Capitol Hill Blue Forums Political Issues Finance, the economy & Economics How will the financial crisis develop?

kap and RT:

Let's turn the cause - effect question around.

If the Credit Default Swaps are not at the heart of the problem, and if they are indeed legitimate financial instruments, based on some reasonable justification, then why prithee, have they not been unwound according to the contractual agreements.

I believe that the uncontrolled risk management formulas served the greed for marginal profits well, and that the lack of any regulation or an honest rating system provided the opacity that compounded the eventual total... even as much as the way Madoff handled the pyramid/Ponzi scandal.

Warren Buffet learned (then forgot) the lesson early on, much to his dismay.

Nowhere except in the CDO's and later the CDS's (and other Acronymic instruments) was there a way to slice and dice the underlying values, and to extend the call dates.

I would suggest that rather than government "meddling" being the cause, that it was the total lack of regulation. The markets buried themselves, though the perps walked and left the people with the bill.

The question then... Why can't the derivative market be unwound?

You're putting words in my mouth. Read again what is being said. It's not that derivatives have not made this recession worse... they have made it worse. But they were not the cause of the recession. The relatively cheap credit was the the culprit and the derivatives have made a recession that could have passed in 6 months in 2005 to possibly a recession that could last years starting in 2008.

Dunno... maybe, but getting to the heart of "cheap credit"; had the banks maintained the collateral, as was intended with Glass Steagall, there would have been less liquidity... less to loan.

The Credit default Swaps were the last step in the Ponzi scheme.

If the repeal of GS is the meddling, then I'll agree, but the problem grew out of the change in banking rules in 1999. I think the FED's part in the interest rates was a result of trying to fix what the bankers and brokers had abused.

.................

False dilemma. The question of legitimacy has nothing to do with with what caused the crisis. If one defines derivatives as being a wise and long-term viable activity, then I'd agree they're not legitimate. They still didn't cause the subprime credit meltdown.

The government has no business setting interest rates. Just as when the government tries to control prices, such action invariably leads to market distortions and loss of efficiency. In the case where interest rates are artificially held low - rather than rising in step with risk as they should - a bubble is invariably created. Investments begin to be judged not on their own merits, but on the irrational exuberance that the long, unbroken stream of past profits has granted.

People keep investing and investing, risk keeps growing and growing, and no one is properly worried about what happens when the music stops -- and why should they be, when the government (through Fannie Mac) is picking up most of the risk?

We knew for years the subprime mortgage market was a time bomb, and that housing was a bubble. Home prices doubling every few years in some areas? Million-dollar McMansions on every street corner? Thousands of fly-by-night banks popping up, then instantly selling all their paper, leaving the taxpayer to foot the bill? EVERYONE knew this was coming. But thanks to the Fed and Congress, no one took action.

In any free market, the interest rate on all those houses would have started to go up years earlier. The bubble never would have formed at all. The market would have cooled off, then continued to grow when sanity returned.

RT:
We're coming at the problem from the same direction. A failure of Government. Yes. I can go that far.

I have a problem with the term "Free Market", because the term has been twