
OK, the math:
Currently the required reserves for deposits are 10%, so if I deposit $10,000, the bank has to keep $1,000 on deposit and it loans out $9,000. That $9,000 is deposited in the bank, and the bank keeps on reserve $900, and loans out $8,100. And it continues. Here is a table:
OK, now you are talking reserves to bank deposits. That is a very different thing then the credit line the Fed gives you if you are a member bank. For instance, the large commercial banks that existed last week didn’t accept deposits. They changed to bank holding company yesterday so they can accept deposits. Before that they got all their money from the Fed, by buying and holding Gov bonds. This allows them, for owning 1 billion in bonds, to borrow 10 billion $ at 2.75 % interest from the Fed. The mortgages are also collateral to the Fed. This is why Fannie and Freddie sunk. Their profit was the difference between the 5 ish % they were charging mortgage holders, and the 2.75 % interest they are charged for every cent that the Fed loans them. Once property values dropped, and they started to foreclose on people, they reached a point where they could not meet their interest obligation to the Fed, and they were taken over.
"You’re missing the fractional reserve aspect. If they loan out $100,000 which they just created, they only have to borrow $10,000 from the Fed or another bank, or have $10,000 in deposits. " - Gilby
Do you see now why that is impossible ? The member bank must give 100,000 $ to the home seller, and a mortgage to the buyer. Unless the bank has the full 100,000 $ to make the check good today ( 100, 000 $ from depositors, not 10,000 $), they must borrow the extra 91, 000 $ from the Fed, and pay interest. If property values drop 15 %, and 10 % of the loans go default, all profits are lost, the bank falls behind on interest to the Fed because of lack of income, and is liquidated like F and F was. This is because the Fed creates the “new money”, not the member bank, and the Fed must collect interest on every dollar.
The discount funds rate is how the Fed can control the expansion of the money supply. The less the Fed charges my bank to borrow, the cheaper they can lend, and the more people will borrow.
So in summery, the reason a member bank can’t create a 100,000 $ mortgage out of 10,000 $ in deposits, is that the home seller is gonna try to cash that 100,000 $ check while the ink is still drying. So if you only have 10,000 $ from depositors, your bank must borrow 91,000 $ from the Fed at 2.75 %, not 10,000 , keeping that 1/10 reserve to cover depositor with draws.
Don’t insurers need deep pockets ? They are the ones who have collected the money already, and now have a basket of potentially enormous liabilities.
