Computer Models and the Global Economic Crash

Anti-Globalism passes along a review in Ars of some recent speculation on the role of interconnected computer models in the global economic crash. "If Ritholtz, Taleb, Mandelbrot, and the rest of the computer modeling and financial engineering naysayers are correct about the big picture, then we really are arguably in the midst a bona fide computer crash. Not an individual computer crash, of course, but a computer crash in the sense of Sun Microsystems' erstwhile marketing slogan, 'the network is the computer.' That is, we have all of these machines in different sectors of the economy, and we've networked all of them together either directly (via an actual network) or indirectly (by using the collective 'output' of machines in one sector as input for the machines in another sector), and like any other computer system the whole thing hums along nicely... up until the point when it doesn't."

Comments

Can somebody 'splain this?

[seanadams.com]

I am not an economist but I have owned a couple businesses and consider myself a reasonably practical person.

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features. The only reason you "need" all that is because the banks created all these funny rules so that they could introduce more and more products and services. This is done so they can charge you more for each of those things, and also to differentiate them from their competitors.

Besides consumer banking, can somebody explain to me why we NEED "commercial paper"? Yes, I've read the wikipedia page and I know how it's used, but I don't understand why it's needed. If you can't make payroll then you're pulling from your credit one way or another - why do we need separate instruments for a 2 week loan versus a longer term loan, or a credit card, or whatever?

And don't even get me started on real estate lending...

It's like freaking starbucks - you can get your banking services just as special as an upside-down triple no foam half calf non fat 160 degree two splenda mocha. But it's one thing for a coffee company to cater to every individual snowflake's desire, and quite another IMHO for something as important as our financial system to become as absurdly complex and fragile as it is.

As for the people who are really benefitting from all this complexity - well, it's only during recession that we all collectively take a good hard look at who's making a contribution to society and who isn't. Unfortunately the powers that be think they can beat a recession by tweaking some rates, stealing from taxpayers, or shuffling money from one hand to the other. That's just going to hurt us more in the long term. We need to clean this shit up now - get rid of unnecessary products and overhead, and let the unproductive companies go bankrupt. Let the UAW strangle themselves to death. Just get it done.

Re:Can somebody 'splain this?

[cbiltcliffe]

It's easily explained by the Golden Rule:

He who has the gold makes the rules.

There. Explained.

Re:Can somebody 'splain this?

[flajann]

Not that we "need" it, but that the overall system dynamics evolved it that way.

Re:Can somebody 'splain this?

[Anonymous Coward]

It all goes back to the "invisible fist" of the free market...

Re:Can somebody 'splain this?

[Z34107]

I am also not a financial expert, but I can see a bunch of reasons why financial paper exists.

Maybe they're like payday loans for corporations. You have a long-term contract due, but not 'till the end of the month, and you want to keep your employees in the meantime. (I'm guessing this isn't as likely; only corporations with outstanding credit ratings can actually have any success in issuing corporate paper.)

Maybe it's a way of getting a loan without going through a bank or issuing stock. Say you want to build a new factory with payroll rather than actually pay your employees; maybe you're assuming the factory will pay off the interest on the corporate paper and then some.

The biggest thing at the end of the Wikipedia article you read is that, whatever the reason the money is needed, it's cheaper than getting it from a bank. If a corporation is big enough and has good enough credit, they can issue corporate paper, at a lower interest rate, instead of paying interest to a bank.

So, that one, at least, wasn't invented by bankers just to secure their own employment. Maybe somebody who actually knows something about this (a banker, maybe?) could enlighten me.

Re:Can somebody 'splain this?

[Anonymous Coward]

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

See Manulife One

Re:Can somebody 'splain this?

[2nd Post!]

I am not an economist but I have owned a couple businesses and consider myself a reasonably practical person.

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

Actually, probably not. I suspect (I'm a programmer by nature, so my experience with code may apply here) it's more of each institution and "network" offering redundant services until multiple institutions mature to the point where these services collide and become confusing.

For example, lots of people have a checking account, savings account, credit card, personal line of credit, HELOC, brokerage account, and more.

That wasn't true one generation ago. My parents had only a checking acount, savings account, and credit card.

I see absolutely no reason why a single account could not offer all those features.

With the advent of computers and networks, now it is possible. But 20 years ago? Not possible.

How would a bank know how much equity you had in your house? How would your credit card company know how much you had in the bank? How would your mortgage company know what your investment amount was?

Today, you actually have one company that handles all of it (and in cases where they don't, they can still trade information). So now I can have a HELOC, personal line of credit, credit card, savings account, etc, all tied together, in that credit from one reduces the amount of credit available on another, and all paid from the same account.

The only reason you "need" all that is because the banks created all these funny rules so that they could introduce more and more products and services.

In this case I actually disagree. Different people have different had different "collateral", so different kinds of credit were available to them. That explains why different products exist. Someone with a house vs someone with a strong credit rating vs someone who had lots of money all had access to different products. Now a single person has access to all of them.

This is done so they can charge you more for each of those things, and also to differentiate them from their competitors.

Besides consumer banking, can somebody explain to me why we NEED "commercial paper"? Yes, I've read the wikipedia page and I know how it's used, but I don't understand why it's needed. If you can't make payroll then you're pulling from your credit one way or another - why do we need separate instruments for a 2 week loan versus a longer term loan, or a credit card, or whatever?

As before, commercial paper was "invented" before credit cards (or business lines of credit or whatever) existed. It satisfied a market need that probably doesn't exist today.

And don't even get me started on real estate lending...

It's like freaking starbucks - you can get your banking services just as special as an upside-down triple no foam half calf non fat 160 degree two splenda mocha. But it's one thing for a coffee company to cater to every individual snowflake's desire, and quite another IMHO for something as important as our financial system to become as absurdly complex and fragile as it is.

It's this statement that brought me to this answer. Software is flexible (soft), so it can be molded quite easily to different needs according to different usages. The problem is that after four versions needs have evolved, but the original code has not, so now you have something complex and fragile that was originally quite simple and straightforward.

As for the people who are really benefitting from all this complexity - well, it's only during recession that we all collectively take a good hard look at who's making a contribution to society and who isn't.

So like software, it's only

Re:Can somebody 'splain this?

[NotQuiteReal]

...banks created all these funny rules...

I think you meant to say "banks created all kinds of workarounds to funny rules that politicians created"

Re:Can somebody 'splain this?

[Anonymous Coward]

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

Er - a savings account has higher interest which you pay for with limited rights of withdrawal. You can't have an account with the higher rates without giving something up. So there can't possibly be "a single account" offering "all those features". The same for commercial paper versus other debt instruments - they have different terms and conditions, and different law applies to different instruments, so they're different. You get to choose the one that you like best.

Re:Can somebody 'splain this?

[uncreativeslashnick]

Most of it is the way it is because it evolved that way, and because of the laws/rules under which it all evolved. You paint with too broad a brush when you say that the vast majority of today's financial instruments have been created out of thin air. That's nonsense spoken out of ignorance, the same way a non-geek might say, "why can't software designers create programs without bugs?"

Commercial paper is a very broad term and encompasses everything from promissory notes to normal consumer checks. Just about any transaction not involving cash or electronic transfer is done with commercial paper. A huge portion of financial transactions are still done with commercial paper. So in the general sense of the term, it is still very, very necessary.

Now if you want to start examining specific financial instruments, like the derivatives backed by (partially) crap mortgages, we can have a conversation. I think the idea behind those instruments was basically sound, but the things ended up being a lot more complicated than people thought. It makes sense that if you lump a bunch of mortgages together, only a small percentage of those will default, thereby distributing your risk. But in a climate where fraud was rampant and the people signing people up for mortgages had no incentive to make sure people could actually pay those mortgages back, your lump of mortgages has a much higher chance of containing too many bad mortgages to make the resulting instrument profitable.

The derivatives market had the perverse effect of creating and encouraging that climate, because the mortgage buyers would buy without enough questions because they knew there were buyers who would buy the derivatives without too many questions. The fundamental problem with the whole concept, it seems to me, is that the derivative buyers and sellers forgot to insist on and question the credentials of the individual mortgagees they were investing in. Had they done a little bit of verification there, we might not be in this place right now.

Re:Can somebody 'splain this?

[xtrafe]

Sure. There's a pretty simple explanation:

Somebody decided to offer these products and services, and one way or another, some other people decided to buy them.

Of course, we could (and do) make regulations that proscribe certain products and services... but our track record in doing this demonstrates less than stellar results. i.e. A lot of the stranger derivatives exist solely to circumvent regulation.

I think, very generally, 'the economy' adapts and optimizes against any regulations that are imposed on it. And unfortunately, the more effective regulation is, the more inefficiency it creates.

So before anybody proposes how the system should be manually 'tweaked', they have the burden of proving that an economy can be effectively regulated -at all- over the long term.

Re:Can somebody 'splain this?

[afidel]

Theoretically it's about risk assessment and market segmentation, allow the people making the loans set their acceptable level of risk and required rate of return. Obviously the system broke down, but that's because they came up with instruments so complex that they eliminated information from the system and thus hid the risk.

Re:Can somebody 'splain this?

[Lumpy]

Ohhh I have an idea.

Instead of doing Shady and immoral accounting practices why not do what honest small business do.

YOU HAVE THE CASH ON HAND TO PAY YOUR BILLS.

Accounting has turned into VooDoo and it's what causes these messes.

I dont run out and buy a shitload of gear on credit for my video and photography business. I do what sane people do.. when I can afford it I buy it. when the hard times hit, I ride it out easily while my competition scrambles to try and pay off the 60 some loans and their credit lines.

What if I need a new piece of gear for a job?? That's what the 50% down for the job is for. I need $8500 in gear for a corperate shoot? I get the $9500.00 downpayment at contract signing and buy the gear, do the shoot, collect the rest at delivery, and call it done. really simple.

Re:Can somebody 'splain this?

[AdamInParadise]

My parents had only a checking acount, savings account, and credit card.

In many developed countries (Europe, Japan, ...), many people have a single account which supports both checks and debit cards. Mine is also used as a brokerage account, but I'm probably not a typical client.

Re:Can somebody 'splain this?

[nelsonal]

Many are developed to not be something that was or is heavily regulated by the government. Commerical paper arose because banks charged high spreads between savers and borrowers mostly because the government put them in a regulated, but market with a raised barrier to entry. Commercial paper side stepped the existitng market to reduce capture that spread (by both borrowers and lenders). Rather than a bank making 3% on a loan, a money market fund manager makes about 0.3% (which is much closer to the actual costs). The major difference between the two was that the government promised to make good on $100,000 of the savers' money which is great for small savers but pretty meaningless when you are a pension fund with $50,000,000 in short term funds.

Short term loans are needed for businesses to invest in long term assets that pay out infrequently but who have cash needs along the way. Think of a farmer. They have a big annual investment (planting) some small cash needs along the way and a bigger future payment. They can get a term loan (with the land as collateral) for the planting, but they'll need something to cover all the fertilizer costs and such in betweeen. The problem arose when the fed used it's monopoly position to make financing cheap for banks (the Fed monopolistically sets wholesale bank costs) to impact the economy after the dot com collapse. Almost everyone could see that it was cheap to finance a whole lot more of their operation with short term loans because now they could tap into the same market or markets tied to wholesale bank funding costs, and save 60-80% of their financing costs.

Re:Can somebody 'splain this?

[Anonymous Coward]

You're looking at it from the small business, I need credit, I need cash, I need inventory, I need to make money point of view and in that case you're correct. One or two accounts suffice.

If on the other hand you want to make a market that lets you share risk and implement hedging strategies much less create value through speculations because you believe you're better at modern market price prediction than your competition then of course one or two accounts don't cover it and you need a liquid marketplace where traders can compete with each other.

Re:Can somebody 'splain this?

[Anonymous Coward]

This may seem like a snark, but it is the plain truth: the financial models failed because none of them allowed for the possibilities that housing prices can go down. The "Real Estate always goes up" myth was baked into the models. It was not physically possible in my experience to plug in a negative number into these predictive models. Look into Quaint Funds - they used these models alot.

Re:Can somebody 'splain this?

[Anonymous Coward]

not just type of accounts, but types of securities and ways of calculating performance. I work in the finance industry and have to write programs to calculate performance and evaluate and present holdings in many ways.

I think most of it is marketing. the different security types exist because of how they are sold. I am sure accounts are the same way. All in one accounts may make the most sense, but many people do not make purchasing decisions based on logic.

Re:Can somebody 'splain this?

[DNS-and-BIND]

Cash in the bank is money sitting idle. You want your money out there, earning for you. If you choose an overly conservative strategy where you don't borrow money, then your business isn't running efficiently. I assume you're an owner...in a corporation, you would be subject to lawsuits and removal if you are not getting the shareholders the maximum benefits available. Remember, a CEO's goal (lawful duty, actually) isn't to make a profit, it's to maximize profit.

Re:Can somebody 'splain this?

[ElliotLee]

Absolutely right.

Campaign for Liberty.com

Re:Can somebody 'splain this?

[countach]

Essentially, every debt has a risk. Risk determines interest rate. 2 week commercial paper for Ford has a different risk to 2 year commercial paper for Ford (which is different again to GM etc etc). You might have confidence Ford can pay up in 2 weeks, but you're not sure if the economy will tank in 2 years.

Now if Ford needs money for a certain period of time, whether to finance some car leases that are expiring in a month, or to finance some new ones that expire in 2 years, they've got to go to the market who will evaluate all the details of the risk and make you pay the appropriate rate.

The complexity of the system is people's attempt to defray risk. The problem is, the risk of the entire system became too aggressive, so all this defrayment of risk meant that nobody had more risk than anyone else, but everyone had too much.

Re:Can somebody 'splain this?

[HisMother]

This bullshit is exactly what's wrong with our entire capitalist system.

Re:Can somebody 'splain this?

[fucket]

I'm at work and want to buy a coffee but I don't have any cash on me. I could put in on my credit card (and pay interest on it) or I could just borrow two bucks from the guy that sits next to me. He knows that I'm getting a paycheck and knows that I'm good for it. That's commercial paper in a nutshell.

Re:Can somebody 'splain this?

[Anonymous Coward]

We don't need it. But the system made people borrow more than they could.

First it was "minorities" (or rather ACORN's definition of a minority "someone who votes for us") that got suspended rules on borrowing, thanks to the CRA, introduced by one disaster president without teeth, Carter, also known for being the cause of the human rights situation in Iran, and activated by the next disaster president, Clinton.

But the damage that this inevitably caused was seen by many opportunists that were just about everyone. So just about everyone, not just Americans, but Europeans, Arabs, Japanese, Chinese, ... the whole nine yards, was given relaxed loaning standards. Since that money ended up in banks, it could be paid to their investors as intrest.

So why did this system work ? Well mostly the money paid for houses was put in bank deposits. So let's depict the money flow :

bank -> lender -> seller -> bank

This is however not how it looks in the administration. Let's check how the accountants enter this scheme :

bank -> lender
bank : + $loan_amount in future income
              - $loan_amount in money
lender : + $loan_amount in money

lender -> seller
lender : - $loan_amount in money
seller : + $loan_amount in money

seller -> bank
seller : - $loan_amount in money, + (100+x)% * $loan_amount in future income
bank : + $loan_amount in money

So now let's look at the total balance of the banks, in the short term :

+ $loan_amount in future income (slightly more)
- $loan_amount in future liability (slightly less)

Ultimately, however, this is a ponzi scheme, but for society as a whole. Everyone who connects is vulnerable in exactly the same way. Even black gold will provide no release, nor will a "knowledge economy".

As long as the pie constantly grows there is no real problem, as the banks control all money (through association with "government banks", or by simply being those banks). They literally print money, which represents value.

But the system needs an ever increasing input of value, or it falls down. As any ponzi scheme does.

Right now the input of 1 subsystem fell *slightly*. Very, very slightly. Eventually the value input will stop altogether (esp. if "peak oil" theories are right, but if they're wrong that will simply provide a delay).

The system is, as they say, doomed.

*AND* we should destroy anyone who was involved in shortselling any commodity related to loans, they should be prosecuted for making (and winning) the bet that tens of thousands of people would lose their livelihoods, their houses. These people's gains should be impounded, their bets imposed for the total disasters that they were. And all other short-selling should be suspended as too risky to the economy.

Or at the very, very least, banks should be prohibited from loaning money to allow shortselling, and they should be forbidden from using money invested in shortselling practices as collateral for loans.

But we won't do that. If we did, the financial sector would shrink to 10% of it's former size, which would put much less money in Obama's hands to work with. Much, much less. And it will mean telling hundreds of thousands the truth, that they cannot be trusted with enough money to buy a house. Many of them will be "traditional americans", but obviously both the poor and "minorities" will be overrepresented, and won't be able to buy a house. (who are the original spark that started the fire, I do not want to claim it's "their fault", but they are part of the problem)

Re:Can somebody 'splain this?

[gregbot9000]

Loopholes have a lot to do with it, a whole lot. They aren't making all those exotic things to keep busy, they are making them to shave a few points off the tax burden, or to sell risky debt for a higher price.

Mainly though it's is liability, security, and liquidity. You have a separate checking account and savings account for stability.

The bank can write off your savings as stable and secure to lend out, since they tend to be stable, where as checking accounts fluctuate wildly. The amount of interest paid reflects that.

Same with loans, you have different types of loans based on your security and the liquidity of the lender. The way you pull credit is what really matters. Commercial paper is drawing on your credit but in different way. It is cheaper because of where the money comes from. The roots run to different places.

You should think of banks and lending institutions as being like any business, they buy up money by offering security and interest payments cheaply, Then they add utility and loan it out for more then they paid. The more they can cater means the more added utility, hence profit for everyone. This Has Worked. The problems with the sub prime, derivatives, and alt-A's isn't from the selection being to large. It would be as if Starbucks was cutting their coffee with radiator fluid and when they got caught they paid off the inspector and told the press it was OK because they were giving coffee to poor people.

Re:Can somebody 'splain this?

[Anonymous Coward]

Most of the banks in the US also offer (force) Debit cards on Checking account holder (your ATM card doubles as a Debit card in most cases unless you explicitly ask for a regular ATM card).

At least in the U.S. Credit Card != Debit Card.

Besides the obvious (credit vs. debit), there is also a difference in the responsibilities in cases of fraud. The simplest explanation is that in the case of fraud with a CC you still have possession of your money until you pay the CC company, and it is often up to a Vendor to prove a charge is legitimate. In the case of a DC, the bank has already deducted the money from your account and it is up to you to prove the charge is false.

Re:Can somebody 'splain this?

[dgatwood]

That would make sense if it were true. Federal law limits the number of withdrawals from certain accounts to six per month. That's not a bank policy. It's a law. Basically, the government wanted to force banks to keep a certain minimum amount of cash on hand (not loaned out to customers), and to preserve that, they put in place both dollar limits and that cap on transactions. Presumably this was because (at the time) computing the amount of cash on hand at the bank took a significant amount of effort. These days, the regulation is just plain idiotic, serves no real purpose, and should have been removed years ago.

That's the problem with laws designed based around limitations in technology. Technology very quickly renders those laws obsolete, but the laws never get removed from the books. Indeed, that's why I feel that all laws beyond a very small core of crucial laws (your basic murder, theft, etc.)---certainly all civil laws and regulations---should be required by the Constitution to have a sunset provision and should be reviewed at minimum every 10-15 years to determine whether the laws are still useful.

Re:Can somebody 'splain this?

[SerpentMage]

Why do we need commercial paper? Why do we need longer terms?

Banks operate in spreads and there are jolts to the spreads namely payroll, etc, etc. Thus to smooth the jolts you issue paper which gets you over those jolts in a very easy manner.

Let me illustrate. A speaker buddy had to pay a sum of money to his ex-wife. She demanded the lump sum and he did not have the money right away. He said he would have had to sell stock. So I said, do the following:

Go to the bank for 50 cents on the dollar to get a loan. Then use that loan to pay off the wife, and make payments until necessary. In other words it is all about the cash flow and utilizing the money you have.

This is not that complex actually. It is rather easy.

Why is the system fragile? Easy too much leverage. Do some history checks and it never is the instrument itself. Each and every bubble can easily be traced to people leveraging themselves. Leverage is death because with leverage you race time.

For example did you know what brought down the market in 1929? What we now call Mutual Funds! Don't believe me, read The Death of the Banker.

Re:Can somebody 'splain this?

[ArsonSmith]

seems like a busness opertunity here. If someone was looking to build an independant bank perhaps a model of the "one account" may be a way to do it. One number that says how much money you have. You could give yourself logical views of it for planning reasons, but it would be a way of holding your savings, checking, credit, mortgage, etc all into one account with one true number. Probably -200k+ for most, but that's where the planning logical views are. You could say to yourself, "my house is worth $230k so I can change that number to $30k" add in your savings and checking of which you may give a logical view of those as well. Or the purest could just leave it at the -200k and pay off everything directly into that number.

Re:Can somebody 'splain this?

[SerpentMage]

Oh come on...

Here is a question do you have a mortgage or did you pay for your house UPFRONT?

What about a car? Pay for all of it upfront?

I am not saying over leverage yourself, but to say companies and businesses don't need credit is completely fool hardy.

Credit is needed in a system where you are able to make purchases in certain items. The problem is when people over leverage themselves.

Re:Can somebody 'splain this?

[thpr]

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

Actually, many of them have a good basis in logic, but are used beyond their original purpose.

For example.... I see absolutely no reason why a single account could not offer all those features.

Part of the reason there are individual companies that separated items like brokerages and commercial banking is historical structure created in the Great Depression, known as the Glass Steagall Act

Other responders to your post have pointed out various specific details, e.g. reason for commercial paper, but let me cover a more general point of view on why so many different products exist: Risk.

The issue, however, is that risk doesn't come in only one form. There are different types of risk:
- Default Risk (if a company goes bankrupt, you don't get back your principal)
- Inflation
- Interest rate risk (if interest rates change, then the value of underlying loans change)
- Tax Rate Risk (different tax rates due to different income or time)
- Counterparty Risk (risk of entering into a contract, but the other party failing to fulfill the contract)
- Secured nature of the debt (recovery in case of default)
- Opportunity cost (cost of not doing an alternative with the money)
- etc.

Looking at various products we can see how they are different. An IRA vs. a Roth IRA actually transfers the Tax Rate Risk onto the government (you pay a known tax rate, and the unknown benefit or penalty due to the future difference is absorbed by the government)

A TIPS (Treasury Inflation Protected Security) vs. a normal Bond issued by the government transfers inflation risk onto the government (presumably the normal bond is accounting for perceived inflation in the offering price, but the TIPS accounts for real inflation, thus allowing one to eliminate the risk of the perception of future inflation being incorrect.

We can see today that today's 4 week Treasury Bill Auction resulted in zero yield (give money to the government for 4 weeks, no interest). This presumably would mean the return one could get in a non-FDIC insured bank account (over the current $250K limit) is entirely bankruptcy risk premium.

Also there are organizations that do market clearing of bonds and stocks that absorb counterparty risk. Part of the problem with credit default swaps was that the holders of those products actually bear the counterparty risk, as they are not regulated like other products. (When combined with a lack of market data on quantity and concentration of the risks around default of bonds, this led to one of the underlying issues in the problems we have right now)

Lastly, there are also "positive" values that are priced into different financial products, such as recovery in case of default. That's why secured loans of [statistically] appreciating assets (e.g. home mortgage) are lower rates than loans on depreciating assets (e.g. automobile) and those are lower than unsecured personal loans. Same reason bonds will maintain value longer than preferred stock.

As a specific example of what is good (and bad), look for a moment at interest rate swaps. They actually serve a valuable purpose, in allowing an investor (or the loaning company) to convert a variable-rate instrument into a fixed-rate one (or vice versa). This is valuable to companies to be able to "lock-in" lower interest rates when rates fall, for example. What is risky is when someone speculates on interest rate swaps without having an underlying asset. This results in significant leverage that can be wiped out very quickly if interest rates (i

Re:Can somebody 'splain this?

[S77IM]

Our economy is a giant pyramid scheme. Wealth is created through lending by investing in business ventures. It's good for the borrower, who gets the capital to grow their business; it's good for the lender, who gets interest on their loan; it's good for the banks, who take a cut; and it's good for everyone, because savings that would otherwise be sitting in a vault gathering dust is instead flowing through the economy being exchanged for goods and services, etc.

But eventually, when things are going well, we run out of things to invest in. Times are good so people have a lot of cash and they would like to loan it to someone, but all the sensible ventures are already funded. So banks and other financial institutions invent riskier and riskier lending schemes, so that they can get a return on their capital. Eventually the banks, brokers, etc. start making bum loans and the money goes down the tubes. There's a chain reaction as investors pull their money (a run on banks, a selling of stocks, etc.).

Every economic downturn includes risky lending as a major contributing factor. The investors who pulled out early, and the financial institutions that take a cut without accepting any risk, are the top of the pyramid. The people who wind up holding the risky loans during the collapse are the bottom of the pyramid. Those guys thought the interest would always come rolling in.

The complexity of the system is there to try to hide this interaction. The rubes at the bottom of the pyramid wouldn't by into it, except that it is so obfuscated that no one can really tell what's going on. (Honestly, selling badly insured bundles of mixed-risk mortgages cost the taxpayers a trillion dollars? How is Joe Six-Pack supposed to guard himself against that?) And like any good pyramid scheme, the con involves great returns for people who get in early. Remember when your 401(k) was trending ever upwards? "Put some of that in real estate, it's huge!"

  -- 77IM

Re:Can somebody 'splain this?

[SerpentMage]

I know by us we need separate accounts for PRIVACY purposes...

Re:Can somebody 'splain this?

[lawpoop]

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

I don't want a single account. I don't want my bank or "Financial institution" fucking with my IRA or checking account if I'm a few days late on my credit card bill. I keep all my financial serviced housed with separate institutions.

Re:Can somebody 'splain this?

[DNS-and-BIND]

What, so you should have a ton of money in the bank sitting around doing nothing? I live in China, and everyone here does exactly that...it keeps a lot of otherwise useful money locked away where it can not influence anyone, nor make more money. Leveraging isn't what's wrong with capitalism, the current crisis was caused by breaking the law (mortgage fraud) on a massive scale.

Re:Can somebody 'splain this?

[mikiN]

No gold no more (for the banks at least). That went in '76 in a puff of heady smoke (remember Nixon?) Just bits'n'pieces.

It's (almost) the oldest trick in the book in a new guise. First they used smoke and mirrors, now they use smoke screens (TFTs and plasma).

Same result: deception.

Re:Can somebody 'splain this?

[PingPongBoy]

How red is the herring?

The masterminds are devious? The ignorance is enforced in the entire system?

Maybe, but could it just be the sheer sustained growth of knowledge and the lack of ability to handle the knowledge? I see people grasping at straws and stepping on each other to acquire not knowledge but wealth. The successes of the few trigger the enthusiasm of the masses. That is exactly what happened until the slippery slope became the avalanche. The funny thing is, what is in this simple analysis that could not find its way into a computer model?

For years, I have heard the occasional debate in the media about how unsustainable the increase in housing has to be. I wasn't even listening to financial gurus. The words of wisdom were coming from typical journalists who were sort of in tune with the common man.

Clearly the missing factor in the computer models, the X factor, is the belief that world progress itself was going to sustain the affordability of the high cost of living. Higher housing costs and education costs were to some people an unavoidable way of life, and a benchmark of progress, and somehow everyone else is able to get into the game no matter how high the stakes are. The message was simple: if you bother yourself in the age of fun-on-the-internet and really-cool-lifestyles to drill down into this mindset, you will see that the whole economy is sound and proper because the wealth is easily sustainable via production on the backs of the third world. Then immigrants will come, cluster, and afford the million dollar 2-bedroom bungalows with no garage, a bizarre effect that will exist in only a few years if housing prices were to maintain their collision course. This mathematics somehow did not appear in a computer model because our ability to control computers has not advanced to the level of simple linear projection.

So what is the data telling us now? The stock market is down because businesses have just focused on raking in as much money as they can from the economic situation of Christmas past. Now it is Christmas present, and there is no real plan for Christmas future. As a result, people are scared shitless to invest anything. The fear can only be allayed with real results. Trust has to be won. These are sweeping concepts that are not that easy perhaps to quantify and observe, not that easy to run on a computer model...

Re:Can somebody 'splain this?

[mikiN]

whoops, first part is about the Gold Standard until '71. The second part still holds.

Must be the jitterbug.

Re:Can somebody 'splain this?

[lysdexia]

There is no cash in the bank. There are records of assets and the authority to create, out of thin air, debt at a rate of (in the best-case) seven times the value of the existing assets to acquire more assets. The money you paid back on the debt is "real" in the sense that it has already been circulated. Unless, of course, your boss just made payroll with commercial paper. And I thought Hopfield nets were magical!

Re:Can somebody 'splain this?

[Captain Splendid]

That's the problem with laws designed based around limitations in technology. Technology very quickly renders those laws obsolete, but the laws never get removed from the books. Indeed, that's why I feel that all laws beyond a very small core of crucial laws (your basic murder, theft, etc.)---certainly all civil laws and regulations---should be required by the Constitution to have a sunset provision and should be reviewed at minimum every 10-15 years to determine whether the laws are still useful.

Agreed, except setting actual limits will be just as stupid. Technology doesn't decay at a uniform rate. What should happen is that the laws should get changed when the pressure and lobbying from interested parties on the legislative body becomes high enough. Unfortunately, those parties are more interested in making life for themselves easier and usually only pressure useful change either by accident or under duress.

Which is why you need regulation, which has been sorely lacking since at least the 80's.

Re:Can somebody 'splain this?

[khallow]

This is done so they can charge you more for each of those things, and also to differentiate them from their competitors.

Well, I'd say that you got it mostly right. There's also a practical matter. In theory, a bank can offer a infinite variety of services. And if we were a lot smarter than we actually are, we could get a service that fits our wants precisely. But from marketing and bureaucratic points of view, infinite variety is bad. It's hard to advertise a huge, nebulous service to customers who can't understand the potential. Concrete simple services are more effectively marketed even if most of the potential is neutered.

Similarly, there has to be huge overhead of dealing with services that can differ greatly by customer. With current services, it's a matter of a few seconds for the employee to grasp the major details of a single service in a single account (eg, "Your checking account has X dollars in it.") and databases need to store only a limited amount of information for each service.

Re:Can somebody 'splain this?

[AlXtreme]

Credit is needed in a system where you are able to make purchases in certain items. The problem is when people over leverage themselves.

And that is exactly what happened. Both businesses and consumers were overleveraged, the realestate bubble burst and the whole cardhouse came crashing down.

Personally I don't see why you would need credit to buy a car though. If you don't have the cash don't buy a new car, get a second-hand one. Cars are a worthless investment, especially new ones. My rule of thumb is to only use credit if you are making an investment that has a very good chance of at least keeping its value.

Homes on the other hand... oh wait, never mind...

(but seriously, even in this market a house will still have considerable value after 10 years, where a car will be close to worthless)

Re:Can somebody 'splain this?

[hey!]

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

Neither did advocates of banking deregulation in the 1990s.

One of the reasons for this "redundancy" is (or used to be) that different rules apply to each kind of account. You used to have have commercial banks, investment banks, and insurance companies, and each did something different under different rules. Then the rules that had been in place since the Great Depression were repealed by Gramm-Leach-Bliley, and suddenly the legal boundaries between these kinds of financial services was gone.

Subsequently, we are facing the greatest economic crisis since the Great Depression. Coincidence? I'm not entirely sure, but surely some of the problem is that practices and attitudes that were normal in investment banking suddenly started to crop up in other businesses.

Although Hank Paulson is actually, in my opinion, one of the more decent individuals as a person in the administration, he's very much the wrong man at the wrong time. One of the things he did as head of Goldman Sachs was to convince the SEC to get rid of the "net capital rule". That was the rule that required banks to maintain a certain level of cash on hand to cover cash demands in unusual situations. This is obviously extremely expensive for companies who had to keep huge volumes of cash on hand, losing mind boggling amounts of value even against modest inflation.

Had the rule been kept in place, we might not have had to pony up seven hundred billion dollars to bail out Wall Street.

Re:Can somebody 'splain this?

[hobbit]

Cash in the bank is money sitting idle. You want your money out there, earning for you.

You're with the wrong bank. My money does earn when it's sitting in the bank. Not as much as it could if I had it tied up in some enterprise where I couldn't use it to pay my employees, but it's also less at risk.

The problem with your line of thought is that its logical conclusion is that money has to keep moving in order to be useful, which is exactly what got us into this whole mess.

Re:Can somebody 'splain this?

[Anonymous Coward]

What, so you should have a ton of money in the bank sitting around doing nothing?

It's doing something. It's insuring me against a rainy day.

That's not to say I couldn't invest some of it, but the emphasis is on some. If I'm riding month to month on rolling lines of credit, like the referenced businesses are, then I did it wrong.

Re:Can somebody 'splain this?

[hobbit]

Actually, the law changed to allow for sub-prime lending before it happened.

Re:Can somebody 'splain this?

[Nursie]

Actually there are a bunch of accounts available in the UK that work just like that. Effectively you have a mortgage/current/savings account which is at a large negative balance. You are charged a mortgage style (i.e. fairly low) rate of interest on the actual balance, on a daily basis, so your mortgage interest is offset by what you keep in there.

Presumably there's some sort of credit limit that ticks upward toward 0 over time.

http://en.wikipedia.org/wiki/The_One_account

Re:Can somebody 'splain this?

[nategoose]

A lot of the complexities are the results of the rules imposed on banks, though the banks do have lobbiest.
As far as mixing account types into one account -- you can usually mix savings and checking (AKA checking with interest) but there will be interest or higher minimum balance rules.
Many banks also offer various forms of overdraft protection, many of which are essentially a line of credit, though usually with a sharp penalty.
Lenders who lend someone else's money need to know how long they long they can use that money and depositers need to know how long they might have to wait to get their money back. That is why a 5 year CD has a greater interest rate than a 3 month CD. Banks make assumptions that checking account deposits must stay fairly liquid, savings account deposits semi-liquid, and CDs are solid until they mature (relative to the depositor of course)
Keeping buckets of money separate and labeled is good.

Lending is the flip side of that; knowing how long money is lent for is important to planning, meeting regulations, and covering transaction costs.
Their's also the rules about how a loan is repaid (lump sum, periodic payments, ...). All of these things make different loan accounts different.

Re:Can somebody 'splain this?

[HisMother]

it keeps a lot of otherwise useful money locked away where it can not influence anyone, nor make more money.

Oh yes. Because we all know that banks take the money we deposit, exchange it for pennies, and lock them in big piles in a closet. When you get a chance, dust off that old encyclopedia in the attic and look up "Savings and Loan Association."

Re:Can somebody 'splain this?

[Estanislao Mart�nez]

Instead of doing Shady and immoral accounting practices why not do what honest small business do. YOU HAVE THE CASH ON HAND TO PAY YOUR BILLS.

Because once a business gets large enough, the cash flow becomes enormously more complex, and very short term credit becomes a cost-effective way of managing cash flow.

Basically, a business wants to match cash inflows with outflows (and to simplify the model, we'll count "profits" as one of the outflows). The problem is when you know that your business is owed cash that's going to arrive in unpredictable payments over the next 30-90 days. Setting up the cash outflows so that they precisely match the inflows becomes hellishly more complex when the number of transactions gets big enough. Short term debt provides a buffer that allows a business to simplify this.

In principle, yes, a business could do the same thing by keeping cash reserves as a buffer, too. But when you take into account the time value of money, that really comes down to the same thing: by keeping cash, the business implicitly pays the opportunity cost of keeping that cash. (And with an inflationary monetary policy, of course, the cash itself becomes less valuable over time.)

So, to sum up, the money owed to the business over the short terms is its accounts receivable; short-term debt allows a business to convert, for a fee, a large fraction of its accounts receivable into cash, and therefore, to draw upon its accounts receivable to finance its operations. I.e., instead of having n dollars of pure, unencumbered cash at its disposal at any one time, it can have n + ((accounts_receivable * reliable_fraction_of_a_r) - interest_on_short_term_debt)); or, equivalently, to keep less unencumbered cash than it would otherwise need to.

Re:Can somebody 'splain this?

[Spasemunki]

...,who are the original spark that started the fire, I do not want to claim it's "their fault", but they are part of the problem)

This whole post is total bullshit. The notion that, somehow, attempts to counter historic discrimination against blacks and other minorities set off the economic crisis is just foolish. The regulations imposed on certain banks were very modest, and were essentially designed to prevent worthy borrowers from being denied due to where their house was located ("redlining"). Nothing in the CRA requires banks to extend loans to people who can't pay them back. Most of the banks that were hit hardest by the mortgage crises weren't even subject to the CRA, because they weren't commercial banks. Yet the whiners in the pundit class persist in arguing that armies of poor people strong-armed poor, defenseless banks into making bad sub-prime loans. Never mind the studies that have shown that CRA-regulated banks were less likely to make subprime loans, and less likely to re-sell their loans. Never mind the fact that only one in four sub-prime loans originated from a CRA-regulated bank. Yep... poor people. The secret masters of our economy.

And Jimmy Carter? He might have been a tool of a president, but blaming him for Iran is bizarre. Horrible policy making in the region going back to WWII sunk Iran. Jimmy was just lucky enough to be there when the music stopped.

Re:Can somebody 'splain this?

[DragonWriter]

If a corporation is big enough and has good enough credit, they can issue corporate paper, at a lower interest rate, instead of paying interest to a bank.

Banks are middlemen. They take money from their depositors and lend it to borrowers, taking a cut out of the middle (actually, they devise a wide range of charges on both ends, but that's what if simplifies to.)

Commercial paper can bypass the middleman to an extent (there are financial services firms that act as middlemen here, but the overall cut they take isn't, in the end, as much as a bank takes between its borrowers and its depositors.)

Re:Can somebody 'splain this?

[Fluffeh]

That's a great post, but one line which is scary can be this one:

let the unproductive companies go bankrupt

While I am normally all for the survival of the fittest especially in a business world, this is a bit of a problem in our current situation, as if we let all the "bad companies" go bust, we would end up with millions of people ready to retire suddenly have nothing to retire on. Millions of homes would possibly be repossesed. It might be better indeed to try to support these places and then look at tighter control rather than just letting these ones die.

Re:Can somebody 'splain this?

[agslashdot]

Take a hollow toothbrush. Fill it with toothpaste. Then take a hollow shaving razor. Fill it with shaving foam. Now glue the toothbrush to the razor. For kicks, lets also glue a fork, a knife and a spoon to this appartus.

Now I claim you can brush your teeth, shave, eat your breakfast, butter your bread, drink your soup - all with this one appartus.

So then why do we have a separate toothbrush, razor, spooon, fork etc ? Is it because we want to ensure the employment of spoonmakers worldwide ?

Without CP, MBS, CDOs honestly there is no way you can run a modern industrial economy. You can glue them up into one savings account, but it would be as unwieldy as your toothbrush-cum-razor-cum-fork.

I built most of this financial gobbledegook in a previous life...

Re:Can somebody 'splain this?

[Anonymous Coward]

I dont run out and buy a shitload of gear on credit for my video and photography business. I do what sane people do.. when I can afford it I buy it for pennies on the dollar from the auctioned bankrupt competitors when the hard times hit, I ride it out easily while my competition scrambles to try and pay off the 60 some loans and their credit lines.

Edited your post for what I do :).

Re:Can somebody 'splain this?

[cyngus]

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

Bzzzzz! Wrong. Every financial instrument out there is there for one reason, and one reason only, someone was interested in buying it. The problems we are in today are not with the tools, the tools functioned exactly like they were supposed to. The problem is that everyone, E-V-E-R-Y-O-N-E was too busy or too lazy to read the manual for the tool. When I say "everyone" I mean the subprime borrowers who should have understood their mortgage agreement, I mean the loan originator who should have known the borrower couldn't conceivably repay, I mean the credit rating agency who didn't do their due diligence on their AAA-rated security, I mean the banker who bought the mortgage-backed security and blindly trusted the rating agency, I mean underwriters of CDSes who didn't do their due diligence in so many ways, I mean the legislators that told Fannie and Freddie to get more people to own houses no matter what, I mean the people who bought shares in financial companies who didn't realize the valuations were completely unsustainable.

A couple of examples in what I'm sure you would call "invented" financial instruments

The mortgage-backed security (MBS) that is blamed most often for this crisis did exactly as intended. This security is perfectly useful, someone said, hey, for the most part a mortgage is a bond, why don't we treat them like it. The problem is that an individual mortgage might not be repaid, but if you pool a bunch of similar mortgages together, you can get a pretty good idea of what percentage will fail. Now, you slice this pool up and sell the puddles. Now people who never could offer a mortgage before because they didn't have the money to lend for a whole house, or couldn't put all their eggs in one basket can essentially sell mortgages and be pretty confident about their risk and return. What went wrong is that the mortgage originators didn't assess the borrowers suitability properly, the rating agency that rated the MBS didn't check the originator's work, and the buyer of the security didn't bother to check the rating agencies work.

How about credit default swaps (CDS)? Paul borrows $1000 from you, and you're pretty sure that Paul will pay all of it back in a year, but you have to have at least $900 to pay for a new liver (you drunk!) in a year. Now, I say, hey, for $5 a month, I'll pay you the difference between the $1000 and what Paul pays you, just in case he doesn't pay you back. This is a great deal for you, because no matter what you get your new liver, and if Paul does pay you back, you get $940. Sound familiar, that's right, this is just insurance with a fancy name! I'm sure you'd agree that insurance wasn't just 'invented out of this air'. The problem was in this case that I didn't assess correctly that Paul was just developing a coke habit and would skip to the Caymans after two months. Now with home insurance, companies can assess the risk very well, because they have a lot of historical data and a big sample size. The risk of default on corporate debt is a lot more complex and has less historical data, and many writing the CDSes (yeah, I'm looking at you AIG) were way off in their assessments.

Bankers are a fun target because they're generally rich and got that way because they happen to like the soulless task of combing through countless spreadsheets and schmoozing clients until they're both too drunk to see, but there's plenty of blame to go around in this mess. The great thing about free market capitalism is that no one is forcing you to do anything. If you were a good little, risk averse, worker ant for the last 15 years you should be very happy right now. You should have plenty of cash and can get a house, a car, and a new wardrobe at a huge discount. You can sit back and buy that prick banker's Manhattan flat for 50% off and laugh

Re:Can somebody 'splain this?

[Chris Burke]

Credit is needed in a system where you are able to make purchases in certain items. The problem is when people over leverage themselves.

Well, that's how the problem starts.

The problem gets compounded when you treat debt like it's a magical source of new money. As in, if I loan you $10, then you have $10, but then I also have a "debt asset" worth $10, which makes a total of $20. That's exactly how people were explaining it to me as recently as 2007 when suggesting that debt is good and actually "creates wealth". But that's bullshit. Ultimately there's not $20, there's the $10 I used to have but instead gave to you, and at the end of the day I can at best expect to end up with that $10 back plus interest. But people kept treating the debt itself like it was additional money, selling the debt, and making additional loans with debt as collateral -- debt-backed debt! So there were trillions of non-existent dollars spinning around in a big financial machine and everyone loved it. It reminds me of Worldcom who made billions of dollars selling unused bandwidth to a subsidiary and then buying it back, tons of money spinning in circles but none of it actually real.

Now this was all fine and dandy for a while, but eventually the system only works if that debt is paid off, which is when the problem became apparent. It turns out that a lot of that debt was never going to be paid back, which means the big debt-amplification-machine was not just running based on a false premise, is was running on nothing. When the debt failed to be paid, that failure was amplified up the system and soon our entire financial system is at risk because of an unusual number of home mortgage defaults. The bubble was burst, the curtain was lifted, and now we're all paying for it.

Credit is essential to our economy. That's for sure. But we can't keep treating debt like it's wealth when really it's a negative asset that you hope to recoup with some payoff. Too much of it is bad, building a whole economic system on it is, well, what we're seeing the consequences of now.

Re:Can somebody 'splain this?

[DragonWriter]

The problem with your line of thought is that its logical conclusion is that money has to keep moving in order to be useful, which is exactly what got us into this whole mess.

If by "this whole mess" you mean the entire progress of the world economy since the invention of currency, you are correct; money exists in the particular forms it has throughout history precisely because it is useful to the extent it efficiently keeps moving, which is why, all other things (security, reliability, etc.) being equal, and even to an extent when those other things favor the opposite result somewhat, forms that are more flexible to create and more easy to move always displace, in practical use, those which are less flexible to create and less easy to move. There's a reason light, high-value, metals became the ultimate in commodity money, a reason commodity money was displaced by representative money (in the form of tokens, paper money, and notations of account) and why even that was displaced by fiat money (in the same forms, and most recently particularly in electronic notations of account.)

Re:Can somebody 'splain this?

[Red Flayer]

Your understanding of accounting is way off (and so you shouldn't claim to speak for accountants when you write that gibberish).

Also there are a few uncertain assumptions in your little 'analysis' -- one, that the seller chooses to reinvest his sale profits with the bank. You claim that most cash proceeds from the sale of houses was deposited in banks -- this is false. Most was actually reinvested in other real property or elsewhere.

Plus, you ignore the opportunity cost of the funds the bank is due and the risk of default (hence the interest rate on the loan).

I know the banking industry has its problems, but claiming it's a ponzi scheme is just uneducated. The banking system is NOT dependent on influx of new investors to pay their creditors (leaving a gaping cash hole when new investors stop appearing). They are dependent on the stream of payments from existing debtors. When that stream dries up, their ability to lend dries up, since they become cash-flow negative, and eventually have no capital to lend.

The problem is that the banks are unwilling to lend when the expected return on their capital outlay is negative. Due to the fluxed up state of the economy, banks in general have decided that lending is unwise, since the risk of default is so high. The big problem is that banks did not properly assign risk to certain loans, so that they undercharged on the interest rate. The reason this slightly relates to a Ponzi scheme, is that as long as another bank was willing to underwrite a risky loan, then bank could get rid of its risk when the property in question was sold. It was a game of hot potato -- whoever was left holding the risky loan when everyone stopped lending lost. And the big problem was that it continued for too long -- eventually the amount of risky loans was so large that almost *everyone* was left holding a sack of hot potatoes. If credit rules had been tightened, rather than loosened, then a few banks would have gotten burnt early, and the problem would not have spiraled.

Re:Can somebody 'splain this?

[kgskgs]

Commercial paper or financial complexity is not the real problem. The real problem is reality. Let me explain.

There were three fishermen in a village. They were not able to do fishing because they lost their nets. One day one of them heard of a fishing net weaver in the neighboring village. So he went and rented a net from the weaver. To pay rent, he borrowed the money from the same weaver. He could go fishing now. The second one found out and he did the same thing. The third one went to rent a net as well. The weaver had only two nets. But he smartly figured out that the three fishermen never go fishing at the same time, so there will always be one net idle. He smartly figured out scheduling algorithm. So also started renting the two nets to three fishermen.

All four were happy. The fishermen always assumed that they will have net whenever required. The weaver was happy to be able to rent two nets to three people.

One fine day the assumptions made in weavers scheduling algorithm broke down and all three fishermen needed the net. They came to realize that there are not really enough nets and sometime they might end up not getting the net. So each fisherman started renting the net for more time than required to avoid the risk. This increased the net renting price (Inflation), also the nets started staying idle for long times (Dropped output). The fishermen could not pay their rent loan installment in time. The weaver started losing money and he could not maintain the nets. Ultimately everyone was poor again.

Nothing changed from start to beginning but everybody's risk perception. Originally, with the false perception of zero risk and abundance of resources was created by the weavers assumptions. This perception broke down and everybody started paying high insurance to avoid the risk and this left little money for investment.

In today's case, the net weaver is the bank and fishermen are consumers.

Do you know what is the biggest difference between developed countries and developing countries /third world? In developed countries people keep less for the rainy day and invest more. In third world, people stack up more for rainy day and invest less.

K

Re:Can somebody 'splain this?

[PermanentMarker]

Well the una bombers manifest explains it too.

There is a moment you cant pull the power of a machine on which you depend, at that moment your enslaved by the machine.

Re:Can somebody 'splain this?

[kgskgs]

I forgot to add last couple of lines.

The problem with reality is that it does not issue one way ticket. Life always runs in circle. You cannot theorize something without assumptions. And rest assured there will be one day when your assumptions will not be true anymore.

That's why reality is the problem.

Re:Can somebody 'splain this?

[Anonymous Coward]

You are right. You are not an economist.

Re:Can somebody 'splain this?

[StormyWeather]

Your exactly right, except that homes really don't go up in value at all, and never have. People just think they go up in value because they go up in price. What they really are is a hedge against inflation.

Re:Can somebody 'splain this?

[maxume]

A lot of people that want to live the car lifestyle need to finance a $10,000 purchase, or even less.

They would probably be better off figuring out how to live without a car, but there you go.

Re:Can somebody 'splain this?

[againjj]

It sounds like those people were talking about the ideas of M0-3 and trying to extend it to debts. There is a reason M3 is no longer measured: as you go up the scale, the values become more and more meaningless/useless.

Re:Can somebody 'splain this?

[maxume]

In the U.S., you get more gub'mint insurance if you have multiple accounts (i.e., FDIC protection doesn't apply to a brokerage account, so even if you have checking and brokerage at the same institution, there is an incentive to have them be separate accounts).

Re:Can somebody 'splain this?

[B4D BE4T]

...thanks to the CRA...

CRA really had very little affect on this whole situation. Here is a good argument against the "Blame-CRA" theory. To summarize, from the link:

...half of sub-prime loans came from those mortgage companies beyond the reach of CRA. A further 25 to 30 percent came from bank subsidiaries and affiliates, which come under CRA to varying degrees but not as fully as banks themselves... Most important, the lenders subject to CRA have engaged in less, not more, of the most dangerous lending.

I don't think that your description of the whole mortgage securities buying/selling process is entirely accurate. My understanding is that it is like a game of musical chairs. Banks bought and sold securities for ($loan_amount + $loan_future_interest). As the interest rate went up on adjustable rates, people were no longer able to pay the loans off and the loans defaulted. So a large percentage of $loan_future_interest was immediately lost by whoever was stuck holding the securities when the music stopped. And a significant percentage of $loan_amount also could not be recovered by taking possession of and selling the property because the property had lost value due to the housing bubble.

...they should be prosecuted for making (and winning) the bet that tens of thousands of people would lose their livelihoods, their houses.

I think prosecution goes a little too far. In most cases, everything was legal. Although I don't think that they deserve to be bailed out either. They made a bad decision, both borrower and lender (the people who took those unaffordable loans are as much at fault as the banks who gave them). Suffering monetarily is punishment enough. Personally, I think that the banks should lose the money (no bank bailouts) and the borrowers should lose their homes (no homeowner bailouts). Why should anyone else (the taxpayers) have to pay for the banks' or the homeowners' bad decisions? Sure, many banks would go under, but is that really such a bad thing? The only decent argument I've heard against letting these banks fail is that it will reduce the amount of available credit. But isn't credit (the idea that property can be obtained now while the money is paid later) what got us into this mess in the first place? Personally, I think the sooner our country loses its addiction to credit the better.

Re:Can somebody 'splain this?

[maxume]

Joe Six-Pack doesn't need to wade into complex security markets. He can buy index and other conservative mutual funds for exposure to various markets that have historical histories of growth. Your comment about putting some of your 401k into real estate is snarky, but it really isn't that difficult to figure out the risk of funds available in structured investment plans, and the risk associated with real estate isn't 'low'.

Joe Six-Pack generally screwed himself in the current crisis, by buying a house based not on the value he placed on it (which is a great decision), but on the value that he thought someone else would place on it sometime in the near future (which is nuts).

Re:Can somebody 'splain this?

[codehalo]

You are a complete idiot. I hope you just came here by chance. The possibility that you could be literate in any way is scary.

Re:Can somebody 'splain this?

[Anonymous Coward]

Yes, just bought my modest sized house with cash (~$200K). Same for motorcycles (when I was poor) and then cars, once I had some more cash.

Re:Can somebody 'splain this?

[dc29A]

the current crisis was caused by breaking the law (mortgage fraud) on a massive scale.

How about: no. Not even close. The current crisis was caused by Credit Default Swaps. Mortgage fraud is a non issue. People living beyond their means was merely the trigger. The failure of a big automaker would have achieved the same exact thing. Another explanation for it: casino capitalism, everyone and their dogs betting on mortgage companies to go down, and when some did, the institutions (Lehman, AIG, Bear Stearns and al) died or almost died because they had no money to cover the lost bets. Oh and these speculators have plenty of bets on each of the big three going down. And guess what will happen when one of those goes under? Yeah, more shit. So are you going to blame that on mortgage fraud too?

Re:Can somebody 'splain this?

[Gription]

The part I want 'splained is: Why does anyone think that the stock market is a serious indicator of the state of the economy?

These types of exchanges (stocks, commodities, etc...) are Gambling dressed up for high society. That doesn't mean that they aren't reasonable investments over the long haul. Any reasonable person looking at them over the short haul will see that they are driven by everyone trying to guess which way everyone else is going to jump. This is simply gambling.

Everyone knows the market is going to be way up in a few years because it is currently highly undervalued but because the vast majority of investing groups are buying and selling with short term gain in mind the market is bouncing around like a superball. Maybe if someone was required to hold a stock for a minimum period of time it would make stocks an indicator of something.

Off to the side of this:
I really think that the government could free up a huge quantity of the credit blockade by lending directly to the enduser to force the various credit companies to wake up and try to compete for their markets.

Example: Home loans. 30 year fixed rates have usually floated at around 2+% over prime. Now because the mortgage companies wrote unserviceable loans so they could sell them instead of service them, they are all licking their wounds and are currently loaning at 5+% over prime. This works out to a subsidy to the mortgage companies so they can make up for their idiot losses. At the same time no one can sell their house because no one can get credit and if the houses don't move the price drops screwing home owners. At the same time banks are dumping foreclosed homes further driving down the home price comps. (Oh and the banks DO make loans for the houses they are dumping!!!)

If they would just refinance the so called "Toxic debt" mortgages at 3% over prime it would drop the payments down to a point where most of the "toxic" loans would be workable for the debtors and then they wouldn't be toxic. At 3% over prime it would be plenty profitable too. If they would force the mortgage companies to carry the paper on a portion of the loans (selected at random) it would guarantee that they wouldn't write fraudulent loans either...

(now get off soapbox...)

Re:Can somebody 'splain this?

[Lumpy]

Which is why I will never EVER become Incorporated. I prefer honesty and doing things right.

What you say makes ZERO sense. I'm not having "tough times" right now. In fact I have CASH and am sucking up lots of gear being auctioned by my competitors at $0.10 on the dollar. I recently got a $4800.00 Beta cartoni tripod for $500.00 at a Grand Rapids business auction.

Sounds like I'm doing it the right way and all my competitors are not.

Re:Can somebody 'splain this?

[TapeCutter]

"My money does earn when it's sitting in the bank."

I think you will find that the bank has lent your money to someone else at a better rate than what they are paying you.

"The problem with your line of thought is that its logical conclusion is that money has to keep moving in order to be useful, which is exactly what got us into this whole mess."

No it didn't get us into the mess, what you're describing IS the mess. That's why it's called a credit FREEZE - ie: money stopped going round because banks stopped trusting each other.

Re:Can somebody 'splain this?

[Lumpy]

if you are taking out a loan to meet payroll. you're almost out of business.

That's a cold hard fact.

Re:Can somebody 'splain this?

[Anonymous Coward]

How did this jingoist troll get rated informative?

haha, yes.. I had to use the jingoist term jingoist for fun.

Re:Can somebody 'splain this?

[dc29A]

The main issue with CDS is not that corporate risk is hard to asses but the fact that anyone can buy a CDS contract without owning one cent in the company he buys insurance on.

For example, I can buy a CDS contract on Ford, betting that Ford will default on its debt and the same time I don't own one single cent in Ford stocks, bonds, whatever. I am merely speculating that Ford will go belly up. If it does, AIG will owe me big money. In car analogy terms, this is the same as if I would take out insurance on my neighbor's car because he drives like a retard and I bet that he'll get into an accident soon. It's all about bets, CDSs are nothing more than speculator's wet dream, it's legalized gambling.

Oh and they are unregulated, traded over the counter and no one knows how many of these CDS contracts are out there. As you mentioned, AIG has written insane amount of these.

Re:Can somebody 'splain this?

[lennier]

"Ultimately there's not $20, there's the $10 I used to have but instead gave to you, and at the end of the day I can at best expect to end up with that $10 back plus interest."

Something I've always wondered: how, exactly, are you going to get that $10+interest back unless at least enough new money to cover the interest is actually *created* rather than just *loaned out*?

Isn't the whole concept of interest-bearing debt really a Ponzi scheme? Eventually it's going to fall over because you can't keep loaning money that doesn't exist and then asking for more back than exists.

Why don't we just forgive all the debts and start again?

Re:Can somebody 'splain this?

[Anonymous Coward]

I think it's more like maximizing profit while minimizing risk (reasonably).

Re:Can somebody 'splain this?

[Anonymous Coward]

holy fucking shit dead metaphor batman....

Please look up "dead metaphor" and try not to use them. Why? Because we live in the internet age, and people not from our culture will have metaphor overload... in short, they will read the first few lines and think you're speaking jibberish.

 

Re:Can somebody 'splain this?

[Profane MuthaFucka]

I love the invisible fist, especially when it's furiously jerking me off.

Re:Can somebody 'splain this?

[Defector!!!]

First - Commercial paper is neither shady or immoral. The terms are laid out in black and white, and investors are equally free to accept the deal or walk away.

Second - What if you DID run out and buy a shit load of gear on credit for your business? And then what if all that gear came in handy for, I don't know, extra unexpected work?! And what if the reward of that unexpected extra work was more money than you paid for both the gear and the interest on borrowing?!

Wouldn't you then have actually benefited from borrowing?

By not borrowing though, you've foregone that opportunity, many many times over. In fact, I guarantee you that your business would be bigger if you had borrowed within your ability to pay this whole time.

Don't believe me? Do some finance reading.

Re:Can somebody 'splain this?

[Anonymous Coward]

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

In part: laws. Credit cards were originally funky devices to evade usury laws. Also, as a result of the Great Depression, you can't have one account mix stocks and regular accounts.

There are also technical reasons. A bank would probably wish to loan out much less of the money in checking accounts than in savings accounts. Keeping your illiquid CDs separate from more liquid assets is also a good thing.

Finance is a complex world, thanks to the myriads of legal rules and attempts to bypass them (think credit-default swaps or collateralized debt offerings).

Re:Can somebody 'splain this?

[atraintocry]

In a Ponzi scheme the company running the scheme is not actually investing your money anywhere, just paying it out to the last guy. This is different than a bubble, where there is still an actual investment, but it's overvalued.

Actually, what happened here is sort of the opposite...the risk associated with these loans was underestimated.

How you can logically connect ACORN and short selling is beyond me. Rather than bang my forehead on a table, I will just wish you luck with pinning a *global* problem on your least favorite political party. My advice is to read more WSJ and less Drudge Report.

Re:Can somebody 'splain this?

[Anonymous Coward]

We don't need it. But the system made people borrow more than they could.

s/system/government. Mandated standards for subprime lending (i.e., giving money to people who couldn't afford it) is one of the largest pieces, if not the largest, that caused the system to fall down.

Another key part of the puzzle was that banks tried to mitigate risk--hence the creation of these mortgage-backed securities. Some of these were designed to sidestep regulatory requirements.

There are also the depressed interest rates and exotic mortgages.

As long as the pie constantly grows there is no real problem, as the banks control all money.

If all the mortgages had been traditional mortgages, and banks only lent to those who could afford these mortgages (or even merely mostly lent), there would have been no problem. The loan interest provides a cushion for falling home values, and the inflexibility of mortgages would have made the accumulation of the vast asset price bubble untenable.

But the government stepped in, caused banks problems, and the banks got creative to ameliorate these problems.

*AND* we should destroy anyone who was involved in shortselling any commodity related to loans.

There's a great satirical article by The Economist which in a nutshell attacks those who attack shortselling. Why prevent people from speculating that prices will fall? If you do that, you might as well prevent people from speculating that prices will rise. After all, it's those damn people buying long (or, egads, naked longs!) that caused all these bubbles...

Better yet, how about we impound all those people who give financial advice based on what they read in their daily newspaper?

Re:Can somebody 'splain this?

[FatdogHaiku]

I don't work at a bank but it seems that the more products you offer, the more you can sell. Capitalization of a plant or store inventory is a totally different need when compared to short term needs like seasonal build up or payroll. Why borrow payroll? If I have x dollars invested and pulling down a good rate of return, it would be better to keep it there and borrow short term if the rate is the same or lower. Also, loans have bookkeeping advantages (assuming the company is solvent and not doing a shell game). And yes, it does create jobs for people selling loan products. But those people also spend the money they make and everyone gets a little piece of that (carpenters, grocers, car sales, etc..) so all in all it is not a bad thing. But it can be abused, shell games can be played, investors can be conned. And in any case, if you don't have the wherewithal to attain your goals, you will have to play some of the game, how deep you go depends on your needs.

Re:Can somebody 'splain this?

[johnsonav]

The part I want 'splained is: Why does anyone think that the stock market is a serious indicator of the state of the economy?

If you're looking to the stock market as a barometer, you're in for a let down. The price of a stock depends on so much more than just the state of the economy. The only real rule is: historically high stock prices usually indicate overconfidence, and historically low stock prices usually indicate undue pessimism.

Everyone knows the market is going to be way up in a few years because it is currently highly undervalued...

You sound like the prognosticators in 1929. But it took 22 long years for the Dow to surpass its pre-depression highs. Don't commit the same sin of hubris that got us here in the first place.

Maybe if someone was required to hold a stock for a minimum period of time it would make stocks an indicator of something.

But that would remove one of the main reasons to own stocks, their liquidity. We don't need stocks to be an indicator of anything at all. All they represent is the value the market places on projected earnings.

I really think that the government could free up a huge quantity of the credit blockade by lending directly to the enduser to force the various credit companies to wake up and try to compete for their markets.

Now here's where you lost me. You think that banks are going to try and compete with the government, which can borrow money to lend at almost zero cost. Banks have to get their money from somewhere, and their risk of default is seen as so much higher than the government's, that the interest rates they can borrow at are sky high right now. Why would they try to compete with the government at all? They're almost guaranteed to lose.

If they would just refinance the so called "Toxic debt" mortgages at 3% over prime it would drop the payments down to a point where most of the "toxic" loans would be workable for the debtors and then they wouldn't be toxic. At 3% over prime it would be plenty profitable too. If they would force the mortgage companies to carry the paper on a portion of the loans (selected at random) it would guarantee that they wouldn't write fraudulent loans either...

I think you underestimate the scale of the mortgage problem. There is too much debt out there on homes that are worth nowhere near what is owed. What incentive does the homeowner have to repay a loan when they are $100,000 underwater? Even at a zero percent interest rate, it just doesn't make sense for the borrower. Those toxic loans are called "toxic" because there's really no good way to fix them.

Re:Can somebody 'splain this?

[feepness]

It makes sense that if you lump a bunch of mortgages together, only a small percentage of those will default, thereby distributing your risk.

Actually, it does not make sense. Mortgage values are correlated in the fact that defaults occur when prices drop, and prices drop when defaults occur. When prices are rising things most mortgages will be fine (which they were). When prices are dropping mortgages as a group tend to be problematic.

Since historically home prices both rise and fall, this should have been obvious.

Re:Can somebody 'splain this?

[symbolset]

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

Yeah, that's pretty much it. Congratulations: You got it in one. The complexity serves no purpose other than to confuse, which only to the benefit of the more experienced person running the game and to the detriment of the rookie customers. Unfortunately they've rigged the game so that you almost have to play.

For what it's worth there are cultures where loans at interest are not permitted. The workarounds they use to allow savers to take advantage of spenders are even more complex and vicious.

Re:Can somebody 'splain this?

[Anonymous Coward]

No, It's an investment just like any other. It just depends on the area. Some locations will go down in value, others will go up. A house in our neighborhood has appreciated roughly 100% in the last 12 years. I KNOW inflation hasn't been that much. Other parts of town have gone up ~15-20%, others 30-40%, others are stationary.

Re:Can somebody 'splain this?

[sgt_doom]

Well, I'm not a professional mathematician, but I received a 100% score on the Math Aptitude test on the college boards many years ago, as well as 4.0 in math up to Multivariate Calc and Linear Algebra.

That said, I know enough to recognize bullcrap when I see it, and the real prob today is the phony financial instrument market, namely, those derivatives (last count of 723 categories, probably more, though): CDOs, CBOs, CMOs, CLSs, Bistro SIVs, credit default swaps, all other "securitized" debt, ABS, MBS and the rest of the BS....

When there exists a tontine scheme, or reverse tontine scheme, whereby trillions can be collected by the bad guys with the end result being the ultra-concentration of wealth, the working guy and gal is royally screwed.

My utmost respect to Prof. Taleb, though, who is a brilliant thinker....

Re:Can somebody 'splain this?

[wellingj]

All those facts and no links? You might get a +5 informative if you posted your references...

Re:Can somebody 'splain this?

[wellingj]

Emphasis on our not capitalist please.

Re:Can somebody 'splain this?

[Anonymous Coward]

Commercial paper is essentially a credit card, but one in which you promise to repay it in full every month. Because the bank gets paid back quickly, it is willing to offer lower rates.

As to why companies need multiple types of loans, let me pose another question: if you wanted to buy a new flat screen tv but didn't quite have enough $ on you at the moment, would you go and take out a second mortgage?

Of course not. The reality is that most commercial lending products were created for a reason: someone needed them. Fortune 500 companies are not suckers that take whatever gets pushed on them. And no, there is no giant conspiracy to waste shareholder value by buying useless products from banks to make the banks money.

Hope that helps, and yes, I am a banker.

Re:Can somebody 'splain this?

[Dun Malg]

Your exactly right, except that homes really don't go up in value at all, and never have. People just think they go up in value because they go up in price. What they really are is a hedge against inflation.

Take a look at housing prices in major cities like NY, LA, SF, etc. Inflation has not been a cumulative 400% in the last 10 years (and this is just the natural curve, minus the "spike" we saw peak a couple years ago).

Re:Can somebody 'splain this?

[Tubal-Cain]

No reason to not incorporate. Just integrate the behavior you desire into the bylaws and/or never own less than half the shares (and make your wishes very clear to the CEO).

Re:Can somebody 'splain this?

[andy_t_roo]

i agree - if the return on a cash investment is 6%, and the government only printed 2% more money, where does the extra come from?

ultimately there can be no such thing as guaranteed return on investment, in real terms, otherwise within a few cycles of money doubling investment people who invest in that scheme own the entire solar system.

Therefore, the average return on investment accross everything has to be equal to the % increase in the amount of goods/money in the system against the increase in the number of people in the system.

Of course there will be a bell curve distribution of wealth, with some people going broke and others making lots of money, but ultimately it must balance out.

Re:Can somebody 'splain this?

[symbolset]

Inflation has not been a cumulative 400% in the last 10 years

And deflation in general won't be 75% as home prices come down over the next three years. That's why it's called a bubble.

The value that your home has is that it keeps the rain off of you, and keeps you from being arrested for sleeping in the park. It also makes a handy place to store the stuff with sentimental value you accumulate over time, like offspring.

There will be some interesting side effects from this boom and crash. Right now home prices are crashing at the same time interest rates hit unsustainable historic lows. Generally that's a good time to buy a home if you don't have one -- but get a fixed rate with a payment you can afford. If you don't, the inevitable inflationary spiral that follows will break you. With a fixed rate, inflation actually works for you by raising your income and reducing the real value of your debt. In the 80's I heard SO many stories about older people who had a nice home that cost $20,000 on a 30 year fixed 6% rate loan at the same time my parent's variable rate swelled to over 18% that the idea stuck. As soon as the market starts showing signs of life the rates will start going up again so don't miss your shot. The opportunity time is coming around again as it does for every generation -- it's almost time to fire your landlord. When it's time many will make the deal of a lifetime. Everybody else gets to spend the next 20 years kicking themselves for missing it, while they do it the hard way.

In short, GP was exactly right. In a perfect market the average home costs exactly as much as the average buyer can afford to pay. The games they've been playing with finance drove the prices up and make getting loans easy for a while and it will be followed by a time when the prices are driven down and loans are difficult to get because the market is not perfect: People always try to game the system and all systems can be gamed and so buyability swings wildly from completely impossible to ridiculously easy and most folks have to take care to get in when the time is right. The minor cycle seems to be roughly 20 years and the major cycle 80.

If inflation gets totally ridiculous, everybody with a fixed rate home loan gets to pay off the loan very easily, though other stuff starts to get harder to get. That's why it's smart to own some gold and silver too - not certificates or shares in mining companies that can be shams or go bust; real soft metal coins and bars. You don't need too much of it because the crisis can't last longer than a few years before things straighten out. Only once you've taken care of these things should you start to think about putting your extra money to work at interest.

Re:Can somebody 'splain this?

[mr_death]

Everyone knows the market is going to be way up in a few years because it is currently highly undervalued but because the vast majority of investing groups are buying and selling with short term gain in mind the market is bouncing around like a superball.

True, but this situation may not be an ideal time to go long. As the old saying goes, the market can be wrong far longer than you can stay solvent.

Caveat emptor, your mileage may vary, and no platypuses were harmed in the making of this posting.

Re:Can somebody 'splain this?

[Wildclaw]

Something I've always wondered: how, exactly, are you going to get that $10+interest back unless at least enough new money to cover the interest is actually *created* rather than just *loaned out*?

That is actually quite simple and something many fiat money opponents don't seem to grasp. (not saying anything about you, just pointing out that I have seen this reasoning used in various places such as the "Money as Debt" movie that is often linked to)

Anyway, the answer lies in the fact that money circulates. Any interest I get from loaning out money to you, I can use to buy goods/services from you which you in turn can use to pay back the loan.

In fact, even if you and I had an economy that consisted of a single dollar bill, we could still use that single dollar bill, you could still pay back a $10 loan if I just used that dollar bill to buy something from you every time you payed back part of the loan.

As long as loans are taken for actual investments they can be a good thing. And no, a car or house for bragging is not an investment. A second hand car that allows you to get to the job can be one however. As can a small house in a decent location be. Credit card debt however is pretty much all "bad" debt as it rarely is used for actual investments.

Re:Can somebody 'splain this?

[symbolset]

Rules are set. Rules are changed. People game the system anyway. Making the management, inspection and auditing of the system complex and incomprehensible is part of the game but really there's no hope for a cure. The game is designed by people and people play the game. Both sides seek dominance and alternately get it to varying degrees until the inevitable loss of control that turns the pendulum yet again. Regulation is needed, but there's no such thing as a permanent regulation in the dynamic finance system that we have - the game changes and getting the regulations turned to your advantage is why people contribute to campaigns.

I don't think we'll ever be quit of it. The trick is to adapt to it and turn it to your advantage.

Re:Can somebody 'splain this?

[billcopc]

These types of exchanges (stocks, commodities, etc...) are Gambling dressed up for high society

Sure they are, but they have billion-dollar marketing campaigns to convince us otherwise. Why the hell does a bank need an ad campaign ? Why is it spending what is supposed to be our money on self-promotion ?

A: Because there's a greedy bastard making a ton of money at the top.

The reason why everything is the way it is, is so that a bunch of people can legally skim off the top, have their dumb yachts, coke and whores and not have to work for it.

And we are the fools for willingly enabling that mass fraud.

Re:Can somebody 'splain this?

[billcopc]

Banks have to get their money from somewhere

No, they don't.

Fractional reserve is the root of our problems today. The system is designed to lend out more money than actually exists, thus the economy is overloaded by design, and inflation is guaranteed.

Well I don't know about you, but I'm pretty sure them cows don't produce 3% more milk with each passing year, nor do they yield 3% more meat. You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world, and printing more money isn't going to change that.

Re:Can somebody 'splain this?

[Anonymous Coward]

... when you take into account the time value of money, that really comes down to the same thing: by keeping cash, the business implicitly pays the opportunity cost [wikipedia.org] of keeping that cash. (And with an inflationary monetary policy, of course, the cash itself becomes less valuable over time.)

You have identified the problem. Thank you, the solution is now obvious (assuming it wasn't obvious 40 years ago or even 400).

Re:Can somebody 'splain this?

[Estanislao Mart�nez]

Thank you, the solution is now obvious (assuming it wasn't obvious 40 years ago or even 400).

You're welcome. Good luck eating your gold in a deflationary spiral. (Good news: it's actually edible.)

Re:Can somebody 'splain this?

[blitziod]

the reason the loans are toxic is not just that the value of the real estate has gone down, but that many are financed with ARMs. The price of paying the note has gone UP and the home owners can;t afford them. The best thing the country could do is NOT bail out banks but bail out home owners. the cost of this bail out will be enough to PAY OFF most of those toxic loans in FULL. Why not instead just allow the home owners to refinance at a lower rate they can afford directly from the fed? Maybe split the loss with the original lender as such I borrowed 100k on a house worth 80k now. My loan was at 4% now the ARM is 7%. I refinance at 90k for 5% and I keep the house. I lost 10k( i paid 90k for an asset valued at 80k) and the bank lost 10k. This would keep people in homes, and keep the market for homes from going down as much. It would cost the banks( and stock holders more) BUT it would help the market for houses and the common guy in the street. If taxpayers are gonna pay for a bail out why should it help investors in CHASE or Citi group?

Re:Can somebody 'splain this?

[FooAtWFU]

On the contrary. Even the New York Times, in their 1999 article Fannie Mae Eases Credit To Aid Mortgage Lending, recognized that 'If [the subprime market] fail[s], the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.' (The thrift industry episode was back in the 1980s, before my time). Fannie Mae is to entirely to blame. The rest of the world didn't help, but Fannie Mae is entirely the core and the cause of the current crisis, and the destructive policies sending us on the road to Hell originated with a well-intentioned attempt to improve credit access to minorities.

That said, grandparent post does contain a modicum of Bullshit too. Consult with your local Ph.D. economist, not zanies on the Internet.

Postscript. Congress is complicit. That goes for both Republican Congress and Democrat Congress. And the Presidents. Extra for Obama, who is the second-biggest recipient of Fannie Mae campaign contributions ever.

Re:Can somebody 'splain this?

[CodeBuster]

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

There are certainly some financial instruments which are almost indistinguishable from gambling. For example, the ability to buy or sell options or derivatives on a futures contract based upon the average temperature over a given week in Los Angeles. However, not all or even most financial instruments are completely without merit. The general idea is to make financing in the right amounts available to the broadest base of qualified borrowers at the most efficient rates possible because this provides the highest possible rate of economic growth (which correlates very closely with standards of living and wealth in general of the society). Having been a small business owner in the past, surely you can appreciate the ability to get loans for your business on generally agreeable terms. Now imagine that some or most of the enabling instruments which you attribute to the greed of bankers and brokers were made illegal. You might find that getting a loan for your small business is more difficult and costs more because you are dealing with a smaller pool of local banks who know you and your business (and know that you will have difficulty going somewhere else for your loan). It would be very difficult for smaller businesses, like yours, to tap into larger regional, national, and international sources of credit because the instruments which serve to aggregate loans and risks have been made illegal. The financial instruments available today are double edged swords to be sure, but attributing them soley to the greed of bankers and brokers or banning for that reason would be short sighted.

Re:Can somebody 'splain this?

[Chirs]

"If you don't have the cash don't buy a new car, get a second-hand one. Cars are a worthless investment, especially new ones."

Around here I found that it was very difficult to find used Hondas and Toyotas at reasonable prices. Given that I plan on owning the car until it dies it ended up costing roughly the same to buy one new car or multiple used vehicles.

Even if you have the cash, it may make sense to buy a car on credit. Sometimes car companies give excellent credit terms, but won't give you a break for a cash deal. In this case it makes sense to buy on credit and invest the rest of the money.

Re:Can somebody 'splain this?

[CodeBuster]

the mortgage buyers would buy without enough questions because they knew there were buyers who would buy the derivatives without too many questions.

The last buyers in that chain where the biggest fools of all for investing in product which they could neither evaluate nor understand. The advice of Warren Buffet on such matters comes to mind (paraphrased), "If you don't understand it, then don't buy it". If you buy it anyway without understanding it then you are speculating (i.e. gambling). If nobody can understand or evaluate it because brokers upstream have concealed or failed to pass on important information then anyone who buys the products without access to critical information about the investment products is a fool and an idiot (no amount of analysis is likely to help when critical information is simply missing).

Re:Can somebody 'splain this?

[Spasemunki]

Fannie May and Freddy Mac got permission to buy sub-prime mortgages in response to the growth of that sector of the market among private lenders. Congress and the Bush administration put through a law that allowed the FM companies to buy out sub-prime loans instead of buying CRA-regulated loans as part of their obligation to buy low-income loans. Fannie May and Freddy Mac have nothing to do with originating loans, as most people fail to realize; they buy loans from others that comply with their regulations in order to keep the mortgage market flowing. Their regs were changed by Congress to allow them to buy into the sub-prime market. The sub-prime market emerged not because of the FM companies, but because private lenders discovered that by extending loans to marginal borrowers and then re-selling them as mortgage backed securities, you could make a lot of money without significant risk. The Congressional reg change helped the sub-prime market grow, but nothing about that regulatory change was done to benefit poor worthy borrowers; it was done to allow Freddy Mac and Fannie May to maximize their profits as semi-private entities. The narrative of attempts to help low income minorities ruining the economy just doesn't hold any water.

Re:Can somebody 'splain this?

[Anonymous Coward]

You're welcome. Good luck eating your gold in a deflationary spiral. (Good news: it's actually edible [straightdope.com].)

Har har. This goes beyond the gold standard. Most people focus on the wrong word when they read "gold standard". The focus should be on the "standard". I strongly suspect that between inflation and the spread betwixt a fed-rate loan and what the consumer typically pays (3 to 30%), there is a big whopping load of money to be made and/or stolen. If we accept that the dollars in our pocket will be worth less 3% next year, and, FURTHER, that it is SURE BET that those dollars will be worth less by some amount (1.5% to 4.5%), then we ought to accept the inevitable conclusion about what type of society we are encouraging. Now - to cut off one line of attack - I will not promote any deflationary strategy as that is so much derided, but we can/ought have an approach that is long-term neutral on the value of currency. This is, of course, to the best of our ability. Instead a game has been created that is literally like hot potato. It makes me a sap for having $5000 in my checking account an $300 in a cash drawer ($100 in the wallet...), and sometimes a few grand in a money market fund. Mine is a criticism of the inflationary monetary policy. Gold does not come into the equation.

People in the financial market have been making BANK for years. And I am not referring to the Warren Buffet way. Nor am I trying to criticize hedge fund managers or other Wall Street tycoons that received bonuses and profits nearing a billion dollars at times. No. This about the fact that something paid for their yachts, mansions, etc. It wasn't something like a soda-drink empire or mega importer (Wal*Mart) where we can identify what is sold and why it is profitable. It is complex, it is esoteric, and I suspect the monetary system we have created is a sort of "juice" (analgous to the 110 buy-in / 100 pay-out a sports-bet-taker makes). That juice funnelled trillions of dollars to someone. Not me. Someone else.

Would you give one billion dollars of your neighbors' money to China if it put one million dollars in your US bank account? I am talking about a legal, nobody-blames-you type of thing.

Re:Can somebody 'splain this?

[amorsen]

Well I don't know about you, but I'm pretty sure them cows don't produce 3% more milk with each passing year, nor do they yield 3% more meat. You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world, and printing more money isn't going to change that.

Wrong. The cows do, in fact, produce more milk every year (not the individual cow, but the average cow). More importantly the dairy industry becomes more efficient every year, making it possible to have more cows using fewer resources. Farming is a bad example though, as efficiency growths in farming in industrialised countries is lower than efficiency growth in many other industries.

Re:Can somebody 'splain this?

[amorsen]

Why the hell does a bank need an ad campaign ? Why is it spending what is supposed to be our money on self-promotion ?

Is it not your money that McDonalds spends on ad campaigns? Or the money that Shell spends? Why are banks different than other businesses when it comes to advertising?

Re:Can somebody 'splain this?

[Stuntmonkey]

Well, the short answer is that the world needs more than one financial instrument for the same reason it needs more than one programming language, operating system, microprocessor variety, animal species, type of food, and so on. It's because diversity is inherently good. (Except when it isn't, which is pretty rare. Sometimes the benefit of standardization trumps diversity, e.g., electrical plugs and rail gauges.) Diversity creates competition, and opens up room for innovation. It also makes a system more, not less, resilient to catastrophe.

If you're looking for something to blame for your vanishing 401(k), here is my starter list:

1. Overly-lax regulatory environment, specifically poor reporting requirements for financial firms, resulting in little visibility into their real risk exposures.
2. Rampant moral hazards throughout the financial world, most notably in mortgage origination. (I.e., your mortgage broker and underwriter don't care a dime if you default or not. Odd, considering they're making the decision of whether to give you the mortgage.)
3. The Fed's stubborn refusal for years to recognize asset inflation as a valid form of inflation, instead using CPI as the exclusive metric for determining monetary policy.
4. Simplistic financial modeling by the quants on Wall Street, which treated mortgage defaults as uncorrelated events from one consumer to the next. (I believe this is what TFA was trying to get at, albeit poorly. In defense of the quants, it's probably impossible to predict when the complex nonlinear system that is our economy will tip into a strongly correlated regime as we've seen recently. Their dilemma is how to incorporate a known, but unquantifiable, term into their quantified decision models.)
5. Fear of recession among our elected officials, which induces them to be over-aggressive in counteracting natural downturns (small recessions), therefore allowing stress to build up in the system. They'd rather have a 5x recession on the next guy's watch than a 1x recession on theirs. Recessions are like avalanches at a ski resort: They are unavoidable, and the goal should be more frequent, smaller corrections.
6. A good old-fashioned crisis of confidence among the people. Honestly I'm spending less than I used to, in case I lose my job or get a pay cut. The problem is everyone is thinking the same way, which is guaranteed to depress aggregate revenue (GDP). It becomes self-fulfilling.

I doubt that financial product complexity is on the list. I'm also skeptical that greed, executive compensation, arrogance, globalization, or financial derivatives played any real part here.

Re:Can somebody 'splain this?

[Anonymous Coward]

Or maybe you're a really small development company with a really big project, or maybe you're growing and so the money from a project can't pay in advance for the next two, which can't pay in advance for the next four...

Re:Can somebody 'splain this?

[xenocide2]

What school do you go to, in order to learn your brand of logic? I ask, because you're hardly the first person to claim banks don't receive the money they loan.

Fractional reserve banking is about keeping a fraction of the money in accounts on reserve. End of story. They don't loan out more money than they receive as deposits. This still leads to inflation and has nothing to do with fractional reserves. If I loan money to you, you now have money, and I have a loan on my books as an asset for the amount, plus interest accruing. Instead in fractional the banking system, that loan gets spent and the people selling goods deposit money in their bank. Who makes a loan on that, perhaps to buy something from a business with the original bank. Eliminating that aspect of banking is impossible; measuring it is slightly less difficult. We have several variations on money, M0 - M3.

(And for the record, cows generally do produce more milk every year, in aggregate. By making more cows!)

Re:Can somebody 'splain this?

[xenocide2]

In the case of America, it's a regulation that causes the split. Savings accounts are, by law, not to exceed x number of transactions a month (6 I think). Similarly, it's tax law that keeps your brokerage account (IRA probably) separate from checking and friends. I can't say how much of all this is due to the New Deal, and how much is due to later regulatory capture.

Not that banks aren't relentless pieces of scum: ever wonder why your bank pushes you to sign credit transactions, and adds fees for debit? It's because they earn way more with credit than debit, and merchants aren't allowed to explicitly charge for credit transactions. Obviously they just make up the difference by raising the price of goods, but your incentives as a consumer are silently molded by your bank for their benefit. Hell, you don't even have to sign for stuff under 25 dollars anymore.

Re:Can somebody 'splain this?

[Jedi Alec]

Right up to the where it furiously rips you(it) off...

Re:Can somebody 'splain this?

[Anonymous Coward]

I'm the original poster. I'm not saying it's wrong to provide loans to "minority" poor people. Or to help them.

What is wrong is treating someone with a dismal credit history, dubious job, no education, no family, etc the same amount of money in loans as you give to a married college professor, with tenure and with 4 kids. Requiring said treatment will, as has been demonstrated, cause a collapse for everyone, which will hit those "poor" people much harder than the rest of us.

And as you admit (if somewhat implicitly) in your sentence, forcing banks to cover idiotic loans is exactly what the democratic congress did.

The congress in fact forced "predatory lending" (loaning someone much more than they could afford, then taking away everything they have) on the banks, as you admit yourself :

to buy out sub-prime loans instead of buying CRA-regulated loans as part of their obligation to buy low-income loans. Fannie May and Freddy Mac have

(btw low-income is incorrect, or "inaccurate". In practice it literally comes down to whoever ACORN claims is a "minority". Basically any somewhat isolated ethnic group that votes for whoever they point to is defended with tooth and nail as a minority, and everyone is a minority, "if you look deep enough". I'm an american with irish roots living in Europe. There aren't many of us. Minority !).

Good intentions - denying the inevitable consequences (corruption, greed, predatory lending, global financial crisis). Both before and after the fact they are denied. The hallmark of "democratic" policy. The only possible socialist policy. Making everybody equally miserable. How miserable ? Well some people are dead, and socialists, let's say, go for equality ! ... and then deny it afterwards. "last time they tried this in russia about 100 million people died" is not a good campaign slogan, after all, "hope and change" is so much better, even if it does mean the same thing.

Or put another way they will eventually transform figuratively bleeding heart liberals into physically bleeding heart liberals, with bullets.

Re:Can somebody 'splain this?

[umghhh]

1. if money lies in your account it is working but not for you or possibly not as efficient as it could. Just to remind you - banks were originally invented to store money in a safe place. It relatively recent invention for the banks not to keep the money but to invest it exposing them to runs.

2a.have you ever considered how big a chunk of credit problem the defaults in subprime actually were?

2b. Why do you think that some other practices like CDS have nothing to do with the problem? They are few orders of magnitude bigger in value than anything what reasonable can be called subprime mortage.

Re:Can somebody 'splain this?

[HungryHobo]

3% more each year would be a bit much but with improvements in breeding stock, feeds, etc each one does produce a hell of a lot more milk and meat than it would have 100 years ago.

There is a fixed amount of natural, life-sustaining resources in the world, of which we're using the most miniscule fraction. What's expanding is our ability to get at those resources cheaply or create aditional resources.

Re:Can somebody 'splain this?

[Anonymous Coward]

Actually, in aggregate, house prices have risen pretty much continuously in recent history. That means that investing in a bunch of mortgages was a good investment plan.

The problem, as I understand it, was that the investments then created a demand for mortgages that could only be fulfilled by loosening the lending requirements. This lead to a lot of questionable loans to be given which helped inflate prices. This was great in the short term because it encouraged people to refinance their mortgages against the higher value of their home. Unfortunately, when the questionable loans started failing it dragged down the whole house of cards, making that good investment in a bunch of mortgages not such a good investment anymore. Whoops. It had the added effect of making many of those people who took out bigger mortgages holding a lot of debt with no assets to back it up.

Re:Can somebody 'splain this?

[Hognoxious]

How did you start this supposed business? You must have spent something up front, even if it grew out of a hobby.

Let's look at some other situations. You think passengers are going to pay the taxi driver before he's bought the car? You think people are going to pay their electricity bills before the power station's built?

Re:Can somebody 'splain this?

[Captain Nitpick]

Well I don't know about you, but I'm pretty sure them cows don't produce 3% more milk with each passing year, nor do they yield 3% more meat. You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world, and printing more money isn't going to change that.

Wrong. The cows do, in fact, produce more milk every year (not the individual cow, but the average cow). More importantly the dairy industry becomes more efficient every year, making it possible to have more cows using fewer resources..

"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Albert Bartlett

Production and efficiency in a single industry can only increase for so long before the results become absurd or impossible.

The average dairy cow in the US produces ~20,000 pounds of milk annually (rounded for simplicity). If we pretend we can get 3% improvements annually, then after 100 years we'll have nineteen times the milk we started with. At the end of 200 years, each cow is producing a pound of milk every four and a quarter seconds. In 300 years, 4.5 pounds/second. You'd have to stick a pipe down its throat just to prevent dehydration.

And as far as more cows using fewer resources goes, you run up against basic physics. Calories in >= calories out. Efficiency improvement is constrained by the universe.

Re:Can somebody 'splain this?

[bonhomme_de_neige]

how, exactly, are you going to get that $10+interest back unless at least enough new money to cover the interest is actually *created* rather than just *loaned out*?

Money doesn't get created, but what gets created is real output that is worth something. You use the $10 you borrowed from me to buy some pumpkin seeds (for simplicity, let's say from me), which you plant and tend.

Your time spent working on tending the pumpkins is worth something to me, because it means that I can eat a pumpkin without myself having to spend any time on growing and tending it.

Because of that, I'm willing to pay you some money for the pumpkin (what I'm actually paying you for is your time spent doing pumpkin work rather than something else). That is money you use to pay me interest on the loan.

So we can use the same money back and forth - it's just a tool for transacting to avoid the double coincidence problem which would occur if we traded by barter instead. What creates the "extra" wealth is that you spend your time on an activity that results in more pumpkins being available than before.

So in case the above explanation wasn't clear - it's all to do with the pumpkin.

Re:Can somebody 'splain this?

[hobbit]

If by "this whole mess" you mean the entire progress of the world economy since the invention of currency

I don't: I mean since currency ceased to be tied to anything of actual value, e.g., gold.

Re:Can somebody 'splain this?

[hobbit]

I think you will find that the bank has lent your money to someone else at a better rate than what they are paying you.

I think you'll find that if you quoted my whole paragraph, I covered this.

No it didn't get us into the mess, what you're describing IS the mess. That's why it's called a credit FREEZE - ie: money stopped going round because banks stopped trusting each other.

No, money stopped going round because banks realised that the game was up and that value which didn't exist couldn't be used to leverage any more.

Re:Can somebody 'splain this?

[Anonymous Coward]

They may not produce more milk or meat, but sometimes they do produce more cows, y'know?

Re:Can somebody 'splain this?

[Capt James McCarthy]

While you are simplifying the financial market, why not go to a flat tax of 10%. Cut out 90% of the IRS (less needed audits, and automated collection) which would save ten billion tax dollars in itself every year (they have 11 Billion dollar budget in 08). It would simplify the tax code to basically one page (I.e. no personal wealth write offs) and would make sure that if you make 20k a year, you pay 2k in taxes, while if you make 200k a year, you pay 20k. I would think that would go farther to increase personal wealth, stimulate growth, and folks would be less apt to try and find tax shelters for their hard earned cash.

As for the banks making money, that is their choice to put out as many products as the market will support. A bank is just like any other business, they want to make money as well. It was the "Gotta have it hear and now" that got the better of us. 99.5% of the population will never have a house on "Cribs" and have to accept that not everyone can be wealthy. Life is not fair, and it's certainly not easy regardless of what is portrayed on TV.

Re:Can somebody 'splain this?

[Capt James McCarthy]

"This whole post is total bullshit."

Why? The point is there, the delivery isn't well formed though. Lending money to folks regardless of race, creed, or gender, who don't have the means to pay it back is going to lose every time.

Re:Can somebody 'splain this?

[Capt James McCarthy]

"I prefer honesty and doing things right."

Well, you are not going to get rich with that attitude. From what I've seen if you are not back-stabbing, vindictive, willing to fire people to keep the stock prices high, pay yourself more then you are worth, consider people leaches and just a number, and use tax dollars as a personal corporate safety net, then you are not a true corporate leader.

Re:Can somebody 'splain this?

[ultranova]

For example, I can buy a CDS contract on Ford, betting that Ford will default on its debt and the same time I don't own one single cent in Ford stocks, bonds, whatever. I am merely speculating that Ford will go belly up. If it does, AIG will owe me big money.

So, hypothetically speaking, it would be in your best interests in that situation to make sure that Ford does go belly up ? Sure, you might not be able to do it alone, but what if you and a lot of your friends took CDS contracts on Ford and then cooperated ? And if you and your friends just happened to be shareholders of a rival bank to AIG, you would get a nice bonus: AIG loses money, giving your bank a competitive edge.

Kinda makes me wonder about the real causes of this financial crisis...

Re:Can somebody 'splain this?

[Anonymous Coward]

Re: Fractional Reserve Banking

Yep, nothing like a 2,000+ year old system to explain away a credit crisis that's turned into a recession.

Go back and research credit crises. There's been many in the US and world history.

Re:Can somebody 'splain this?

[Anonymous Coward]

IAAFA

Different financial products exist because it is more objective to grant credit to people based on single or few variables - house value, creditworthiness, savings deposits, equity holdings. "I want to finance this $x house, I make $y a year, and have $z credit score." You will get an objective, transparent reply.

A holistic approach "please come look at all my assets and determine if I am creditworthy," is more open to abuse. Your reply may be based on your actual creditworthiness, or it may be based on your creditor's mood, your race, etc. But you can't be sure because no one else has your exact situation. This is opaque.

I like to borrow and lend in transparent markets.

-----

While I'm here, Anti-Globalism is about the worst mantra you can have.

Re:Can somebody 'splain this?

[Spasemunki]

Why? The point is there, the delivery isn't well formed though. Lending money to folks regardless of race, creed, or gender, who don't have the means to pay it back is going to lose every time.

Because nothing about the regulations that the GP poster was talking about ever required banks to lend to people who were unable to pay. Because banks who were subject to those regulations were not responsible for the majority of the sub-prime loans that trashed the market. You're correct that lending to people with bad credit, who can't possible repay their loan, is a bad idea. The idea that banks were compelled to do that by legislation that put an end to certain discriminatory lending practices (like "redlining", the practice of identifying minority neighborhoods and declaring that no resident of that neighborhood, and no home within it, was a reasonable credit risk) is complete nonsense. Banks started extending sub-prime mortgages to unsafe lenders because they thought there were profits to be made in doing so, not because they were compelled to lend by anti-discrimination laws.

It's pretty simple. In the old days, two people walk into a bank. They both have modest, working-class jobs and good credit history from auto loans and store credit cards. They are both asking for loans in about the same amount. One guy is buying a house in a working-class white neighborhood. The other is buying a house in a working class black neighborhood. What happened before the CRA was that the first guy got a loan, and the second guy either got denied or had his fees and rates jacked up. The CRA simply said that if you were challenged on it, you had to be able to show that you were consistently following through with your risk calculations without regards to race or the ethnic makeup of certain neighborhoods. A good borrower asking to buy a house fairly appraised at $200,000 in a historically black neighborhood couldn't be charged twice the rate as the same borrower buying in a white neighborhood.

Now if the person asking to borrow is an obvious credit risk- bad history, no income, loan principle vastly in excess of their income or earning capability- you can still deny them under the CRA. You just can't deny people who's mailing address is in one zip code, and lend to people from another zip code. Nothing compels you to lend to bad risk borrowers.

Some right-wing pundits are claiming that this was somehow responsible for the sub-prime meltdown. They claim that in order to avoid the appearance of discrimination, banks were making bad loans to minorities in order to pad their numbers for loans to minority borrowers and neighborhoods. But this simply isn't true; in fact, most of the lenders making sub-prime loans were never subject to the CRA. Even if the CRA was compelling banks to make loans they otherwise wouldn't (which there is no evidence for), the private lenders who wrote most of the sub-prime loans had no need to give the appearance of compliance, and could make decisions purely based on the risk/reward profile of their customers. They decided that people with low incomes and poor payment histories were a good bet, because they could re-package the debt as mortgage-backed securities and resell the risk. They didn't make loans to poor people who couldn't pay because the law compelled them, or out of the goodness of their hearts; they did it because they believed there was a profit to be made. Meanwhile, the CRA regulated banks, which conservatives claim were being forced to lend to bad borrowers, were making far fewer sub-prime loans, and weren't attempting to commoditize their debt aggressively the way the private lenders were.

The real truth is that the growing housing market, low interest rates in the wake of the dot com bust, and the unregulated market in debt-backed securities created a toxic environment. Private lenders saw great potential profits in lending to the sub-prime market, and believed that debt-backed securities gave them a way to avo

Re:Can somebody 'splain this?

[dc29A]

Taking out a lot of CDS contracts on Ford has negative consequences. The CDS spread, an indicator will tell the market that confidence in Ford is eroding. This might cause a stock fall/collapse. Ford might be downgraded by rating firms, lot of negative results can be achieved by simply buying a lot of CDS contracts.

In fact, as soon as a company/bond/mutual fund/whatever is downgraded by ratings companies, the insurer immediately has to set aside more money because the likelihood of a company going belly up just gone up. This is a collateral call, this is what caused the death of Lehman, too many collateral calls from the Fannie/Freddie nationalization and other downgrades like AIG, AMBAC, MBIA, etc.

So by buying a lot of CDS contracts, people can hurt both the insurer AND the company they buy insurance on.

Oh and what stops me from doing insider trading? Let's say I know Ford is in deep shit because I work in the high spheres of Ford. Downgrade by ratings firm is imminent. I buy a lot of CDS contracts at 2% premium. Ford gets downgraded, the premium goes up to 4%. I sell my CDS contracts and make a lot of money, 110% legal, even if I had insider information because CDS contracts are never regulated and are over the counter.

The sheer amount of abuse of the current system that can be achieved through CDSs is mind blowing.

Kinda makes me wonder about the real causes of this financial crisis...

No need to wonder really, it's all caused by Credit Default Swaps.

Re:Can somebody 'splain this?

[RobBebop]

At the same time no one can sell their house because no one can get credit and if the houses don't move the price drops screwing home owners. At the same time banks are dumping foreclosed homes further driving down the home price comps.

Emphasis mine. I think you mean, because buyers can't get enough credit to buy the houses at their present values.

I'm nearly positive that I'd get a $200,000. Heck, I could probably get a $300,000 loan. Unfortunately, house prices are $400,000+ for anything worth living in (i.e. not a closet and not in the bad section of town).

Thus... the complaints you raise about falling prices are actually the invisible hand of the market bitch-slapping the buyers who got in right before the bubble burst. But fortunately for those people, the government is stepping in with Foreclosure avoidance programs and as a result they aren't going to be financially ruined for the rest of their lives (as opposed to the people who have rightfully been foreclosed on because they can't afford their ARM loans that are sky-rocketing in cost... those people made dumb moves and they deserve the hardships that they'll go through dealing with the mess they've created).

Re:Can somebody 'splain this?

[Hordeking]

Well I don't know about you, but I'm pretty sure them cows don't produce 3% more milk with each passing year, nor do they yield 3% more meat. You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world, and printing more money isn't going to change that.

Wrong. The cows do, in fact, produce more milk every year (not the individual cow, but the average cow). More importantly the dairy industry becomes more efficient every year, making it possible to have more cows using fewer resources..

"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Albert Bartlett

Production and efficiency in a single industry can only increase for so long before the results become absurd or impossible.

The average dairy cow in the US produces ~20,000 pounds of milk annually (rounded for simplicity). If we pretend we can get 3% improvements annually, then after 100 years we'll have nineteen times the milk we started with. At the end of 200 years, each cow is producing a pound of milk every four and a quarter seconds. In 300 years, 4.5 pounds/second. You'd have to stick a pipe down its throat just to prevent dehydration.

And as far as more cows using fewer resources goes, you run up against basic physics. Calories in >= calories out. Efficiency improvement is constrained by the universe.

You have two cows.... Don't forget that a cow has to produce a calf (with a 50% chance of being a bull) who consumes some of that milk. But then the calf grows up, and if it is a cow, it will also produce milk. Also, a cow's milk production decreases with age.

Re:Can somebody 'splain this?

[DragonWriter]

I don't: I mean since currency ceased to be tied to anything of actual value, e.g., gold.

And what do you mean about it? The economy of the world hasn't been a bigger mess since the end of the gold standard than before it, and the big messes that have happened in the interim all have explanations that are independent of the absence of the gold standard (and currency remains tied to something of "actual value", to wit, the issuing government's willingness to accept it in payment of debts, fines, and taxes.

The move to fiat money was driven by exactly the same forces that drove the move to representational money which were important forces that drove the selection of the particular commodities used in commodity money, the need for money to keep moving to be useful as a medium of exchange.

There's perhaps a reasonable argument that fiat money is less secure than other forms as a store of value, but in an economy in which one can buy commodities freely with the fiat money, there is little reason to use money as a store of value in the first place, anyway. And, anyway, representational money has most of the same problems in that role (and of course, any system relying on notations of account is effectively, at best, representational money, even if the cash form of the currency is commodity money.)

Re:Can somebody 'splain this?

[nelsonal]

Incorporation is mostly about ring fencing assets between personal and business. There's no law that says the corporate owner can't be the only employee, too. Every business (no mater the structure will need to deal with principle agent problems once it begins hiring employees (and they grow in magnitude when all the employees are no longer primary owners of the firm).

Re:Can somebody 'splain this?

[Anonymous Coward]

Actually, you missed something in the above. If you loaned me $10, then the following transactions occur:

You: -$10 (paid out to me)
You: +$10 (debt asset)
Me : +$10 (cash I got from you)
Me : -$10 (debt liability I owe you, which you forgot to mention earlier.)

The above sums to 0. There's still just $10 in the system. You've just transferred it (temporarily) to me. When the loan comes due, I pay you back your $10. There is no magical "money appears" situation.

The same applies to collateralised debt and suchlike - the person who's owed the money changes, but the debtor and the amount owed is the same. The issue today is that the following parameters were mis-estimated:
1) The solvency of the debtor
2) The value of the collateral behind the debt
3) The ease of re-negotiating the loan
4) Human behaviour in the face of a collapsing financial system (we're not rational after all!)

Credit is beneficial if and only if you can put your borrowed money to better use than the interest you're paying.

Re:Can somebody 'splain this?

[DragonWriter]

No, they don't.

Yes, they do.

Fractional reserve is the root of our problems today.

No, its not. And regulated fractional reserve banking requires banks to get their money from somewhere, contrary to your indication that it does not. They have to acquire the reserves, and the permission to issue more money via reserve regulations.

The system is designed to lend out more money than actually exists

No, it doesn't. All money that is lent out actually exists as much as any money exists.

thus the economy is overloaded by design, and inflation is guaranteed.

Inflation is not guaranteed. In fact, for the last several months the US has been experiencing deflation.

Well I don't know about you, but I'm pretty sure them cows don't produce 3% more milk with each passing year, nor do they yield 3% more meat.

Perhaps not, agricultural is a pretty mature field after thousands of years, though increases do continue. Technology isn't limited to computers.

Of course, there are lots of fields that are less mature than agriculture where a 3% increase in yield annually would be small.

You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world

No, there isn't. Well, there is for some resources, there are declining quantities for others, and increasing quantities for yet still others.

and printing more money isn't going to change that.

Nor is it designed to. Nor is that particularly relevant to inflation, or to the actual problems we face at the moment.

Re:Can somebody 'splain this?

[nelsonal]

Why is it so bad that you can buy insurance on something you don't own? What if you own something similar that isn't insurable? Say Mazda bonds or car loans that no one is willing to write a CDS against, is it still gambling? The real problem with AIG's writing an insane amount of them was that they failed to consider that the contracts have an important provision to protect buyers from those who don't have one red cent, pledged collateral. AIG didn't correctly consider their risk that because of their own credit rating, they might have to rapidly increase the amount of collateral they must pledge (even if almost none of the defaults ever actually occur, the liquidity event can and did bankrupt them).

Re:Can somebody 'splain this?

[Anonymous Coward]

But a finished product (that people want to buy) is worth more than the cost of its raw materials. Finished working commercially viable source code is worth more than blank text files.

Do you think Apple had to mine iPods from the earth and sell them for nothing more than their intrinsic value? They had an idea, created a design, assembled raw materials, and made a nice profit.

I use Apple as an example, but really any successful company or individual can create wealth from nothing. A well made chair is worth more than some spare wood. A nice painting is worth more than the paint and canvas it was made out of.

Re:Can somebody 'splain this?

[Anonymous Coward]

glad to see we have some knowledgeable cow experts on /.

Re:Can somebody 'splain this?

[Anonymous Coward]

Yes I personally think fractional reserve banking is the root of the problem, and it will never be fixed unless you all demand this.

The problem with everything is that alot of people think other people will fix the problem, but in truth money decides the course of actions. Even for the ones willing to change. Slave to a system that holds you while you aren't even aware of it. You are held against your will to a mortgage, loan etc.

Here is a nice explanation, even my mother could understand this ;-).

Titled: Money as debt.
video.google.com/videoplay?docid=-9050474362583451279

The truth is: There is no spoon.. err money, only debt.

Re:Can somebody 'splain this?

[Abcd1234]

Fractional reserve is the root of our problems today.

FYI, just 'cuz you says it's true, doesn't *actually* make it true.

The system is designed to lend out more money than actually exists,

Wrong. The system is designed to allow banks to *create* money by providing loans. In effect, the value of, say, a home, is translated into liquid cash which then enters the economy.

As such, a fiat currency, rather than being backed by a single asset, like gold, is backed by the sum total of assets that exist in the economy, which actually makes a lot more sense, as it means the amount of cash grows as the economy grows, this preventing disastrous deflation.

You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world

Ahh, I see. So you're saying no one ever creates wealth. Well, that's funny, because I'm pretty sure my house is worth more than the sum total of the material it's made of. And that additional value must come from *somewhere*.

Re:Can somebody 'splain this?

[plague3106]

I find your post amusing. What actual value does gold have, except that you are willing to trade it for goods or services?

Re:Can somebody 'splain this?

[dwye]

If they would just refinance the so called "Toxic debt" mortgages at 3% over prime it would drop the payments down to a point where most of the "toxic" loans would be workable for the debtors and then they wouldn't be toxic. At 3% over prime it would be plenty profitable too. If they would force the mortgage companies to carry the paper on a portion of the loans (selected at random) it would guarantee that they wouldn't write fraudulent loans either...

Oddly enough, this was the original finance industry bailout plan, basically.

One problem with your suggestion is that property values have fallen in some areas to the point where it is a better deal for someone owning a home with an affordable mortgage to default, then rebuy it at "market price" with the worst loan (i.e., highest mortgage) that they can get. This is especially a problem in areas where real estate speculation by ordinary homeowners occurred, like Southern California. What I read is that they expect prices to fall by as much as 70% there (which is only about 4 or 5 years of increase, though).

And it would certainly help some if the Collateralized Debt Obligations went away. It wouldn't help Iceland, though, and I expect that there are lots of other cases where "normal" investments at high leverages are the problem.

Re:Can somebody 'splain this?

[Abcd1234]

They don't loan out more money than they receive as deposits.

Actually, they do. In most modern fiat currency models, banks must hold a minimum reserve relative to the amount of loans they give out, but can otherwise issue loans up to that ratio.

In fact, banks quite literally create money by making these loans, which is how the US money supply grows (and is one of the reasons why adjusting the interest rate affects inflation... if you reduce the rate at which loans are granted, you reduce the rate the money supply grows, which translates to lower inflation). It's actually a pretty fascinating, if confusing, topic. I'd recommend reading up on it!

Re:Can somebody 'splain this?

[dc29A]

Why is it so bad that you can buy insurance on something you don't own?

It's called gambling and it's illegal. I have a choice to take out insurance on my 50,000$ stereo, but I can't take out insurance on someone else's stuff. Insurance allows you to insure stuff you own, not someone else's. Since CDS is nothing more than insurance, it should function the same way. But currently, it does not.

What if you own something similar that isn't insurable? Say Mazda bonds or car loans that no one is willing to write a CDS against, is it still gambling?

It's called investing and it comes with risks. These CDS contracts are very recent, developed around 1997. People were investing fine before. And the vast majority of these CDS contracts are used for nothing more than gambling, not protecting an underlying investment. And that is the root of the problem.

The real problem with AIG's writing an insane amount of them was that they failed to consider that the contracts have an important provision to protect buyers from those who don't have one red cent, pledged collateral.

Exactly, when Lehman went belly up, AIG had to pay out a lot of CDS contracts, but they didn't have any collateral so Fed had to step in or AIG would have gone belly up too (and dragged down pretty much the entire financial system into the gutter). This was nobody's fault but AIG's. They didn't keep any collateral to cover their lost bets because no one regulates CDS contracts. Something similar would have been impossible with real insurance, because that is heavily regulated.

Don't get me wrong, I like the idea of a CDS. However it needs to be (1) regulated, (2) traded openly like stocks on a centralized exchange (not over the counter) and (3) people buying these MUST have investments in these entities for the amount they are buying insurance for.

CDSs need to be treated like what they are: insurance, not some made up term that's only goal is to evade regulation.

Re:Can somebody 'splain this?

[Sobrique]

A house maintains value, and a car doesn't.

But in neither case are you (generally) buying them based on the profit/loss. A house that you own, you don't have to rent. The mortgage repayments are a cost, but one that secure you an asset at the end of the day.

A car is a different matter - it's a lifestyle option. You can get by without a car, better than you can get by without somewhere to live. But ability to travel 'car distance' is also a factor in job selection and general mobility.

But a second hand car isn't always cheaper than a new car - you're trading off a new vehicle, under warranty for a few years which will maintain _some_ value in 3 years time, against a second hand one - which is _probably_ less reliable, and will certainly cost you for any work that needs doing.

I've done both - bought a cheaper car (10 years old, high milage) and ran it for a while, and bought a more expensive one. I would honestly say there's not much in it in terms of net cost - the cheaper car was less upfront, but used more fuel for a smaller chassis and had annual maintenance bills that were significant enough to make up the difference over a few years.

My 'newer' more expensive car (3 years old, not much milage) - well, has cost me substantially less over it's lifespan. It's not used anywhere near as much fuel, and I've yet to pay anything for 'maintenance' work, beyond the regular service schedule. Despite my borrowing to 'buy' it, and the associated interest payments and the depreciation, this car has cost me less over my 3 year sample period. Additionally it's much more comfortable to drive, bigger and thus can carry more stuff/people, safer and better on the road handling, and I'm not risking getting in trouble at work because 'the car broke down'.

So there's a very good reason to buy a car on credit - it costs you less in the long run, and you get a nicer driving experience.

Re:Can somebody 'splain this?

[nelsonal]

I disagree that gambling is illegal, it depends on your location. What about the futures market? That's a pretty important market. There's always room for speculators. I'll concede that the CDS market was an innovation that routed around some restrictions on insurance firms. I'm more than in agreement that they should be traded openly, and depending on what your regulations are would agree with that, but I don't see why you should have to own the underlying.

Markets are a lot like media pirates, trying to limit them usually leads to worse consequences and rarely solves the problem. (CDS got created to avoid rather severe restrictions on insurance companies). If these are too heavily regulated, what ever is next will probably be worse.

However, what killed AIG wasn't that they had to pay out for Lehman (that was a hit but a fairly small payout compared to the size of the firm), it's that their models made no anticipation to the huge numbers of contracts they had written that included terms with increasing collateral on non-defaulting CDS, when AIG's credit rating was downgraded. That was a gigantic hit to their cash reserves, because to use your stereo insurance example, it no longer mattered that your stereo was stored in Fort Knox and hadn't moved, AIG still had to front another 10% of the value of the contract to protect the CDS buyer from a potential AIG default. Creating a loop (the collateral payments would trigger further credit rating downgrades) that would quickly bankrupt the firm (as it happened the first one was more than large enough).

Re:Can somebody 'splain this?

[Anonymous Coward]

Sure but you have to pay interest on the debt,

So the question becomes, is the amount of:

n + ((accounts_receivable * reliable_fraction_of_a_r) - interest_on_short_term_debt))

less than or greater than:

n + (accounts_receivable) + interest_on_n_from_bank))

Don't you pay for living one debt period ahead of your cash income?

Re:Can somebody 'splain this?

[Anonymous Coward]

The cow may not necessarily get more productive, but we may be able to adjust what we feed the cows to get more milk at less cost/calories input. We might be able to improve our methods so you only need one farmer to manage twice as many cows.

Milk production per cow is not the only measure of productivity.

Re:Can somebody 'splain this?

[Anonymous Coward]

What if you are opening a car dealership? You will need several million dollars of inventory to open one to make say a 10% profit margin. Are you proposing that only millionaires should be able to open a car dealership?

You own a store. Very large amounts of your cash are tied up in your inventory. PS3 is coming out and you know it is going to be a hot seller, but it is very expensive compared to your other products and you don't have enough cash to fulfill Sony's minimum order size. Borrowing money over the short run will help you here.

Yes credit can be used poorly, but these above scenarios are why the financial industry exists in the first place.

Re:Can somebody 'splain this?

[Rycross]

On the consumer side, we also had a lot of people who believed that housing prices could only go up, and so over-extending yourself was OK, because you could refinance. I was personally told this by an agent trying to get me into a mortgage, and again by friends and coworkers. I opted to just keep renting, because I wasn't comfortable spending literally every penny of my monthly savings allowance on my mortgage and depending on a tax break to make up for it.

Re:Can somebody 'splain this?

[2nd Post!]

How can he make zero sense?

Cash in the bank IS sitting idle. There is no way else to describe that. However, just because it is sitting idle doesn't mean it's wrong, either.

So you are now using your cash, it is no longer sitting idle, you are purchasing gear cheap. You happen to have a different strategy, but you are doing the exact same thing the other guy is describing except you aren't using debt to power your business.

PS, he's not right, either, there are companies out there, publicly held, without debt. Apple comes to mind. I'm sure Microsoft and Google are also (largely) debt free. You know, the hugely successful companies despite the downturn?

Re:Can somebody 'splain this?

[2nd Post!]

Actually, the land a house sits on goes up because land is a scarce item (there is a finite amount of it and a largely infinite number of uses for it).

In most parts of the world land is not really scarce, only in certain locations (such as California and Hawaii) where weather, business, and local conditions push up demand beyond supply.

Re:Can somebody 'splain this?

[Wildclaw]

And that is the real reason for the economic downturn.

Creating wealth is about doing mutually benefital deals. When both parts no longer tries to do that, but instead just are interested in screwing the other part for your own profit, you don't get a wealth creating economy, but instead just an economy that shuffles money around.

Society can tolerate a smaller amount of foul play, but when the general attitude becomes that it is ok to screw anyone to earn money it falls apart. This is no different than the 1920s. People's attitude were just as bad back then from what I have read. And it took a world war to get people cooperating again.

Re:Can somebody 'splain this?

[Bob Uhl]

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

Because they offer different features. A checking account has lots of activity and fluctuates in value considerably. Due to its need for liquidity, it carries a lower interest rate. A savings account has lower liquidity because money in it is meant to basically stay there. Because of its lower liquidity, the interest rate is higher. A credit card is a short-term monthly loan; if you want you can get a debit card which is basically a check card on a checking or savings account. A line of credit is basically a pre-approved credit limit, similar to a credit card but generally intended to be used differently, and thus has different interest rates. A personal LOC is unsecured; a HELOC is secured by one's home equity. Again, different rates apply because of the different circumstances. A brokerage account exists to manage investments, which are an entirely different animal.

All those different accounts can't be merged into one because they serve different needs. The closest merge you can make is between a brokerage and a checking account. My bank offers one of those and it's a real delight: the interest of a savings account with the convenience of checking. But of course it has its own tradeoffs.

Banks offer different accounts because customers have different requirements.

As for other financial instruments, they exist because there's a need for them as well. Let's take the case of futures contracts as an example. Commodities prices fluctuate constantly, even by the minute. This makes planning for both producers and consumers difficult. Steel mines have a lot of uncertainty about what price they'll be able to get, and railroads have a lot of uncertainty about what price they'll pay. This uncertainty is not good. So what they do is settle on a futures contract, in which the parties settle on a price today for delivery of a quantity in the future. This means the steel mine and the railroad alike know what their longer-term outlays will look like and can plan accordingly.

So yeah, it's a weird financial instrument--but it's a useful one.

Of course, someone else could buy that contract to sell steel at $20/pound if he thinks the price of steel will drop to $10/pound by the delivery date; he'll buy steel that very day, hand it over to the railroad and pocket $10/pound for his troubles...

Re:Can somebody 'splain this?

[Bob Uhl]

*AND* we should destroy anyone who was involved in shortselling any commodity related to loans, they should be prosecuted for making (and winning) the bet that tens of thousands of people would lose their livelihoods, their houses.

That doesn't make any sense at all. It's not their fault that anyone lost his home. If I bet that Mariah Carey will die within the next week and she does, it's not my fault. Likewise, if I shorted lumber three months ago it's not my fault that home construction has decreased.

Re:Can somebody 'splain this?

[XNormal]

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

Most of today's financial instruments have very good legitimate uses. Unfortunately, the vast majority of actual total trading activity in these instruments is speculation.

Re:Can somebody 'splain this?

[Bob Uhl]

You used to have have commercial banks, investment banks, and insurance companies, and each did something different under different rules. Then the rules that had been in place since the Great Depression were repealed by Gramm-Leach-Bliley, and suddenly the legal boundaries between these kinds of financial services was gone.

GLB is part of why the banking sector has imploded entirely: banks that are successful have been able to buy the failing banks.

Europe has integrated banking and it seems to work for 'em.

Re:Can somebody 'splain this?

[Bob Uhl]

While I am normally all for the survival of the fittest especially in a business world, this is a bit of a problem in our current situation, as if we let all the "bad companies" go bust, we would end up with millions of people ready to retire suddenly have nothing to retire on.

That's why retirement shouldn't be based on a company pension, nor on company stock, but rather on a diversified investment portfolio. It's better to lose 30% than 100% after all...

That's why 401(k) plans and IRAs are so very important: if your company fails, you still have your retirement because you own it.

Re:Can somebody 'splain this?

[Omnifarious]

A car is worth what you can do with it as well as its eventual 0 sale price.

I do think people way over-estimate how useful a car actually is. I've gotten by without one for my entire adult life, and I suspect most people who think they 'need' a car could do just as well without one.

But in order to accurately estimate whether or not a car loan is a good idea you have to look at how much money you're making with the car as well as how its resale value changes over time.

Re:Can somebody 'splain this?

[feepness]

Actually, in aggregate, house prices have risen pretty much continuously in recent history.

This depends strongly on your definition of continuous and recent history. Check here.

That means that investing in a bunch of mortgages was a good investment plan.

If your definition of recent is less than ten years, and your definition of risen continuously includes the occasional dip here and there, then yes, it would be an excellent investment.

However, I hesitate to call anything that looks no further back than ten years a good idea.

Re:Can somebody 'splain this?

[EvilBudMan]

Yeah a bank is a machine that makes money out of thin air and they don't even have to print it.

Yet with a plan like that they are still loosing money.

Give the bailout money to the ones that can't pay their mortgages and want to buy a car and let them decide what to do with it.

What we will get instead is more trickle down economics otherwise know as corporate welfare.

Re:Can somebody 'splain this?

[Nevyn]

Everyone knows the market is going to be way up in a few years because it is currently highly undervalued...

You sound like the prognosticators in 1929. But it took 22 long years for the Dow to surpass its pre-depression highs. Don't commit the same sin of hubris that got us here in the first place.

The DOW as it exists now didn't exist in 1922, but anyway what I assume the GP was trying to say is that in "a few years" the DOW will be significantly higher than 8,000. You are arguing that it might well take "a long time" for it to surpass 14,000. You might both be correct.

Re:Can somebody 'splain this?

[Pope]

No one in their right mind would ever consider a car an "investment," unless it's already a classic or rare one already. They depriciate as soon as you drive off the lot, and continue to drop the more you own them. True investments pay off by growth, and a car isn't one of those. It's something you buy to use up.

Re:Can somebody 'splain this?

[Pope]

Remember, a CEO's goal (lawful duty, actually) isn't to make a profit, it's to maximize profit.

I see. So where is this law written, exactly? State? Federal? County? City? Which country/countries?

Re:Can somebody 'splain this?

[Anonymous Coward]

This can also be applied to not only corp to corp, but to corp to employee, and employee to corp.

Re:Can somebody 'splain this?

[ultranova]

The best thing the country could do is NOT bail out banks but bail out home owners. the cost of this bail out will be enough to PAY OFF most of those toxic loans in FULL. Why not instead just allow the home owners to refinance at a lower rate they can afford directly from the fed?

If it helps corporations, it is capitalism, which is Good. If it helps the people, it is socialism, which is Evil. Remember: when you're helping grandma keep her house, you're promoting communism.

Re:Can somebody 'splain this?

[vertinox]

The biggest thing at the end of the Wikipedia article you read is that, whatever the reason the money is needed, it's cheaper than getting it from a bank. If a corporation is big enough and has good enough credit, they can issue corporate paper, at a lower interest rate, instead of paying interest to a bank.

Just wanted to chime in that Corporations avoid bank loans like the plague simply because they don't want the strings attached with what they can do with that loan money.

With stocks and bonds, they basically have free hand to do whatever they want with the money.

Re:Can somebody 'splain this?

[vertinox]

This bullshit is exactly what's wrong with our entire capitalist system.

The problem is that companies that don't leverage their money (instead of sitting on it) will be beaten by their competitors that do when done wisely.

Therefore... Public companies that don't do this will be run out of business or berated by their shareholders.

Sure it sucks, but its like arguing that guns are unfair to bring to a knife fight. You use whatever tools are at your disposal or you get eaten by the other guy who does.

Re:Can somebody 'splain this?

[rcamans]

The government does not actually want us to know the state of the economy.
They report unemployment figures, not how many people are out of work.
they do not report the average wage, when people who lose jobs are losing higher paying jobs, and people who are getting jobs are getting lower paying jobs.
They do not report the change in uninsured (more people are uninsured every day, and more alarmingly, more children)
They do not report the number of people not owning a home, a number that is increasing as more people default on loans.
They do not report on the non-mortgage loan default rate.
They do not report on the business failure rate.
They do not report on the number of people in jail or prison.

Basically, they do not want people to know the state of the union at all. Make like there is no problem, hide heads in the sand, maybe it will all go away.

They really do not want people to know the divide between the rich and the rest of us. Government is in the business of keepin gthe rich rich and happy, not in the business of keeping the voters gaining financial wealth and stability. They just do not want the masses to panic. Remembere Max Headroom?

If they wanted us to be informed, they would immediately be voted out, recalled, removed from office, or charged with crimes.
Like they really want that.

Re:Can somebody 'splain this?

[FreakWent]

"There is a fixed amount of [...] resources, of which we're using the most miniscule fraction."

Wait what? This only works if "we" means, like the people reading this article, and not the global population.

How do you determine that 12,800,000,000 litres of crude oil per day is the most miniscule fraction?

Habitat destruction on every continent is so severe that the extinction of species is no longer a shocking tragedy.

Why is clean water now under strong pressure in almost every major city in the world?

Furthermore, one cannot "create" a natural resource, since, you know, it's natural. As for cheaply, there's nothing cheap about tar sands or deep sea oil.

You really, really, need to read up on this stuff. "most miniscule fraction" my hairy arse!

Re:Can somebody 'splain this?

[FreakWent]

They aren't. All advertising is morally and ethically suspect.

For the market to work properly there's an implicit assumption that the purchasers are well-informed, which is the ostensible purpose of advertising. However, not only is most advertising deliberately misleading, and of course never mentions the bad parts, there's also the two problems that almost all advertising encourages spending behaviour, and it's used mostly not to inform but to manipulate in order to generate and arguably false demand for a product.

Re:Can somebody 'splain this?

[toddestan]

Well, the difference is, as the owner of his company he's probably interested in its long-term success. So he's not going to run it like these corporate types who shit all over everything in the name of short term profits, then bail with their golden parachutes before the long term effects can kick in. If we only threw these people under a bus instead of paying their bonuses with taxpayer dollars, the world would be a much better place.

Re:Can somebody 'splain this?

[FreakWent]

Except he's still out of pocket for his share of the losses in bailouts, and in forgone tax revenue, and in forgone profits if he's a businessowner, or maybe he's out of his job.

The entire affair, as with everything else the neocons do, is blatant class warfare, but the Amercians just can't bring themselves to see it. Always keep an eye on things that move money from the poor, or the public purse, to the rich.

Re:Can somebody 'splain this?

[FreakWent]

That's their problem. Why should we dumb our language down to accomodate the ignorant? Perhaps they can learn what a red herring is.

Re:Can somebody 'splain this?

[pipingguy]

Were a lot of these "bad loans" encouraged by groups like Acorn?

Re:Can somebody 'splain this?

[pipingguy]

The banking system is NOT dependent on influx of new investors to pay their creditors

When house prices reach astronomical numbers (and no newcomers can afford to get into the market because of this) doesn't the whole thing fall apart/dry up? Then again, I'm a late Boomer and just pissed-off that I didn't get in on the game early enough so I could have a couple Mercedes based on the "value" of my house. Just for the record, when I see an expensive car I don't automatically think, "Asshole undeserving jerkoff rich bastard".

Re:Can somebody 'splain this?

[amorsen]

And as far as more cows using fewer resources goes, you run up against basic physics. Calories in >= calories out.

Doesn't matter. The efficiency in producing the energy for "calories in" goes up as well.

Efficiency improvement is constrained by the universe.

Sure, eventually it is, but we are so many orders of magnitude away from that limit that it is of no practical concern for now. The universe doesn't force us to get milk from cows; improved technology could make it possible to synthesize it directly or to just have the milk glands without the rest of the cow. We may choose to not pursue those possibilities, but you can't blame the universe for that.

Re:Can somebody 'splain this?

[CTachyon]

No, its not. And regulated fractional reserve banking requires banks to get their money from somewhere, contrary to your indication that it does not. They have to acquire the reserves, and the permission to issue more money via reserve regulations.

Have you read up on what an "open market operation" is? I have, several times, and I still don't know how that ever passed for legitimate bookkeeping. Here's roughly how it works:

The Fed sets an interest rate target. By itself, this would be tilting at windmills that meant nothing. But if banks are charging interest rates that are higher than the target, the Fed buys securities (usually Treasury bonds) from the banks, depositing money directly into the banks' individual reserve accounts at the Federal Reserve in order to purchase them. Because the banks now have more reserves, they can make more loans. This is a rise in supply of loans without a corresponding rise in demand for them, and thus loan prices (interest rates) fall through competition.

Wait, where did the Fed get the money? That's the 2 Trillion Dollar Question. Federal reserve accounts are just ledgers full of numbers. Today they're spreadsheets on a computer; previously, paper ledgers were used, but it's the same idea. Either way, no physical dollar bills ever changed hands from Fed to bank, ever since the Fed was created in 1913. And, when you unwind it all, which is a long and annoying process described in very obfuscatory language on the Fed's own websites, the Fed basically prints money to buy back the government's own debt. The Fed just marks a number under its own "Fed liabilities" column, labeling it "Oops, my bad, this is an IOU not real money", but the Fed also gains a security with equal dollar value to the IOU, dropped under the "Fed assets" column, so the Fed's books come out with a net change of $0.

And, of course, because the bank selling the securities now has more money sitting in its reserve account, and it doesn't need to hold the reserves to cover any new checking deposits, it can make profits by lending the money out. The recipients spend it, and those who were paid deposit it into their own checking accounts. At this point 90% of that gets loaned out a second time (10% reserve requirements[*]), and 90% of that gets loaned out a third time (net of 0.90*0.90=0.81, for those counting at home), and so on until the money supply has expanded by nearly 10-fold (limit 1/0.10=10 as t goes to infinity).

([*] Actually, it's worse than that. The 10% reserve requirement is the figure for demand deposits, i.e. checking accounts. For time deposits -- i.e. savings accounts, CDs, and anything else with time restrictions -- the reserve requirement is 0% instead. And the law recently changed so that banks can automatically roll over customers' demand deposits into time deposits, without asking or telling the customers, if money sits in a demand deposit account for long enough. So the process can potentially reach infinity.)

This flow of money from bank to bank is the "velocity of money" euphemism that economists speak of. What's actually happening is that the small amount of monetary inflation created through open market operations is multiplied through fractional banking, and at the same time the monetary inflation transforms into price inflation driving up prices as it changes hands. This saves the Fed work, because each new round of loans adds more competition on interest rates, but each new round also drives up price inflation to ever-increasing heights. This is the reason why the government eventually has to "cool off the economy" during boom years (i.e. slow down the "velocity of money" and decrease monetary inflation) by raising target rates and pumping money back out of the economy through security sales. If the Fed didn't take back and destroy the IOUs (thus raising interest rates), inflation would get out of control and the economy would fall into a stagflationary recession (i.e. what happened in the 1970s when politicians practiced straight Keynesian economics and just opened the money spigot).

Re:Can somebody 'splain this?

[CTachyon]

Actually, you missed something in the above. If you loaned me $10, then the following transactions occur:

You: -$10 (paid out to me)
You: +$10 (debt asset)
Me : +$10 (cash I got from you)
Me : -$10 (debt liability I owe you, which you forgot to mention earlier.)

You missed something as well. People weren't pushing debt liabilities on third parties, but they were pushing debt assets on third parties. The debt assets were being treated as real money, as a backing of financial value for a purchase by the debt asset holder, when they weren't real money. And when debt assets were used as collateral for yet more debt, the inherent asymmetry in the system permitted unbounded recursion.

Re:Can somebody 'splain this?

[Anonymous Coward]

With the passing of the bailout bill, reserve limits are allowed to reach 0%, meaning the bank need not have any money on hand at all.

        SEC. 202. INCREASED FLEXIBILITY FOR THE FEDERAL RESERVE BOARD TO ESTABLISH RESERVE REQUIREMENTS.

        Section 19(b)(2)(A) of the Federal Reserve Act (12 U.S.C. 461(b)(2)(A)) is amended--
        (1) in clause (i), by striking `the ratio of 3 per centum' and inserting `a ratio of not greater than 3 percent (and which may be zero)'; and
        (2) in clause (ii), by striking `and not less than 8 per centum,' and inserting `(and which may be zero),'.

The section from the FRA:

        2. Reserve requirements.

        A. Each depository institution shall maintain reserves against its transaction accounts as the Board may prescribe by regulation solely for the purpose of implementing monetary policy--

        i. in the ratio of 3 per centum for that portion of its total transaction accounts of $25,000,000 or less, subject to subparagraph (C); and*

        ii. in the ratio of 12 per centum, or in such other ratio as the Board may prescribe not greater than 14 per centum and not less than 8 per centum, for that portion of its total transaction accounts in excess of $25,000,000, subject to subparagraph (C).

Re:Can somebody 'splain this?

[Anonymous Coward]

Actually, thanks to the bailout bill banks are no longer required to have any reserves. (I tried posting this before but don't see that it came through, sorry if it double posts)

        SEC. 202. INCREASED FLEXIBILITY FOR THE FEDERAL RESERVE BOARD TO ESTABLISH RESERVE REQUIREMENTS.

        Section 19(b)(2)(A) of the Federal Reserve Act (12 U.S.C. 461(b)(2)(A)) is amended--
        (1) in clause (i), by striking `the ratio of 3 per centum' and inserting `a ratio of not greater than 3 percent (and which may be zero)'; and
        (2) in clause (ii), by striking `and not less than 8 per centum,' and inserting `(and which may be zero),'.

The section from the FRA:

        2. Reserve requirements.

        A. Each depository institution shall maintain reserves against its transaction accounts as the Board may prescribe by regulation solely for the purpose of implementing monetary policy--

        i. in the ratio of 3 per centum for that portion of its total transaction accounts of $25,000,000 or less, subject to subparagraph (C); and*

        ii. in the ratio of 12 per centum, or in such other ratio as the Board may prescribe not greater than 14 per centum and not less than 8 per centum, for that portion of its total transaction accounts in excess of $25,000,000, subject to subparagraph (C).

Re:Can somebody 'splain this?

[Anonymous Coward]

Here's a simplified example for why we need Commercial Paper.

Take a car maker. It will be able to produce a finished car in 6 months, but do not have cash on hand to pay off the costs for those six months. However, it can easily pay off those costs with the revenue they would receive after they put their cars on the market in 6 months time. So it issues CPs to cover its expenses prior to them rolling out the cars. Once it gets actual money in when it sells the cars, it can use the money to pay off the CPs, and pocket the difference as profit (or reinvest the money).

Re:Can somebody 'splain this?

[HungryHobo]

no i mean humanity.
we're using a lot of the easily accesible oil.True.
On the other hand we're only using a tiny fraction of the enegy sources available to us.
It's like when people spew bullshit about how there's only 100 years of copper left or 50 years of uranium or yada yada yada.
There's vast quantities of just about everything, it's simply slightly more expensive to get at. As technology advances and deposits which were formerly not economic to get at become available the quantities available rises vastly.
Just about the only natual resource we're truely wasting is genetic code. Wiping out the various plant and animal speciese is akin to drilling for natural gas in a situation where you have no way to use it and simply releasing it into the air (wait, we do that...).
All that genetic code could be worth much much more in years to come when genetic engineering and cloning gets more refined.

Are there even any projects to collect viable genetic material from near-extinct species so we can hopefully bring them back later?

Re:Can somebody 'splain this?

[DragonWriter]

Have you read up on what an "open market operation" is?

Yes.

I have, several times, and I still don't know how that ever passed for legitimate bookkeeping.

Open market operations are not form of bookkeeping, "legitimate" or not. This seems to be the first problem in your understanding. Clearly, records have to be kept of open market operations, but those records are not the operations.

The Fed sets an interest rate target. By itself, this would be tilting at windmills that meant nothing. But if banks are charging interest rates that are higher than the target, the Fed buys securities (usually Treasury bonds) from the banks, depositing money directly into the banks' individual reserve accounts at the Federal Reserve in order to purchase them. Because the banks now have more reserves, they can make more loans. This is a rise in supply of loans without a corresponding rise in demand for them, and thus loan prices (interest rates) fall through competition.

Yes, that's the basic theory. And the fed does the reverse if the banks are charging each other interest rates lower than the target.

Wait, where did the Fed get the money? That's the 2 Trillion Dollar Question. Federal reserve accounts are just ledgers full of numbers. Today they're spreadsheets on a computer; previously, paper ledgers were used, but it's the same idea. Either way, no physical dollar bills ever changed hands from Fed to bank, ever since the Fed was created in 1913.

So? Physical dollar bills are nothing special, they're just an expense. A fiat currency of account is exactly the same as a physical fiat currency.

(Plus, of course, this isn't true: paper dollars change hands between the Fed and banks all the time, which is, in fact, how all paper dollars get into circulation. The banks pay for the paper dollars out of their reserve accounts.)

This flow of money from bank to bank is the "velocity of money" euphemism that economists speak of.

The velocity of money is the number of times the same dollar is spent (within a bounded, temporally and often geographically as well, universe of analysis), whether it touches a bank anywhere in between is irrelevant. It is not the magnification in the actual supply of money caused by fractional reserve banking.

What's actually happening is that the small amount of monetary inflation created through open market operations is multiplied through fractional banking, and at the same time the monetary inflation transforms into price inflation driving up prices as it changes hands.

Except when it doesn't, as now, when the Fed is pouring out money, and prices are deflating. But, yes, the a major point of open market operations is to influence inflation, both by contracting the money supply to avoid high inflation (tight money policy), and to expand the money supply to fight deflation (loose money policy) as the Fed is currently attempting.

 

Re:Can somebody 'splain this?

[Anonymous Coward]

This isn't quite accurate - the breeding cows who produce offspring are rarely the same cows used for milking or beef nowadays. Same with chickens - breeding hens don't end up on your dinner plate.

Re:Can somebody 'splain this?

[Mattcelt]

You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world, and printing more money isn't going to change that.

If this was true, we wouldn't be able to support 6.7+ billion people worldwide right now. In 50 years, we've seen a threefold expansion - that's nearly a 6% increase per year, on average.

In a way, you're correct; the resources are limited. However, ingenious creatures as we are, we continue to come up with new ways to more efficiently use the resources we do have, which has consistently outpaced the growth rate, and seems set to continue to do so for a while to come.

Add to that that there are some resources (including manpower) that actually do increase as time goes on (more people are born, and existing people have more output with each new periodic measure), and you can see that the economy still has room to grow.

Economics is not a zero-sum game. It never has been, and never will be. New resources are committed to the economy all the time.

Re:Can somebody 'splain this?

[Anonymous Coward]

And yet, the stupid ranting cunt got modded insightfuk. Such is the power of a low 5-digit ID.

Re:Can somebody 'splain this?

[floodo1]

good point about money in the bank being something of an insurance policy. Especially when you consider that when the parent speaks of the money not influencing anyone or making more money, he's talking about what is inherently a risky business. SO you go from having your capital being a protection for you to a liability for you.

Re:Can somebody 'splain this?

[hobbit]

It's physical.

Re:Can somebody 'splain this?

[Captain Nitpick]

Doesn't matter. The efficiency in producing the energy for "calories in" goes up as well.

Given the amount of fossil energy we're putting into that side of the equation, I doubt the efficiency of producing grains has actually increased.

Sure, eventually it is, but we are so many orders of magnitude away from that limit that it is of no practical concern for now.

As far as getting milk out of a cow, we're probably within one order of magnitude. The term has a meaning, it's not just shorthand for "a whole bunch".

The universe doesn't force us to get milk from cows; improved technology could make it possible to synthesize it directly or to just have the milk glands without the rest of the cow.

The issue here is the interest on loans taken out to buy cows. The possibility of disruptive technologies makes the original statement that "them cows don't produce 3% more milk with each passing year" even more true. A market flooded with cheap mechanically produced milk would result in existing cows having negative growth in produced milk value, even if production volume increased.

Re:Can somebody 'splain this?

[Captain Nitpick]

You have two cows.... Don't forget that a cow has to produce a calf (with a 50% chance of being a bull) who consumes some of that milk. But then the calf grows up, and if it is a cow, it will also produce milk. Also, a cow's milk production decreases with age.

Increasing the number of cows does not increase the efficiency of each cow, assuming we've already taken advantage of economies of scale.

Re:Can somebody 'splain this?

[CTachyon]

Open market operations are not form of bookkeeping, "legitimate" or not. This seems to be the first problem in your understanding. Clearly, records have to be kept of open market operations, but those records are not the operations.

They are a purchase (or sale), obviously, not a form of bookkeeping... but you have to account for the money spent on the purchase (or earned by the sale). If you promise IOUs but aren't good for the money you've promised, then you are committing fraud — even if you are the government. If this were a business or a city government or a state government, people would be in jail for it. But it's the Federal Reserve, so it's "business as usual". Nevermind that the creation of the Federal Reserve itself in 1913 was itself the cause of the Roaring Twenties speculative bubble, and the inevitable spectacular crash as the federally-enforced Ponzi scheme unwound.

So? Physical dollar bills are nothing special, they're just an expense. A fiat currency of account is exactly the same as a physical fiat currency.

(Plus, of course, this isn't true: paper dollars change hands between the Fed and banks all the time, which is, in fact, how all paper dollars get into circulation. The banks pay for the paper dollars out of their reserve accounts.)

A paper currency still maintains a fig leaf of respectability, because inflation is limited by (a) how fast your physical printing presses run, and (b) people noticing that more physical notes are circulating. Previous attempts to inflate a physical fiat currency (e.g. the Civil War Greenback) resulted in a currency crash as people fled from the inflating currency into more stable currencies, like gold coin. Having a fiat currency of account means that (a) you can inflate your currency as much as you desire, and (b) people won't notice it as quickly, because numbers on a check or credit card statement don't have the same visceral impact as piles of paper bills or stacks of metal coins. Having a currency of account is a move to reduce accountability and thus hide fraud.

The velocity of money is the number of times the same dollar is spent (within a bounded, temporally and often geographically as well, universe of analysis), whether it touches a bank anywhere in between is irrelevant. It is not the magnification in the actual supply of money caused by fractional reserve banking.

In a system where the vast majority of money is in the form of a fiat currency of account, money cannot change hands except through the banking system. All transactions begin as deposits in the account of the buyer and end up as deposits in the account of the seller. This is what allows the Federal Reserve's open market operations to have more than a trivially small effect.

Except when it doesn't, as now, when the Fed is pouring out money, and prices are deflating. But, yes, the a major point of open market operations is to influence inflation, both by contracting the money supply to avoid high inflation (tight money policy), and to expand the money supply to fight deflation (loose money policy) as the Fed is currently attempting.

The deflation of prices in the current economic environment is inevitably a temporary matter. There is a massive amount of pent-up monetary inflation that has been pumped into the system, but cash is a hedge against uncertainty and banks are facing a mountain of uncertainty, therefore banks are choosing to hold reserves nearly equal to 100% of demand deposits because they're terrified that they'll be the next bank run victim. The result is that the multiplier effect isn't currently happening, therefore the Fed's actions are having little to no immediate effect. As that uncertainty

Re:Can somebody 'splain this?

[DragonWriter]

A paper currency still maintains a fig leaf of respectability, because inflation is limited by (a) how fast your physical printing presses run, and (b) people noticing that more physical notes are circulating.

Actually, no. Increases in the money supply are limited by (a). Inflation is limited by neither (a) nor (b), even in a physical currency system. Inflation is not the same thing as increase in the money supply, nor is it the same thing as perceived increase in the money supply. It is something that simple supply and demand analysis suggests is a likely consequence of increases in the money supply if all other variables are held constant.

Previous attempts to inflate a physical fiat currency (e.g. the Civil War Greenback) resulted in a currency crash as people fled from the inflating currency into more stable currencies, like gold coin.

No one ever attempts to inflate a currency, except perhaps cinematic villains. What arguably happened in the civil war was an attempt to monetize the debt by printing more money. Inflation is likeyl side effect of debt monetization, but not the intended goal. (Avoiding debt monetization by governments is one reason beyond the adoption of an "independent" central bank as near-universal norm in the modern world.)

Having a fiat currency of account means that (a) you can inflate your currency as much as you desire, and (b) people won't notice it as quickly, because numbers on a check or credit card statement don't have the same visceral impact as piles of paper bills or stacks of metal coins.

Inflation isn't a product of "visceral impact", its a product of people actually having more money to spend when the pool of goods to buy grows less quickly. Further, information about the quantity of money in circulation in the modern world spreads with equal rapidity whether its in account or paper.

In a system where the vast majority of money is in the form of a fiat currency of account, money cannot change hands except through the banking system. All transactions begin as deposits in the account of the buyer and end up as deposits in the account of the seller.

Wrong. In a system where the vast majority of money is in the form of a fiat currency of account, most exchange of money must occur via exchanges of account (which need not involve banks -- non-bank institutions can sell on direct credit and settle without a bank transfer, though as a practical matter one expects that will generally be a very small fraction of total transactions. You don't get from "vast majority" to "all" in any case.

The deflation of prices in the current economic environment is inevitably a temporary matter.

All of human society is a "temporary matter", and one certainly hopes that deflation isn't long-lasting.

There is a massive amount of pent-up monetary inflation that has been pumped into the system

"monetary inflation" isn't a thing that can be "pent-up" or "pumped into the system", much less both. What there is is a lot of money that has been created by Fed lending, largely in response to the money that has been destroyed by the evaporation of private credit.

The result is that the multiplier effect isn't currently happening, therefore the Fed's actions are having little to no immediate effect.

Well, some of the Feds actions are having no immediate effect because they are purely symbolic, and not actual "actions". For instance, lowering the Fed funds target rate to 0-0.25% seems like a big action, but it was really a non-action since despite the higher target rate, the Fed funds rate was in the 0-0.25% range before the target rate was lowered.

As that uncertainty eases up, and banks are less afraid of runs, t

Re:Can somebody 'splain this?

[i*rod]

The part I want 'splained is: Why does anyone think that the stock market is a serious indicator of the state of the economy? Everyone knows the market is going to be way up in a few years because it is currently highly undervalued but because the vast majority of investing groups are buying and selling with short term gain in mind the market is bouncing around like a superball. Maybe if someone was required to hold a stock for a minimum period of time it would make stocks an indicator of something.

I empathize with your struggle to construct an intelligible declarative sentence that describes the current state of the US economy.... but... NOT "Everyone knows the market is going to be way up in a few years..."

Quite the contrary.

..."For with the US alone having unprecedented and unsustainable household, corporate and public debt of $51.1 trillion at the end of 2007 and projected to be at least $53 trillion (equivalent to nearly the whole economic turnover of the entire world) by the end of this year". [2008] Dr David Hill World Innovation Foundation Charity (WIFC) Bern, Switzerland 27th September 2008

That is a far cry from the $10 trillion ND that most Americans are led to believe [see "National Debt Clock"] is what they are carrying into 2009.

As of 2007, there were about 138 million taxpayers in the United States, including many (about one third of all filers) who don't pay any income tax.

According to GAAP and FASB, (i.e., based on the Accrual Method of Accounting) projections for 2008 put the Federal Debt at $53 trillion. This represents $384,059 of Federal Debt per taxpayer. A 2 income household is on the hook for more than 3/4 of a million dollars.

The interest on this $53 trillion (estimated to average out to 3.77%) amounts to $2 trillion, or $14,493 per taxpayer per year; which interest isn't being paid. It's 'accruing'. It's what economists call "Unfunded Debt".

The simplest, and most accurate 'splanation' is that the US is, and has been for 4-5 years, bankrupt. What we are witnessing isn't a succession of institutional and corporate bailouts and 'stop-gap' measures to buy time until things turn around. No growth potential imaginable can ever catch up to the spiraling debt, now increasing by $2.5 to $2.7 billion a day. Rather, all this busy work amounts to nothing more productive that bailing water from one compartment of a sinking ship into another.

Until the US finally gets around to declaring it's insolvency, no meaningful 'reconstruction' policies and projects are going to be formulated and undertaken.

The source of the problem

[Anonymous Coward]

has nothing to do with computers. The source of the problem is the source of money. Who decides how much money there is? Who reaps the benefits of creating money which is not backed by real productivity? If you're truly looking for the root of the problem instead of symptoms, then you have to find out about the inner workings of the money system. In other news, the "Federal" "Reserve" bank has once more lowered the interest rate. The dollar is now less than 0.25% away from being free (i.o.w. worthless) money.

Re:The source of the problem

[Anonymous Coward]

Parent AC is especially poignant when taken in concert with cbiltcliffe's post above. Guess who has all the gold?

/alreadymodded

Re:The source of the problem

[megamerican]

Don't worry, I'm sure Congress will audit the Federal Reserve and we'll get to the bottom of this mess!

The Federal Reserve recently refused to disclose $2 trillion in loans requested by a FOIA request citing "trade secret" clauses.
http://www.bloomberg.com/apps/news?pid=20601109&sid=aGvwttDayiiM

In response to Bloomberg's request, the Fed said the U.S. is facing "an unprecedented crisis" in which "loss in confidence in and between financial institutions can occur with lightning speed and devastating effects."

In other words, we'll tell you when we're ready to finally destroy the economy!

No wonder Congressman David Scott said we've "been bamboozled!"

The real number of the bailout is actually $8.5 trillion (as of two weeks ago and is probably closer to $10 trillion now.

http://www.sfgate.com/cgi-bin/object/article?f=/c/a/2008/11/26/MNVN14C8QR.DTL

Re:The source of the problem

[amliebsch]

That's not what a .25% interest rate means. It means that a dollar a year from now is .25% away from being worth the same as a dollar today. It doesn't say anything at all about the current value of the dollar.

Re:The source of the problem

[DragonWriter]

The dollar is now less than 0.25% away from being free (i.o.w. worthless) money.

A fed funds rate near 0% doesn't mean the dollar is near worthless, it just means that borrowing them has a low nominal cost for those who can borrow at that rate. (Usually, this would mean even a lower real cost, as well, but not in the case of deflation, and the perceived cost could by higher than the nominal cost if deflation is feared/expected, even if it didn't occur; expectation of deflation would also explain otherwise irrational results like the recent dip in short-term T-bill returns into negative territory, meaning that people were actually willing to pay to lend the US government money rather than expecting a positive nominal return for such lending.)

Re:The source of the problem

[DNS-and-BIND]

An interest rate of 0% means that your money will be worth the same tomorrow as it is today. What other financial instrument today offers this sort of certainty?

Re:The source of the problem

[DragonWriter]

That's not what a .25% interest rate means. It means that a dollar a year from now is .25% away from being worth the same as a dollar today.

It doesn't mean that, either; the fed funds rate might rationally be expected to have some loose correlation with the value of the dollar over time, but its not the same thing. It relates to how many future dollars someone privileged to borrow at the fed funds rate must sacrifice to get a current dollar, not what the dollar will be worth at the time that bill is due.

(Of course, for anyone to borrow at that rate, the borrower must expect that the expected return of what they can do with the dollar exceeds the interest rate by enough to compensate for the risk of failure, but that's about return, not value of the final dollar.)

Re:The source of the problem

[Znork]

It doesn't mean that either; the value of the dollar is also driven by demand and supply, and the supply is currently simultaneously in freefall due to credit destruction in combination with fractional reserve banking and rapidly being inflated through 'quantitative easing', ie, the Fed running the printing presses (they've expanded the money supply by some 150% since september).

Currently the credit collapse is winning out, meaning more money is getting destroyed than the Fed manages to print and distribute, leading to deflation. Which means that with a rate of 0% you're still better off having your money in your mattress (or treasuries, as is more common), as its purchasing power will increase anyway (and particularly you're better off with the money safe than lending it to some deadbeat for minimal interest and who'll probably default anyway).

Eventually, of course, the mass printing will probably lead to a collapse in the value of the dollar, but not until either the credit destruction is complete or an external asset makes a massive carry trade lucrative.

Re:The source of the problem

[Tomfrh]

The dollar is now less than 0.25% away from being free (i.o.w. worthless) money.

It doesn't mean the dollar is worthless, it just means the exchange rate between the future and the present is approaching parity. I.e., no-one expects much to happen for a while...

Re:The source of the problem

[Anonymous Coward]

That characterization was intended to be a dramatization, not a mathematically precise analysis. Free money would result from a -100% interest rate, obviously: Get some money, pay nothing back. At 0%, you still have to pay it back, just no interest on it. That said, consider the effect that 0% interest money has on market prices and the amount of money in circulation, especially in the face of the "too big to fail" psychology fueled by the government bailouts. Just take a look at DOW, USDEUR and USDJPY today.

Re:The source of the problem

[gregbot9000]

OMG I love AC's, lets go over this:

you have to find out about the inner workings of the money system ... once more lowered the interest rate. The dollar is now less than 0.25% away from being free

You don't even know how inflation works! And you want people to learn about the banking system? Why? So they can laugh at you? Inflation is caused by a little more then just how much money the Fed prints. And how much inflation occurs has to do with the banking system, and if there is a signifigant Zero bound problem this may not be enough.

I'm no fan of counter cyclical monetary policy, but if you're going to critique the system you might want actually know what your talking about instead of parroting the John Birch society or wherever you get you kool-aid from.

Re:The source of the problem

[andreasg]

Without knowing the real interest rate there's no saying that your money will be worth the same tomorrow as it is today, even with a 0% nominal interest rate.

Re:The source of the problem

[khallow]

Even a negative interest rate doesn't automatically result in free or worthless money. You still have to pay the principle back and the interest comes (as a payment) in the future where the currency may be worth a lot less.

Re:The source of the problem

[Hatta]

Oh hell no. The value of the dollar is based on supply and demand. A 0% interest rate means that you can borrow dollars at no cost. So if the rate hit 0%, more banks would borrow more money. No reason not to right? This would flood the market with dollars, increasing supply, and so decreasing the value of the dollar. Low interest rates = inflation.

Re:The source of the problem

[gregbot9000]

Sigh, I'm no fan of the Fed's countercyclical monetary policy so it pains me to defend it, but your charges seem a bit off the mark.

This all has to do with inflation, marginal reserve banking and the confidence of the banks in lending. The Fed is not going to make the mistake they made during the "great contraction" and allow banks to fail and deflation to run rampant. The banks make the money supply by re-lending, They got scared stopped making loans, money supply shrinks and Bobs your uncle you have deflation. Deflation is bad, very bad.

The Fed system works through loans. They have issued loans. The loans will be repaid. It really isn't that big of a deal if the fed issued $10 trillion in loans(If they lent that much). They printed that money from thin air and lent it out to compensate for the contraction and deflation that would have happened due to the financial institutions failing.

Since it's printed money it would cause inflation if the economy was running well, but since it isn't the money that is put out will make up for the money the banks won't lend out due to fears about profit. It will hopefully keep business running where they need loans, and help the economy(thats the theory, seems to be working). The potential problem is, that things pick up and the Fed still has all this money lent out, causes massive inflation. But since these are loans, they will be repaid. The Fed would hope to start pulling back in all that freshly printed money and tossing it into a fire in time(hopefully) to keep inflation from happening.

Re:The source of the problem

[hobbit]

But since these are loans, they will be repaid.

Unless you're underestimating the scope of the problem.

Re:The source of the problem

[hobbit]

I don't get it. The currency may be worth a lot less, but it's still costing the lender.

Re:The source of the problem

[nategoose]

has nothing to do with computers. The source of the problem is the source of money. Who decides how much money there is?

I want to decide how much money there is.

Who reaps the benefits of creating money which is not backed by real productivity?

I can do that too!

If you're truly looking for the root of the problem instead of symptoms, then you have to find out about the inner workings of the money system.

Root of the problem is being comfortable living (or operating) on credit, and even though it has tax benefits (in the US) it's interests (well, not with the new US interest rate) and risks should be enough to scare people.

Re:The source of the problem

[Anonymous Coward]

0% interest doesn't make money worth 0. It makes the time value of money 0, meaning $1.00 today is worth $1.00 in the future, instead of $1.04 or whatever. That makes it easier on you if you owe a lot of money like the U.S. government does, particularly if there's any inflation. But, it's still not worthless.

Money becomes worthless through severe deflation, which is something few people living today have personally experienced. But it causes the economy to stop working because no one will buy anything unless they absolutely have to, because they know they can buy it cheaper tomorrow and cheaper yet next month.

Re:The source of the problem

[francium de neobie]

Don't worry, I'm sure Congress will audit the Federal Reserve and we'll get to the bottom of this mess!

You're trusting your politicians would someday, somehow, become competent?

Oh man. I don't know how to say this... But, you know, I'm actually a prince in Nigeria, and I have need to transfer a large sum of funds overseas. Can you help?

Re:The source of the problem

[Wildclaw]

With a 1% negative interest rate you can loan as much money as you want, put aside 99% of it to be paid back and keep the remaining 1% to do whatever you want with it.

Essentially free money as long as someone doesn't rob you of the money you put aside to pay back.

Re:The source of the problem

[Pfhorrest]

Oh hell no. The value of the dollar is based on supply and demand. A 0% interest rate means that you can borrow dollars at no cost. So if the rate hit 0%, more banks would borrow more money. No reason not to right? This would flood the market with dollars, increasing supply, and so decreasing the value of the dollar. Low interest rates = inflation.

This is only true if it is possible to produce more dollars. If we were talking about, say, corn instead of dollars, and there were some way for corn growers to produce a ton of more corn for free (or at least, on 0% interest credit), then suddenly a whole lot more corn will be produced, flooding the market, increasing supply, and so decreasing the value of corn. But for a commodity with a fixed supply - like say, antique Roman coins, genuine articles of which cannot be produced today - there is no way that readily available 0% credit can result in a flood of product on the market.

But can help to draw the product to the places it is most valued, in this case by enabling Roman coin collectors to purchase the coins they want on credit now rather than having to save up more and buy it later. If our dollars wre of fixed supply - that is, if we weren't printing new money all the time - then low interest rates could not spur the production of more dollars, leading to inflation. It could only serve to draw dollars out of reserve and into productive use where they are more valuable. Thus, the root of the problem of inflation is not low interest rates; it is the production of new money.

Re:The source of the problem

[0-until-pink]

  free = worthless
 
Do you work for Microsoft perchance?

Re:The source of the problem

[khallow]

Good point. Still limited negative interest rate loans are one way to inflate your way out of "bad" deflation. They devalue the currency (which would be the obvious intention), but don't automatically make the currency worthless.

Re:The source of the problem

[CTachyon]

Deflation is bad, very bad.

Nearly everybody says this. Hardly anybody says why. Nobody who says why does so without invoking long-discredited Keynesian ideas.

If inflation were simply, "Oh, I woke up with twice as many dollar bills in my pocket, but oh, prices doubled overnight", then inflation would have zero effect. Instead, inflation is time-skewed: the Fed creates money, and those who touch the money first can buy things before the prices have risen in response to created money. Therefore, those who get lots of money directly from banks benefit from inflation: big businesses who take out million dollar loans. Those who don't get lots of money directly from banks see their incomes fall relative to prices: people on low and fixed incomes, i.e. the poor. Doubly so because wage changes lag price changes. In other words, inflation is a net transfer of wealth from the poor to the rich: a hidden regressive tax.

Deflation, logically, is the opposite: people who hold cash benefit first from falling prices. Since (again) wage changes lag price changes, those on low and fixed incomes will benefit the most. Frankly, with the rich-poor gap having grown as skewed as it has over the past 50 years, we could use a good decade's worth of deflation just to partially undo the mess. The corrupt business interests that lobby DC won't let that happen, of course, but maybe we'll get a year or two of benefit out of it before they kill it.

Right, this is all a big computer crash

[BadAnalogyGuy]

Funny how all the computers seem to be working properly when the prices are going down, but not working half the time when prices need to go back up.

I guess it's like how gas pumps will correctly increase the price of gas when the price per barrel of oil goes up, but are buggy and won't reduce the price later when the costs come back down.

Re:Right, this is all a big computer crash

[amliebsch]

No it isn't.

For one, the price of gasoline is not directly tied to the price of crude oil - it's also affected by refinery capacity, supply and demand of other petroleum products, and the varying supply of gasoline in particular.

For two, I've recently witnessed gas prices fall from around $4 to almost $1.50. Am I hallucinating this?

Re:Right, this is all a big computer crash

[Anonymous Coward]

The joke is that he was blaming the price movement on the gas pump rather than on all the other factors that actually have an impact on the price.

Re:Right, this is all a big computer crash

[neomunk]

Ahem... look at your parent posters username... :-D

Garbage In - Garbage Out

[theaveng]

An old, old saying but many of the "newbies" who have adopted computers since the Dot-Com genesis haven't learned the lesson yet. You can't just blindly believe the computer's projections - you need to doublecheck what data was fed to it & if it was valid.

Most financial planners did not do that, and they bet their millions on faulty data or assumptions.

Re:Garbage In - Garbage Out

[Anonymous Coward]

The data was valid, the predictions were correct, the reactions were prudent. Just because you don't take first-mover-advantage in order to avoid upsetting the market doesn't mean nobody else will. Everything worked as advertised.

Re:Garbage In - Garbage Out

[Anonymous Coward]

you need to doublecheck what data was fed to it & if it was valid.

They should not have even needed a computer model to foretell an eventual collapse of the credit market. This played essentially the same as the last time the markets and credit providers allowed people to play on the margin. The longer it lasted the more weaker players they had to let in to keep it afloat via inflation of the market and they had to worsen the margin playing to let them in. The main differences this time was that it directly involved real estate and the creditors proferred "insurance" which only insured that the collapse would be much wider then if they had just placed all the notes in the hands of stock financed real estate investment corporations as they originally set out to do.

Greed and ignorant thoughtlessness proving once again that those who don't remember their history are doomed to repeat it. Isn't it a comforting thought that our country's leaders count on inflation in regards to its indebtedness too?

Re:Garbage In - Garbage Out

[lenski]

Everything worked as advertised.

Absolutely not.

The individual quantitative analysts ("quants") built redundancy into their individual company's systems by counting on external "randomness" (approximately), insuring against possible losses emanating from their highly leveraged transactions through insurance contracts (credit default swaps).

However, All the other quantitative models were built on essentially the same set of assumptions: That their insurers had sufficient capitalization to cover the CDS contracts. The triggering event, a loss in home valuations is particular markets, started an avalanche consisting of lots of finance companies invoking the CDS contracts, all at once. That's when they found out that the insurer (AIG, for example) was just as undercapitalized as everyone else. (There's way more to this sordid tale, so this is a necessarily compressed synopsis.)

Unless one counts "we got ours, you're fucked" as implying "working as advertised", then it didn't work by any stretch of the imagination.

Read Nassim Nicholas Taleb's comments on the Black Swan Event for a properly thought and documented analysis.

BTW, The Edge is a great resource for the intelligent and curious reader. I have no financial interest in these guys, but I've found their insights to be highly informative and balanced.

Re:Garbage In - Garbage Out

[Anonymous Coward]

"we got ours, you're fucked"

Basically that's it: first-mover. The question is whether the decisions would have been any different without computers. I see no reason for that at all. The models were not fed with bad assumptions on purpose. The data was still correct, the computers reacted the way they were supposed to react and no sane broker would have reacted differently. In a way the fact that the safety didn't work is immaterial to the decision, because not investing wasn't an option.

Re:Garbage In - Garbage Out

[theaveng]

I've heard financial employees admit, straight-up, they just blindly followed the computer. But now that they've sat down and done the calculations by hand, they can see the computer's advice was wrong.

It's the GIGO principle. Also a little too much "computers are trustworthy" and "I should believe the computer" flaw inherent in many human beings - the same flaw that led us to think computerizing voting machines would magically remove corruption on election day.

Economics models are like goat entrails predict...

[tg123]

Economics models are like using goat entrails to predict the future so this wouldn't surprise me. sorry just had to put my 2 bits in

Death to the quants!

[Anonymous Coward]

Long live the stockpickers!

Snow Crash?

[dosh8er]

Isn't the system based on 'speculation' ? I suppose it's different when my broker misplaces a decimal point, versus a computer program that misplaces a decimal point for thousands of 'clients'. Technology might be a great thing for convenience, but it's certainly starting to show its limits in the scope of what humans expect from it.

pointing fingers

[girlintraining]

I'd just like to point out the bleedingly obvious: That people programmed these computers. They are functioning exactly as they should be. If they weren't, we'd have heard about it by now. So the problem is not the computers, or the network, but rather the people who control them. Thank you. You may now resume your regular ranting, already in progress.

Re:pointing fingers

[dosh8er]

which, i believe is why the garbage in garbage out syndrome is affecting 'users'. I can't imagine what the 'QA/QC' is like involved in the development of the modeling software for financial sector. shouldn't it be as regulated as, perhaps, the nuclear industry? Or maybe nobody can maintain all those lines of COBOL...

Re:pointing fingers

[girlintraining]

It's very tightly regulated, and the source code must be independently reviewed prior to certification. They're very ugly about that kind of thing. Computer models might be a problem, but only because they were based on bad assumptions made by the designers... That is a human failing, not a machine one.

Re:pointing fingers

[AJWM]

Two words: "emergent behaviour".

No one group of programmers programmed all these computers, there was no single set of specs for the whole network. All the components may well be "functioning exactly as they should be" (although in reality I'm sure there are a few bugs in the systems, but that's irrelevant here), but the system overall may behave in an unexpected way.

(That said, I don't think that's the whole problem either -- too many people playing a bit fast and loose and less than honestly with other people's money is also part of the problem.)

Re:pointing fingers

[BigTom]

What is tightly regulated? Half the Quant algo trading models get thought up in the evening, coded overnight and activated in the market the next morning.

If you try and slow them down they just run to the head of the desk bleating that the "nasty IT man stopped me making $1000,000,000 for the bank with his silly QA nonsense" and whoosh, its in production. It is prop trading so its their risk.

Re:pointing fingers

[girlintraining]

the systems are designed to have transactional integrity. it doesn't prevent someone from making idiot trading decisions.

Re:pointing fingers

[Znork]

Considering the fundamental basis of the whole system is based on the flawed assumption that credit can be infinitely expanded the current failure is hardly surprising. The Austrian school pointed out the fallacies that caused both the last depression and the current one almost a hundred years ago.

Computers have very little to do with it. Constructing models to fit political economics rather than to reflect reality is closer to the actual problem.

Re:pointing fingers

[DragonWriter]

Two words: "emergent behaviour".

Its not emergent behavior of computer systems. Its the exact same kind of behavior markets have displayed without computers.

Sure, things haven't been this bad recently, so some elements of it are new, at least in the short term, and the details change always. But none of the big picture stuff has much to do with computers, fundamentally. Economic markets are vastly interconnected because their substantive outputs and inputs (not just data outputs and inputs of the computer systems currently used as tools in managing them) are directly linked.

Blaming computers is about as justified as blaming witches.

Re:pointing fingers

[girlintraining]

No one group of programmers programmed all these computers, there was no single set of specs for the whole network. All the components may well be "functioning exactly as they should be" (although in reality I'm sure there are a few bugs in the systems, but that's irrelevant here), but the system overall may behave in an unexpected way.

There's a bug in Internet Explorer. That must mean the entire internet is broken. No. Financial transaction systems are heavily audited, rigorously tested, and subjected to heavy regulation. They are the most hardened systems in wide use in the commercial sector. Period. That doesn't mean there aren't problems, but a problem big enough to cause a network-wide malfunction are very, very low.

What we're dealing with now are people who made bad assumptions about the economy, got cocky, and now we all are paying the price for the lack of oversight and auditing done on the decision-makers responsible. Looking for simple solutions (ie, "the computer did it") to complex problems is naive at best. This took many several thousand people, all making the same bad decisions, to bring us to where we are now. I will say it again -- this is not a technological failure, it's a failure of people. And if you ask me, we should start publishing the "bugs" -- ie, the names and faces of these people, so the rest of us know to never let them anywhere near the financial sector ever again.

But that would just be too easy.

Re:pointing fingers

[Anonymous Coward]

I can't imagine what the 'QA/QC' is like involved in the development of the modeling software for financial sector.

the most important stage in QAing a new model is seeing if it crashes with array bounds checking turned on. if it does, you fix it by turning array bounds checking off. then you put it into production and bet a couple of billion dollars on what it says.

Re:pointing fingers

[martin-boundary]

They are functioning exactly as they should be. If they weren't, we'd have heard about it by now.

Not always. Many finance outfits use Excel a lot, which doesn't do statistics properly. However, modern finance has become very statistics heavy in the last ten years, so this shortcoming matters now a lot more.

Re:pointing fingers

[martin-boundary]

Financial transaction systems are heavily audited, rigorously tested, and subjected to heavy regulation.

No. The amount of auditing, testing, and regulation varies widely depending upon the type of transaction (the consumer banking market is much more regulated than exotic derivatives).

Re:pointing fingers

[girlintraining]

No. The amount of auditing, testing, and regulation varies widely depending upon the type of transaction (the consumer banking market is much more regulated than exotic derivatives).

It's still more audited and tested than the overwhelming majority of software, even on a bad day.

Re:pointing fingers

[BigTom]

The plumbing is not the problem here. It is the Quant models that _are_ the market in many cases (certainly where ever hedge funds are significant players).

Re:pointing fingers

[martin-boundary]

It's hard to audit statistical processes, and modern trading in investment banks involves a combination of many individual transactions to achieve an overall stochastic goal over time. The protections can easily fail, eg Nick Leeson, Jerome Kerviel.

Perhaps a good analogy is with internet peering. There is no attempt to price every packet of data correctly, instead the telecoms just keep tabs on volume.

Re:pointing fingers

[girlintraining]

Er, Nick Leeson got away with what he did because his managers were idiots. In the second case, managers failed to heed warnings that the auditing system was giving out, despite his careful attempts to hide the subterfuge. I happen to believe him that what was occurring was off-the-record permission by management to conduct his activities -- I've seen it every department that is profit-driven; marketing, sales, etc., at every company I've worked, to some degree.

Auditing doesn't prevent people from making bad choices. It just makes them responsible.

Re:pointing fingers

[loners]

Just start by publishing the list of people who got home loans (foreclosures) they couldn't afford, and the loan officers that approved the loans.

Re:pointing fingers

[fabs64]

Exactly.

An unregulated market (derivatives) resulted in a bubble that popped, and we're all shocked and reeling and looking for excuses like a we've just been hit with something novel and amazing.

Re:pointing fingers

[Neon Aardvark]

The fundamental issues is these programs *didn't* fail whatsoever from the view point of most of those who programmed them, and who used them.

They by and large individually have done very well for themselves , albeit at the expense of fucking up the economy for the rest of us.

And they have done so by being reckless because they all were being reckless - they make their money by acting like the rest of their herd acts. (And now they're all being overly prudent, because they're all being overly prudent).

Re:pointing fingers

[hobbit]

There's a bug in Internet Explorer. That must mean the entire internet is broken

Nope -- just the web ;)

Re:pointing fingers

[Red Flayer]

There are very few finance outfits that do any kind of statistical analysis with Excel... none on the scale that would have much of an impact on the economy.

If you think financial actuaries and eocnomists use Excel for statistical analysis of their data... well... you need to talk to people in the industry.

Re:pointing fingers

[martin-boundary]

Statistical analysis can be as simple as computing a sample mean and variance, or as complex as estimating the parameters of multidimensional SDEs with custom software.

Given that (to be fair: older versions of) Excel wasn't even able to compute variances correctly, I think the scope is too wide to make definitive statements as to its overall impact or lack thereof on the economy.

Re:pointing fingers

[Anonymous Coward]

Just start by publishing the list of people who got home loans (foreclosures) they couldn't afford, and the loan officers that approved the loans.

Why? Are you looking for some free publicity or something, Mr Loners?

Re:pointing fingers

[Red Flayer]

The OP's statement was that financial houses are using Excel for statistical analysis and for transactional processing. This is false.

You're right that I over-reached in arguing that if any do, it's not enough to impact the economy... but considering that using Excel for transactional processing doesn't satisfy basic requirements as defined by law, I can stand by what I wrote.

Re:pointing fingers

[Anonymous Coward]

This is true... The computer analogy is not more insightful than other explanations of the financial collapse, other than to have a discussion on slashdot.
   

Re:pointing fingers

[Anonymous Coward]

I work in the financial industry, and have worked at Goldman Sachs and another large investment bank, both in trading and for a time credit derivatives (among other exotic derivatives).

From what I have seen the software isn't the problem. There is a class of software out there in the financial world called modeling software that for a given security type (stock, bond, CDO, etc) will take a bunch of inputs and output "what-if" scenarios saying what will happen to the value of your security, or more likely your entire portfolio of securities, if you change the input parameters.

The problem generally isn't the software. There are lots of unknowns. For a stock you have to guess what a company's earnings growth will be. For an option you have to compute volatility, and usually do that based on the historical volatility for the underlying stock + what you gauge the current market volatility to be, and usually other components, sometimes including the trader's/portfolio manager's "gut" feeling. In my experience, the software will tell you what the value of a security will be for all ranges requested in the spec of that program. For instance, I have never seen a case where in modeling a stock, you couldn't have entered that you felt that the company would lose money instead of earn it.

Instead, what happens is that the input parameters upon which these valuations and what-if scenarios are based use unrealistic parameters, and aren't properly "stress tested."

Fictious Example: Noody's, a bond rating agency for Mortgage backed securities (MBS), gets a request from BIG Investment Bank Co. to rate a bunch of securities it wants to sell. Noody's has software that took some very smart quants and software engineers quite a long time to develop and probably cost Noody's several million dollars to develop and maintain. Some of the inputs to this model are the default rate for the borrowers, the projected price level appreciation or depreciation of house prices over the next few years, the projected employment rate for the next few years, etc. Noody's happily puts in that house prices are going to rise between 4-10%/year for the next 10 years, borrowers are going to default at their typical pace of 2% a year, and that unemployment will stay flat or rise to maybe 6%. The software comes out and says that these securities are virtually riskless and will make piles of money.

But obviously those inputs were wrong. The software was just fine, but it is a tool just like a nail gun, and if not used properly you shoot yourself in the foot. From what I have seen, this is what has happened. The software is fine, the basic Garbage IN Garbage OUT principle is the root of the "software problem."

Re:pointing fingers

[martin-boundary]

While I do accept your point, I don't quite see that either TFA or girlintraining's original post is as specific as you claim. I also cannot accept the implicit assumption that huge financial and legal incentives prevent serious bugs (which is no slight on the talent of individual software developers).

It's a firesale

[amliebsch]

Everything must go

As with anything man-made. . .

[mosb1000]

It works well as long as you aren't too dependent on it or too obsessed with it. We often hold ourselves and others to an unreasonable standard of perfection.

Understand the System Dymanics of Emergence

[Anonymous Coward]

It is not just the computers, but the humans as well. The entire interconnected system of humans and computers in one planetary collective. A planetary economic dynamical system emerges from this, and takes on a life and behavior of its own, including organizing itself towards a "self-organized criticality" state that would eventually avalanche as it is doing so now.

The system grew far faster than it's underlying resources would allow for, ultimately driving it to a point of exhaustion and shock, leading directly to a cascade of failures spreading around the globe to nearly all segments of the market. It was inevitable, and I saw it coming many years ago, though I could not predict when it would transpire.

It's kinda like earthquakes. You can see the tension between the tectonic plates building up, but you can never be sure when that pressure will release itself. So it goes with the global financial marketplace.

Many parts of this market is zero-sum, yet predicated on the fallacy of "infinite-growth". You cannot have it both ways, my friends. It must fail, and that can "easily" be shown mathematically.

And so my "Greater Fools" theory of the market stands. If you hold a stake in it, your only hope is to find a "greater fool" than yourself to take it off your hands at a higher price. Since the supply of fools are finite, and the resources they hold are also finite, someone *must* be left holding the bag, due to the zero-sum dynamics of the market.

Computers being in the mix only make the shocks more severe and dramatic; but the same applies regardless.

Re:Understand the System Dymanics of Emergence

[DragonWriter]

Many parts of this market is zero-sum, yet predicated on the fallacy of "infinite-growth".

Many parts "is" zero-sum? Name, say, three parts that are zero-sum. Or even constant-sum.

Re:Understand the System Dymanics of Emergence

[Neon Aardvark]

I think everyone saw it happening at some point, because it always has happened at some point, all the way throughout financial history.

And the primary point is this: you make money on the whole if you follow the herd, and do what others are doing. And these people have made a lot of money. There has been no failure from (most of) their individual points of view, merely from an overall economic point of view that includes the rest of us.

Re:Understand the System Dymanics of Emergence

[againjj]

Many parts of this market is zero-sum, yet predicated on the fallacy of "infinite-growth". You cannot have it both ways, my friends. It must fail, and that can "easily" be shown mathematically.

Which are zero sum? And please, I want the "easily" shown proof of failure. I'm not holding my breath.

Re:Understand the System Dymanics of Emergence

[maxume]

If you can't take delivery, futures markets are essentially zero-sum.

Re:Understand the System Dymanics of Emergence

[Anonymous Coward]

Since the supply of fools are finite, and the resources they hold are also finite, someone *must* be left holding the bag, due to the zero-sum dynamics of the market.

that's why they created interest. it brings time into the equation and creates inflation and depreciation.

mathematicians always forget about time.

i would know. i think i am one.

--k

Can't model in human traits

[HW_Hack]

How can you model in greed - corruption - and the ever popular human trait of freaking out ?

Tech bubble - Real Estate bubble ... next time I even see/hear the word bubble in the markets I'm cashing out for a while

Re:Can't model in human traits

[Xyrus]

Right now there is a treasury bubble as everyone is fleeing to security. This actually caused yields on short term treasuries to drop below zero for a while.

That's right. People where willingly and knowingly paying MORE for a treasury bond than it was worth.

~X~

Re:Can't model in human traits

[gregbot9000]

That is to be expected, with the investors flushed with cash from expansionary monetary policy, and 8 years of pro supper rich government structuring.

They have more money then the market can bare them spending, or even saving, While the common man lose their jobs.

The question is, what caused this? I side with perverse incentive structures and a tax policy thats borders on regressive.

Re:Can't model in human traits

[Capt James McCarthy]

"Tech bubble - Real Estate bubble ... next time I even see/hear the word bubble in the markets I'm cashing out for a while"

What if it's a "currency bubble?"

Re:Can't model in human traits

[Timberwolf0122]

Bubbles would not be an issues if when they happen (it's not like they are hard to spot) everyone just held back and let it deflate, however this will never happen as everyone will want to get in while they can. It's like watching lemmings being herded off a cliff.

Re:Can't model in human traits

[lewiscr]

Too late. The Energy bubble is already starting.

Re:Can't model in human traits

[Anonymous Coward]

I thought the point of a bubble was that it burst, and that they're named bubbles after the fact. Maybe you were going for funny?

But hell yeah, steer clear of the bubbles, in case you spot them beforehand.

Does the argument support the conclusion?

[MoellerPlesset2]

Seems to me the author is repeating the mistake himself: By drawing a conclusion not supported by the data, in this case being the evaluation of the role played by computer models here.

And I agree with that datas: The problem isn't the computer/mathematical models. It's how they were used. In particular, people were using models designed to evaluate one kind of mortgage asset, and plugging in an entirely different kind of mortgage, etc.

The author grants that conclusion, but then makes the claim that although the problem wasn't caused by the computers themselves, that it was somehow exasperated by them. - I don't see how that's the case.

Computers and computer modelling makes it easier to create advanced derivatives and such. But it doesn't make us do it. Just look at the engineering world; We don't choose technically advanced solution just because we can. In fact, the tendency is to go for the simplest possible solution. ("KISS rule")

There's only one reason why you would create advanced, incomprehensible derivative structures: To con people, essentially. To obfuscate the risks. To create money out of nothing. (the most profitable way to make it)

That's not a new problem. There's a reason we created financial regulations, why we have book-keeping, demand financial transparency, auditing, etc. This happened because it was allowed to happen. Because nobody stepped in and stopped this obfuscation from happening. I don't blame the computer models. If someone cons you into signing a bogus, misleading contract - the problem isn't with the paper it was written on or the language that was used. The problem is with the law allowing such contracts to have legal force (which is a regulatory problem from another century).

To extend that analogy, this is a bit like standing in that situation and asking whether or not written contracts are a bad thing, and whether we shouldn't go back to simpler, oral contracts. The bottom line is: As long as it's profitable, there will always be people trying to obfuscate and hide information for economic gain, and there will always be a need for regulation and oversight to stop people from doing that. But blaming the methods by which it's done is pointless.

Re:Does the argument support the conclusion?

[Anonymous Coward]

A scientist trained a frog to jump on verbal command.
The frog jumps a distance of 8 feet.

The scientist chops off a leg, now the frog jumps 6 feet.

The scientist chips off another leg, now the frog jumps 4 feet.

The scientist chips off the 3rd leg, now the frog jumps 2 feet.

The scientist chops off the final leg. The frog jumps 0 feet.

The scientist comes to the conclusion that the frog is now deaf.

Anything blamed on a computer...

[DragonWriter]

...involves at a minimum two human errors, one of which is the error of blaming it on the computer.

The scariest thing about high finance these days

[David Gerard]

The very scariest thing about the computers sending serious amounts of money around?

They're almost all Excel spreadsheets.

Yes, seriously.

Mod parent up!

[David Gerard]

Couldn't have put it better!

Gaming the system

[Anonymous Coward]

I was actually pretty involved in automated trading systems until a few months ago. The over-arching problems with the systems is they can either be tactical or strategic. Tactical systems make trades in milli-seconds and make decisions based on a dozen or so parameters. There is no human intervention. The money is made getting your trades in faster than the other guy. The problem is there are a lot of reactionary traders out there who see this movement and then react... without really determining what caused the movement. They just see a large percentage of stock moving and follow the lead.

Strategic trading is data-mining and looking at hundreds of factors and incorporating expert opinion into and making decisions based on long term movements and not singular announcements.

A very good example is Enron. Tactical trading systems would have always bought it because it meet or exceed it's numbers. A through analysis such as the one done by Daniel Scotto would have seen through the fraud.

Unfortunately ... tactical trading is fast and sexy and attracts the Gordon Gecko/Boiler Room types. Very few college grads aspire to be Warren Buffet.

What does it have to do with computers?

[Anonymous Coward]

You kids and your newfangled things! No good will come of it!

The current problem is due to borrowers taking out home loans that they couldn't repay, and lenders assuming, based on no evidence at all, they the borrowers could repay. One day, the lenders found out that borrowers weren't paying, and therefore the lenders were hundreds of billions (or trillions) of dollars poorer than they thought they were. How is that the fault of computers?

Also, asset bubbles, based on 'irrational exuberance' for something that people think will always increase in value (from tech stocks to houses to tulips), existed long before computer models existed. I don't see the relationship of asset bubbles to computers.

the current global system is in an "undefined state." This means that there's no way to predict what its output will be

Are they suggesting that we can't predict the economy and markets? Think about it for a minute: If you knew that for certain, at any point in history, would you be reading Slashdot? Could we predict the markets before the advent of computer technology?

established modeling techniques presume falsely that radically large market shifts are unlikely and that all price changes are statistically independent; today's fluctuations have nothing to do with tomorrow's--and one bank's portfolio is unrelated to the next's. Here is where reality and rocket science diverge.

He's saying that the models didn't take into account 'systemic' risk. First, I wonder to what degree that's true. Second, were our models any better when we used slide-rules? Computers somehow make our models less sophisticated?

I think he identifies some problems, especially garbage-in-garbage-out, but I don't see how they are related to computers.

Re:What does it have to do with computers?

[David Gerard]

Computers allow you to make Godawful mistakes so much faster than your competitors.

Re:The scariest thing about high finance these day

[TheKidWho]

Functional Programming at it's best.

And we all thought Skynet would use nukes!!!

[tjstork]

Instead, its a financial meltdown by a suddenly emergent AI. Why destroy the planet when it is so much easier to just starve humanity to death!

In all seriousness though, the usual anti-globalism doomsayers are not the only one. A careful reading of the insurance industries actuarial newsletters will show a growing skepticism of computer modelling. It's kinda funny but remember the big brouhaha over Mann's Hockey Stick was that he used some software, I think, that was also used for Wall Street trading models. What if he just royally screwed up?

Log Normal Assumption

[DJ Jones]

The vast majority of financial models (including the dreaded CDO models) use stochastic calculus to predict price movement by setting up individual security prices as random variables. By doing this, you are making a very broad primary assumption that the markets for these securities, as a whole, are log-normal.

Right there, from the beginning of all these models, you are making a broad assumption. No one has ever proven that any of the financial markets are actually log-normal.

The model assumptions were ideological

[grandpa-geek]

There are two equally valid descriptions of markets. One is by Adam Smith, with the "unseen hand" guiding the markets. Smith markets are well behaved, efficient, and amenable to analysis by what amount to small-signal statistics.

The other description is by Charles Mackay in his book "Extraordinary Popular Delusions and the Madness of Crowds." In that book he describes the Dutch tulip craze and other bubbles in history prior to the mid 1800's. This economic crash is more of the same.

The models, probably because of "free market" ideology, assume a market where Adam Smith's "unseen hand" is at work. The modelers don't consider the kinds of markets described by Charles Mackay. Most of the models are based on the Black-Scholes option pricing theory. If you look at the assumptions underlying that theory, they describe good behavior, efficiency, and changes describable by what amount to small-signal statistics.

Mackay markets are boom and bust, with greed and lies and herd behavior all around. That's what we had. The underlying mathematics has been studied, but not for markets. If you have a pre-LCD TV, an electronic circuit that is non-statistical but related to boom-and-bust market behavior creates the sawtooth sweeps that paint the picture onto your screen.

Re:The model assumptions were ideological

[fabs64]

Correct me if I'm wrong, but didn't even Smith acknowledge necessary intervention in markets for situations such as monopolies?

I thought the current prevailing ideology was more of a modern one ala Milton Friedman?

Re:The model assumptions were ideological

[metallurge]

The underlying mathematics has been studied, but not for markets.

Actually, it has. Ralph Nelson Elliott discovered these fractal sawtooth sweep patterns in market behavior in the 1930's. Basically, Elliott waves and their patterns are a quantification of mass psychology. Current Elliott wave authors of note are Robert Prechter, Jr. and Glenn Neely. Worth investigation.

Re:The model assumptions were ideological

[Animats]

Actually, Makay doesn't have a "model"; that 1841 book, which I've been recommending to investors since 2001, is simply a history of the classic early financial crises. Great book; anybody with money or interests in getting some should read it. It describes Version 1 of all the famous disastrous financial schemes, from Law's bank to the South Sea Bubble.

The "ideological assumptions" that were a problem involved deregulation, which got completely out of hand. We used to have a heavily regulated financial system designed during the last depression. Investment and banking were completely separate; banks couldn't speculate in stocks, and brokers couldn't take deposits. This kept stock market problems from taking down banks. That was the Glass-Stegall Act, repealed in 1999.

The US also used to have a savings and loan system that took deposits and sold mortgages, and didn't do much else. Mortgage securitization is quite new; it didn't become big until the mid-1990s. And mortgages used to require a 20% down payment and be limited to under 3x borrower annual income.

US banks used to be unable to lend for stock market speculation. Only brokers could do that, as "margin", and brokers couldn't create money in the way banks can.

With all those constraints in place, the financial system held together better during stock downturns. The dot-com collapse didn't take down banks. Now we have banks going down because they lent to hedge funds.

Re:The model assumptions were ideological

[Anonymous Coward]

From Nature 455, 1181 (30 October 2008)

Economics needs a scientific revolution

Jean-Philippe Bouchaud

Compared with physics, it seems fair to say that the quantitative success of the economic sciences has been disappointing. Rockets fly to the Moon; energy is extracted from minute changes of atomic mass. What is the flagship achievement of economics? Only its recurrent inability to predict and avert crises, including the current worldwide credit crunch.

Why is this so? Of course, to paraphrase Isaac Newton, modelling the madness of people is more difficult than modelling the motion of planets. But statistical regularities should emerge in the behaviour of large populations, just as the law of ideal gases emerges from the chaotic motion of individual molecules. To me, the crucial difference between modelling in physics and in economics lies rather in how the fields treat the relative role of concepts, equations and empirical data.

Classical economics is built on very strong assumptions that quickly become axioms: the rationality of economic agents (the premise that every economic agent, be that a person or a company, acts to maximize his profits), the 'invisible hand' (that agents, in the pursuit of their own profit, are led to do what is best for society as a whole) and market efficiency (that market prices faithfully reflect all known information about assets), for example. An economist once told me, to my bewilderment: "These concepts are so strong that they supersede any empirical observation." As economist Robert Nelson argued in his book, Economics as Religion (Pennsylvania State Univ. Press, 2002), the marketplace has been deified.

Classical economics has no framework through which to understand 'wild' markets.

Physicists, on the other hand, have learned to be suspicious of axioms. If empirical observation is incompatible with a model, the model must be trashed or amended, even if it is conceptually beautiful or mathematically convenient. So many accepted ideas have been proven wrong in the history of physics that physicists have grown to be critical and queasy about their own models.

Unfortunately, such healthy scientific revolutions have not yet taken hold in economics, where ideas have solidified into dogmas. These are perpetuated through the education system: students don't question formulas they can use without thinking. Although numerous physicists have been recruited by financial institutions over the past few decades, they seem to have forgotten the methodology of the natural sciences as they absorbed and regurgitated the existing economic lore.

The supposed omniscience and perfect efficacy of a free market stems from economic work done in the 1950s and 1960s, which with hindsight looks more like propaganda against communism than plausible science. In reality, markets are not efficient, humans tend to be over-focused in the short-term and blind in the long-term, and errors get amplified, ultimately leading to collective irrationality, panic and crashes. Free markets are wild markets.

Reliance on models based on incorrect axioms has clear and large effects. The Blackâ"Scholes model, for example, which was invented in 1973 to price options, is still used extensively. But it assumes that the probability of extreme price changes is negligible, when in reality, stock prices are much jerkier than this. Twenty years ago, unwarranted use of the model spiralled into the worldwide October 1987 crash; the Dow Jones index dropped 23% in a single day, dwarfing recent market hiccups. Ironically, it was the very use of a crash-free model that helped to trigger a crash.

This time, the problem lies, in part, in the development of structured financial products that packaged subprime risk into seemingly respectable high-yield investments. The models used to price them were fundamentally flawed: they underestimated the probability that multiple borrowers would default on their loans simultaneously. These models again neglected the very possibility of a

Re:The model assumptions were ideological

[Big Nemo '60]

Nassim Nicholas Taleb

In 2006, in The Black Swan [ 16 ]

Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks - when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crisis less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur ...I shiver at the thought.

The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deem these events "unlikely".

Turner

[Elektroschock]

Probably the best comment on the current financial crisis comes from Mr. Adair Turner.

It is not the computers or the communication standards. Sorry, not our poor computers, not the right target for the blame game.

The challenge of the crisis is intellectual. Look, I remember that economists always explained me that they have no clue where the US growth rates come from systemically or can explain where the financial markets make all that money. The surprise was that it didn't crash earlier.

Re:Turner

[Qrlx]

I think the challenge could be described as "intellectual honesty." Or perhaps just simple honesty.

Certainly, lots of people got wrapped up in this thing who weren't dishonest; from the poor IT guy at Lehman Brothers to the poor family buying a house on a jumbo loan.

But there were shenanigans going on, and some people who knew better just looked the other way. (And some spoke out too, to little effect.)

Mr. Turner remarked that they didn't fully understand the implications of complex financial instruments. It's a bit like a person with a syringe full of heroin, shooting up for the first time, remarking quite truthfully that they aren't really sure how it's going to feel. And then shooting up anyway.

Hmm, I'm not sure if that makes sense now that I read it. Anyway, great link, thanks for that.

Re:Turner

[Elektroschock]

What I found asthonising was the ability of Turner to declass his interviewer who threw some sticky phrases at him. I am as you probably notice no native speaker, and I really admire the different shapes of British language, in particular the more sophisticated ones. He doesn't say: "bullshit!". He says "I think it is a bit odd..."

Then there is the French person, Trichet, who is totally different. He sounds like a French EU technocrat. He has authority, so he dumps some thoughts on the interviewer. These are the kind of personalities whose main task is to find and shield brilliant people who work for them.

So if I had to chose I would take Trichet because I know that personalities as Turner are very direct and sophisticated on a message level but they are not effective and too risk averse in their communication, too vulnerable politically, too intellectual.

Don't Worry...

[Anonymous Coward]

It's all part of The Plan.

Re:Don't Worry...

[mosb1000]

I always think it's funny when people discuss putting the laws of robotics into practice. They seem to forget (or perhaps did not notice) that Asimov's short stories concluded that such laws and rules won't work. I think in this case it is a very apt comparison.

Taleb's explanation of the Narrative Fallacy

[icke]

http://en.wikipedia.org/wiki/Nassim_Taleb "Narrative fallacy: creating a story post-hoc so that an event will seem to have an identifiable cause."

Strategic Military Significance

[Anonymous Coward]

Forget the Fed.
Forget the Treasury.
The most sophisticated global economic simulations are done by the DoD.
Weather is important.
Foreign logistics need to be tracked.
Nuclear device simulations maintain the arsenal.
BUT THERE IS NO ASSET WITH MORE MILITARY SIGNIFICANCE THAN OUR ECONOMIC POSTURE.
More DoD resources are spent tracking, forecasting and simulating the global economy than any any other military resource.
AS IT SHOULD BE.

There is nothing new under the sun

[BenSchuarmer]

Bubbles, panics, and crashes have been happenning periodically for hundreds of years.

My investment advisor ...

[PPH]

...Bernie Madoff assures me that my portfolio is safe and I shouldn't worry.

Let's try...

[Estanislao Mart�nez]

Besides consumer banking, can somebody explain to me why we NEED "commercial paper"? Yes, I've read the wikipedia page and I know how it's used, but I don't understand why it's needed. If you can't make payroll then you're pulling from your credit one way or another - why do we need separate instruments for a 2 week loan versus a longer term loan, or a credit card, or whatever?

Because the risks, terms and structures of the loans are different between the different products, and it requires different expertise to successfully make loans of one kind vs. another. Not to mention that the borrowers are different for each product. This means that the separation of the loans into distinct product types represents a division of labor among lenders.

Just to list some of the important factors:

1. Commercial loans vs. consumer loans
2. Large corporations vs. small businesses
3. Large loans ($100k+) vs. smaller loans
4. Fixed term and rate vs. revolving loan
5. Secured vs. unsecured loans
6. Secured loans with different types of collateral
7. Large volume of small transactions vs. small volume of large transactions
8. Prepayment options
9. etc.

This is not to say that the line of product offerings doesn't have any significant overlaps, but most pairs of products you can think of are differentiated along at least one of these, if not others. The commercial paper market, for example, exists because large corporations seeking large ($100k+) short-term loans can get better rates than at other kinds of credit product. Large corporations with good credit ratings also get better rates on long-term borrowing by issuing bonds than they could by going to a bank. Credit cards feature point-of-sale networks and allow for a large volume of small transactions, while personal lines of credit require you to borrow in much bigger chunks at a time in exchange for a better rate (a volume discount, so to speak). And so on.

One problem with that.

[khasim]

What we're dealing with now are people who made bad assumptions about the economy, got cocky, and now we all are paying the price for the lack of oversight and auditing done on the decision-makers responsible.

But those same people were "geniuses" for making so much money for their investors BEFORE it all collapsed.

See Bernard Madoff.

And it will happen again.

Re:One problem with that.

[maxume]

Ah-hah-hah, Bernie made-off with their money, ah-hah-hah.

I am a childish bad person.

Don't blame the computers

[deodiaus2]

There are lots of problems in the financial system that have nothing to do with computers. If anything, computers have brought these problems to light.
You see a lot of this pointed out on Jim Cramer's show "Mad Money", http://madmoney.cnbc.com/
Most of our problems have to do with the lack of transparency in financial systems on supposedly public traded companies. As Cramer pointed out, "How can you have these levels of fiction after Sarbone-Oxley?" Moreover, with the recent Ponzi scheme uncovered, it makes you wonder just how interested is the SEC in maintaining the integrity of the financial system? That and allowing the short sellers to destroy the banks, leaving the tax payer to bail out the investors in order to preserve the financial system.
Thank god, we have the best form of government money can buy. Unfortunately, it even works to preserve the status quo when the original players are bankrupt. Nothing new here, after all, Japan's emperor was able to maintain control long after he had been defeated.
I am sure the US empire will survive this minor setback. The Hessian empire was bankrupt for hundreds of years before it ultimately collapsed. Maybe we can drag this on until the next Ice Age or until we poison all life to extinction, so who cares about the messes in the meantime?

Re:Don't blame the computers

[Xyrus]

Jumping Jeebus on a camel hump.

If you get your financial advice from Kramer you need help. The guy really is out there.

BTW, short sellers have nothing to do with banks going bankrupt. Short sellers are taking advantage of the stupidity of the banks who have bankrupted themselves.

You may argue that if shorters weren't shorting the banks they could sell more shares and raise capital. However, that is incorrect. Bank balance sheets were already decimated. Issuing more shares would have done (and in fact did nothing) even when a ban on shorting was in place. That is for the simple reason that people don't want to invest in shaky financial institutions. Whodathunkit.

The problem, as is usually the case, was caused by the banks themselves. The fact that people are profiting from their idiotic self-destructive behavior is a small plus in the general global cluster-f@ck that they managed to deal the planet.

~X~

Re:Don't blame the computers

[deodiaus2]

You said "If you get your financial advice from Kramer you need help. The guy really is out there."
You might be right, however, unless you really give me a well formulated and well thought out arguement, I think you are just mindlessly bashing and raving nothings.
Yes, Cramer is a clown. However, he presents a well thought out formulation on his GOOD days. Of all the financial advisors I have heard, Cramer has been right over the last few months.
But to allow the short sellers to bring the prices down so low, only to bail the banks out is not serving the taxpayers interests. You can't have government intervention and claim to have free markets at the same time.
The only place where Kensian economics exists in in Keynes's and his follower's minds!

Re:Don't blame the computers

[khallow]

That and allowing the short sellers to destroy the banks, leaving the tax payer to bail out the investors in order to preserve the financial system.

You got a bad meme in there. Shorts didn't destroy the banks. Bad decisions destroyed the banks.

Nothing new here, after all, Japan's emperor was able to maintain control long after he had been defeated.

The Emperor was never in control.

The Hessian empire was bankrupt for hundreds of years before it ultimately collapsed.

There never was a Hessian empire. There was a Holy Roman Empire which had Hesse as a principality.

Maybe we can drag this on until the next Ice Age or until we poison all life to extinction, so who cares about the messes in the meantime?

Non sequiturs.

Re:Don't blame the computers

[Anonymous Coward]

You are using Jim Cramer as a reference and get modded up?!?!

Simple routing protocol error

[isotope23]

It's just an error in a GDP neighbors statement.
We're routing the JIT and USD to Null0.

When FDIC re-establishes its Link State we'll be good to go.....

half of the world's money is "fake" money

[peter303]

Money doesnt just mean paper, but loans, and shares, insurance, and derivatives thereof. The problem was in the past decades tens of trillions of poorly structured derivatives called CDOs were created totally half of the world's financial assets. They were posed as private contracts- so they werent regulated by any government agency. They did not have asset reverses backing them up like banks accounts and insurance are required. They aren't tradeable on any exchange, so its difficult to come price them. The Fed and SEC were perfectly aware of them, but ignored them for many reasons.

Re:The scariest thing about high finance these day

[David Gerard]

DysFunctional Programming.

It's the same in the USA.

[Estanislao Mart�nez]

In many developed countries (Europe, Japan, ...), many people have a single account which supports both checks and debit cards. Mine is also used as a brokerage account, but I'm probably not a typical client.

That is also common in the USA. As another poster mentioned, debit cards and credit cards use the same networks, but have some extremely fundamental differences.

It is also common to have brokerage and banking accounts linked; a lot of "banks" and "brokerages" are in fact holding companies that own both a bank and a brokerage, but have most of their market share in one of the two. So Wells Fargo (a retail bank) and E-Trade (a discount broker) offer a similar range of services, allow you to fund your investments from your bank accounts, and allow you to sweep money from your investments right into your bank accounts.

I do think it's more common for people to have separate companies for banks and brokerages in the USA, but only because that's the best deal that way. A retail bank gives you access to a much better ATM network, but usually isn't as good as a brokerage as a company that specializes at that. (And also, in the USA, the cheapest and way to build an investment portfolio is to open an account at a large mutual fund company like Vanguard, and buy their funds direct from them, with no brokerage commissions.)

How Can You Expect Otherwise?

[DynaSoar]

Lorenz 'discovered' chaos when he found non-linear, self-similar but non-replicating, and increasingly unpredictable results coming from a set of three interdependent (each variable was a term in the other two) recursive LINEAR equations.

You've got humans in this equation. They are not only not linear, they're not even rational.

The "beauty" in John Nash's "A Beautiful Mind" is best typified early in the movie when he tells his fellows that if everyone goes after the brunettes, they'll all get laid, but if any one of the goes after the blond, none of them will. That became the essence of his most famous works in game theory. Granted "This man is a genius." (the sum total of the recommendation letter his Carnegie mentor penned to Princeton), but through many trials and errors you'd expect others to come to similar results, knowingly or not. But NOOOO everyone wants the blond, even though the intended result is not affected by hair color. The decision making process if very often not controlled by the frontal lobes.

I'm speaking from history, metaphor and a male perspective here. I don't defend it, nor do I hold up for contempt. It's just that I can only speak from the male perspective. I suspect females have equally irrational perspectives they can speak from (though they may be more likely to have more sense than to do so).

una bomber manifest explains it too...

[PermanentMarker]

There is a moment you cant pull the power of a machine on which you depend, at that moment your enslaved by the machine.

That's not correct.

[Estanislao Mart�nez]

Subprime lending in general has never been forbidden. What change in the law do you have in mind?

Re:That's not correct.

[Restil]

Not forbidden... just stupid.

-Restil

Re:That's not correct.

[Estanislao Mart�nez]

I recommend you read this discussion of the history of subprime lending. To put it shortly, the issues around subprime lending are a lot more nuanced than you seem to think.

Re:The scariest thing about high finance these day

[Red Flayer]

You're serious, aren't you? Have you any evidence to support that assumption, or did you pull it out of your ass?

Financial transaction processing is done via relational database in almost all cases. Or do you really think the volume of transactions handled by a decent-sized bank, even on a daily basis, could fit in 65k lines?

GIGO

[AK Marc]

Yes, it is a computer failure. They were given crap numbers, and accurately calculated a crap answer. Enough people ran with that crap answer, and crash. So yes, it was caused by computers, computer models, and all that. In the same sense that you can blame the CAD program when a car crashes.

It IS all a scam

[cjonslashdot]

Commercial paper is needed: it is a financing instrument.

However, recent forms of commercial paper (swaps) were not regulated, thanks to the Bush administration. That commercial paper was over-extended: backed by assets whose value was in a bubble, and when the bubble collapsed, the paper was worthless because there was too little true equity.

BUT, the thing that is unreported in the news, is that the people at the top of the pyramid must have seen this coming. They KNEW that these instruments were unregulated. They knew that it would eventually collapse. And therefore they most likely sold their interests in the banks just around the right time, before the collapse, knowing that billions would be pumped in, at which time they will buy back those assets and ride the new rise in value, based on our tax dollars.

They must have known this would happen. Thew knew their models were not able to handle large fluctuations and that the investment banks, Freddie, Fannie, etc., would continue on this mad rush because the decisionmakers are all driven by short term goals. But the people who are TRULY at the top - wherever they are - must have seen this coming.

Re:Economics models are like goat entrails predict

[VernoWhitney]

To steal from an old RPG: Lies, damned lies, statistics, and computer modeling.

Leverage

[Archangel Michael]

Much of the problem is commercial leveraged investment instruments. Some of these leveraged instruments were bundled together in a "derivative", again adding leverage.

This all works fine and well as long as the market is going up up up. Leveraged instruments make gobs of money for those in the beginning, but like a pyramid scheme, late comers and those who stayed in way too long ... end up with the short stick.

And nobody questions the leveraged invesments, nor compounded leveraging going on, because all the people at the top, are making gobs and gobs of loot.

Those people are buying the likes Chuck Shumer and GWB in a spread the wealth around and keep the regulators off our back protection racket.

You end up with 20 + years where this is working and then BAM, it all comes apart at the first sign of collapse.

If you think about it, all the people making money for the last 10 years or so, didn't make anything, just trading paper back and forth.

And now, they are continuing the scam, with Trillions of dollars of international treasuries trying to keep the scam going.

The problem is, nobody is willing to do "Nothing", which is the ONLY thing we can do, until reality sets in. The shit isn't worth what people STILL think it is worth. Some of it has negative net value, but nobody is asking for those holding the negative valued paper to pony up.

Why? Because they that have the negative value assets own the politician on both sides of the isles.

(D) bad, (R) bad, and both are in the race for "worst".

sure

[z-j-y]

at this speed of money supply, all the computers deal with money will soon overflow.

New machines,

[Evoluder]

Many machines on Ix, new machines.

The Machine the Won the War

[sp332]

Reminds me of Isaac Asimov's (very) short story of how computers won a major fictional battle. First, bad data was input. Then, the results were fudged. Then, the output was ignored by management. In the story, things turned out well. In real life, apparently, not so much. Text: http://drop.io/hidden/oyoyld5o6xkjlu/asset/bWJhNTgwLXRoZW1hY2hpbm

It's like programming

[mechsoph]

I have always believed that the vast majority of today's programming languages have been invented out of thin air for no reason other than to ultimately ensure the employment of programmers and consultants.

For example, lots of people use Fortran, C, C++, Python, Perl, Java, or C#. I see absolutely no reason why a single language could not offer all those features. The only reason you "need" all that is because the programmers created all these funny quirks so that they could introduce more and more products and services. This is done so they can charge you more for each of those things, and also to differentiate them from their competitors.

Seriously though...

Different accounts offer different features. You could try to make do with a single deposit account instead of a checkings/savings/CC combo, but probably wouldn't get as much return as you do with specialized products. Loans are totally different from deposit accounts, though, so I don't know how you'd plan to combine them. Also, a lot of the complexity here comes from dealing with Congress's regulations. Since everybody seems to think we don't have enough of those now, that's probably not going to get simpler anytime soon.

cheap oil

[Anonymous Coward]

This is so stupid, its clear why the GFC happened, we ran out of cheap oil!!
once that happened, we now have to wait 10 years for replacement technology (electric cars etc).

greed is good algorithm

[blad3runn69]

i think we've had a buffer overflow...

Re:greed is good algorithm

[blad3runn69]

buffer overrun... BSOD blue screen of debt A problem has been detected and has been shut sown to prevent damage to the current account deficit. Plaese check to make sure you remembered to pay the bills...

Re:Economics models are like goat entrails predict

[Anne Thwacks]

Economics models are like using goat entrails

Nonsense - barbequed goats entrails are quite tasty, while barbequed software - nyaagh!

Re:Economics models are like goat entrails predict

[tg123]

Economics models are like using goat entrails

Nonsense - barbequed goats entrails are quite tasty, while barbequed software - nyaagh!

hmmmm - yea alright i will give you that.

mod previous post up please

Fractional Reserve Banking REQUIRES growth

[Colin Smith]

The grantparent is largely correct, and it has nothing to do with accounting.

When banks create the money that they loan out (and it is the creation of money which is what makes a bank a bank), they do not create the money required to pay the interest on the loan. Therefore more and larger loans must continually be created to pay the interest on the previous round of debt. If more and larger loans are not taken out, there is a recession, or depression as the debt consumes the credit. The economy is basically a giant pyramid scheme. The longer the period of growth, the bigger the crash at the end of it. It is simply the bankruptcy process destroying the debt which allows another round of growth.

most cash proceeds from the sale of houses was deposited in banks -- this is false. Most was actually reinvested in other real property or elsewhere.

WTF? Do you think the paper was magically converted into bricks? Was it burned to fire the ovens?. No it was deposited into another bank account.

They are dependent on the stream of payments from existing debtors. When that stream dries up, their ability to lend dries up, since they become cash-flow negative, and eventually have no capital to lend.

And where does the money to pay the interest come from? It was never created, and when credit pays off debt, there is nothing left over. You call the grantparent uneducated but clearly either don't understand how banking works or are deliberately misrepresenting the process.

Re:Fractional Reserve Banking REQUIRES growth

[Red Flayer]

WTF? Do you think the paper was magically converted into bricks? Was it burned to fire the ovens?. No it was deposited into another bank account.

No. Typically it was invested in other property, whether real, via a fund, or otherwise. Are you lumping in investment institutions with banks? Are you lumping in real property with banks? They are not the same thing. The GGP post was claiming that the funds received by the seller were held on to by the bank. In most cases, while this happened for the (very) short term, in the long term the funds were typically invested elsewhere -- whether in another property or in a fund of some sort.

And where does the money to pay the interest come from? It was never created, and when credit pays off debt, there is nothing left over.

Sigh. Do you really not understand investment? The GGP post had nothing to do with fractional reserve lending, so it'd be best if you leave your personal bugaboo out of the discussion, since it is immaterial. Regardless of whether the lending is based on a fractional reserve or not, the simple truth of the matter is that people and institutions will tend to lend capital if their expected return is greater than the return for investing elswhere. This happens more frequently when we are undergoing growth, since no one wants a negative return, but is not dependent completely upon growth, as even in a shrinking economy there are investments that may yield a positive return.

When banks create the money that they loan out (and it is the creation of money which is what makes a bank a bank), they do not create the money required to pay the interest on the loan. Therefore more and larger loans must continually be created to pay the interest on the previous round of debt.

That's not necessarily true, it depends on what kind of terms the banks are borrowing by. If they borrow via short-term, or overnight loan, then they can get (and have gotten) into a mess. If they are borrowing on a long-term basis, it is not impossible for a bank to be cash-flow positive based on present debtors only.

The problem currently has a lot of causes, but the biggest one is not fractional reserve lending. The biggest problem is banks failed to properly assign risk to the loans they issued, thereby overvaluing the mortgage-backed securities they held.

Re:Fractional Reserve Banking REQUIRES growth

[John Bayko]

And where does the money to pay the interest come from? It was never created, and when credit pays off debt, there is nothing left over. You call the grantparent uneducated but clearly either don't understand how banking works or are deliberately misrepresenting the process.

In brief, interest is accounted for in two ways:

1. The risk of bankruptcies. A certain amount of money isn't coming back, so the interest ensures that those who will repay loans will cover those who don't.
2. Growth, specifically increased productivity from technology, better organisation and planning, economies of scale, and so on. Maybe this can't go on forever, but while it does, the same results have lower expenses, the difference being profit shared between the capital owner and the lender (as interest paid).

Lenders also use some interest for profits, but they are like any other business. All this is also subject to government intervention (taxes, fees, subsidies, etc.).

Depends where you live

[fantomas]

Good on you buddy. Where I live a small terraced house (red brick, neighbours on both sides) costs GBP 160,000 (approx $300K?). Not many folk have the kind of job that lets them save that up in cash. Most of us have to take on credit (a mortgage) to buy a house.

I'd agree houses are overpriced but there's nothing you can do as the man in the street to change that. You either don't buy a house or you take on credit. Best you can hope for is to work hard and save enough of a deposit that you get a decent mortgage.

Re:The scariest thing about high finance these day

[jimicus]

It's only anecdotal, I know, but I've heard similar stories.

While DBMSs may be the backend for the transactions themselves, a lot of the decisions for what transactions to make are based on spreadsheets.

I'm a Quant....

[Anonymous Coward]

...and I don't think this is the first time financial modelling has been blamed for provoking or exacerbating a crash.

In 1987, it was a simple product called 'Synthetic Portfolio Insurance'. Sounds complicated? It isn't.
Basically, I have a portfolio of risky (stocks) and riskless (bonds) assets, and I want my portfolio to benefit from the greater upside performance of the risky asset, but at worst, I want my portfolio to perform no worse than the riskless. Everyday, the seller of the product rebalances the portfolio according to a set of rules.

So, when the stock market is good, most of my portfolio is in the stocks, and when it's bad, most of my portfolio is in the bonds. This is much like how you or I might behave if we were investing our own money.

However, this is assuming that the instruments don't influence the market. If the holding of the instruments is great enough, there is an unfortunate feedback loop. Should the market suddenly crash, the writers of the instruments are obliged to rebalance their portfolios (i.e., sell stock, buy bonds), which then causes further depression in stock prices, causing further rebalancing, and so on.

This brings me to a second point. True, quantitative modelling makes assumptions about how the market behaves. Good risk management should be taking reserves against the 'known unknowns' due to the model assumptions.
We know that crash events are inherently unpredictable, so we're supposed to be constantly checking the books to ensure that we know our worst-case exposures and that our hedges work.

On the other hand, we then calibrate these models against prices we see in the market.

It's my very strong feeling that the models weren't necessarily entirely terrible (although CDO, CDO^2 and CDO^3 does seem to be pushing it a bit), but that the market was also significantly underpricing risk, particularly credit risk (both default and counterparty default risk) and correlation between credit events, because of the benign market conditions we have had for so long.

So, some of the 'garbage-in' were the market observables used to calibrate the models.

Personally I don't see why you would need credit t

[Anonymous Coward]

Because you can utilise the car during the time it takes to make the money to buy it.

Smoke and Mirrors

[d0n0vAn]

In January 1970 the DOW average was about 770 points. Trend that to late 1999, 2000 and it is about 11,000 points with a high point at almost 14,000 points. Consider that trend with the consumer debt in this country. American Express was started in 1958. Visa and MasterCard changed their names and gained prominence in the late 1970s. Non-mortgage debt at the end of 2007 was about 2.5 trillion dollars. In October 2008, we had almost 1 billion in revolving debt. This is only possible with our current fractional-reserve lending practices. Would we have the big-box stores or mega malls without consumers spending money they don't have to buy shit they don't need? Our entire financial system is a house of cards and it isn't 'if' but rather 'when' it is going to fall.

You are an idiot!

[gbutler69]

<p>
Go back and read what you said. Does the bank print money? No. Then they don't lend out more than they take in in deposits, PERIOD!
<p>
Stop believing every non-sensical, right-wing, load of clap-trap you hear and use your intellect to THINK and you won't look like an idiot!

Re:You are an idiot!

[jahudabudy]

Go back and read what you said. Does the bank print money? No. Then they don't lend out more than they take in in deposits, PERIOD!

Of course the bank prints "money". Ever gotten a cashier's check? Bank printed it. Oh, you meant cash currency? No, they don't print that. Then again, they also don't pay out loans in cash, so I'm not sure how that imposes limits on their ability to loan out more money than they actually have.

Stop believing every non-sensical, right-wing, load of clap-trap you hear and use your intellect to THINK and you won't look like an idiot!

Fractional banking is a right-wing load of clap-trap? Well, not sure about the ideology, but you might actually have a point there...

Re:You are an idiot!

[Abcd1234]

I strongly suggest you go read this. Specifically, go read the section on money creation. As an aside, I'd strongly suggest you learn the difference between money and currency.

Re:You are an idiot!

[xenocide2]

Ah yes, Wikipedia, where knowledge and Heisenberg uncertainty meet. Even Wikipedia suggests the neutrality of that article is in dispute. I agree that making loans increases the money supply, but to equate that with printing currency is misleading. (Nearly) every dollar a bank loans originated from a deposit (the rest comes from bank capital, from the sale of stock etc). In no circumstance are they issuing more loans than they possess. It's fractional reserve, not imaginary reserve.

If you strongly believe that fractional reserve banking causes inflation, can you recommend an alternative loan system to replace it?

Re:You are an idiot!

[Abcd1234]

If you strongly believe that fractional reserve banking causes inflation, can you recommend an alternative loan system to replace it?

Why would I? I think fractional reserve banking is a good idea, and that full-reserve banking is a road straight to deflationary hell.

The OP was just wrong, and I was correcting him/her. Fractional reserve banking means that, quite literally, banks *create* new money, and that money enters the money supply, increasing the total amount of money in the system. This is true. And it's all I'm saying.

Incidentally, FRB generally results in inflation because, of course, the money supply is constantly growing. But low levels of inflation is a good thing, not a bad one, so I don't consider that a criticism of the system.

Re:You are an idiot!

[CTachyon]

Dude, fractional reserve banking is the biggest plutocrat conspiracy ever built. The people who are against it are no right-wingers (although some are stupid enough to think they are).

Fractional reserve banking is the cause of inflation. Why? Because IOUs issued by banks are indistinguishable from actual money (by law, thanks to Federal Reserve Notes and legal tender laws). Because IOUs issued by banks get treated as real money, they get deposited in other banks. Then the secondary banks themselves treat the IOUs as real money, and loan out yet more IOUs. If reserve ratios fell to 0%, the result would be infinite money creation. Since reserve ratios are fixed at 10% by law, the result is 10-fold money creation, with a 10-fold multiplier on every action taken by the Federal Reserve.

Why is inflation a plutocrat conspiracy? Because the people who first touch the newly created IOU money are the ones who benefit most from it: prices haven't risen yet, even though new money has been created, so if you touch the loans first you can stock up on unnaturally cheap goods, depriving other people of what they need. Who gets the most loans? Big businesses. Any given big business will take out millions of dollars per year in loans. Who gets the fewest loans? The poor. They get loans anywhere from once every 10 years to never, and in amounts that never break the $1 million mark. So the poor get higher prices sooner than they get higher income, while the rich get higher income before they get higher prices. The net result is a transfer of wealth from the poor to the rich. Inflation is the very reason why the gap between poor and rich has grown so dramatically over the last 50 years.

No true liberal would ever support the current system, if they knew the terrible truth that it was enacted by big business interests and the proto-fascists of the 1910s (including people who went on to praise Mussolini and Hitler in the early 1930s).

Re:You are an idiot!

[Abcd1234]

No true liberal would ever support the current system

Actually, I'm very much a liberal, and I support the current system because I realize that inflation is *much* better than the alternative, that being deflation.

But, of course, my belief is based on actually understanding the affects of both. How 'bout you?

Mod Parent Up

[Knara]

This is a very accurate recounting of what happened.

computers!? try trillions of dollars of war debt

[johnrpenner]

just like new Orleans - the public reserve was squandered on trillions of dollars of a war started 'to rid saddam of weapons of mass destruction he was immenently going to use on us' - when we needed the balance of trillions of dollars of taxes to keep things humming (after living decadently on mass credit) - those trillions and soldiers couldn't help us or new Orleans because some darn numbskul squandered it all on his religious war barkin saddam possums up an Iraqi tree - when the American economy tanked due to this - the robots in the other countries - since our fates are all interconnected - dutifuly tanked along,and made the crisis a global one.

2cents from Toronto

Re:The scariest thing about high finance these day

[TheKidWho]

I heard people used to design bridges using just calculators. Scary thought isn't it?

Simply Product Differentiation

[plehmuffin]

I see absolutely no reason why a single account could not offer all those features. The only reason you "need" all that is because the banks created all these funny rules so that they could introduce more and more products and services.

While some of these product distinctions are due to things like differing tax treatments for different types of investments, most of these things basically boil down to banks attempting to differentiate their products and because different models give different values to certain types of investments.

For instance, there is no inherent theoretical reason, according to the conventional risk-return gaussian models, why bonds should be treated differently from stocks with a suitably adjusted risk premium in the expected returns. But in actual fact, these things are very different: Bonds have a guaranteed return, and stocks could lose significant quantities of their value in a severe market downturn.

For that thing, it's actually a good reason we have all these different types of investment products, because they do have different risk profiles, and to maximally reduce your specific risks you'll want to load up on some and avoid others. It's when someone starts telling you that 'this high-yield investment is just as safe as a government bond' that you should get suspicious.

In Flint, Michigan

[symbolset]

In Flint, Michigan supply is definitely in excess of demand. In real estate, prices do not always go up. It's reasonable to expect that this duplex was once worth more than the current $4500 price it's offered at. It's a shame I don't have enough cash to invest in Michigan real estate. It seems certain they'll find a use for the state someday. By that, don't take it that I would live there. I wouldn't, even if homes were free.

It's sad that people in Michigan are still renting. A 30 year mortgage on $5k is $28.00,/mo if you can find a lender that will mortgage that little. Renting in that situation is just dumb - a week's work at minimum wage is enough to pay your mortgage for more than a year.

Foreign folks pay much more than $5k just to come here. To come here, have a home and a spare they can rent out for more than their mortgage costs is a gift. We're due for a huge influx of immigrants.

Some of the people who come to the US don't do it for the opportunity - they do it because the situation in their home country is really really bad. I feel for them. Some of them are my friends. I wouldn't wish on them the economic conditions of Flint, MI, but in reality it's better than not coming here at all.

When we talk about how bad things are here, we need to keep an eye to the context of how the rest of the world is doing.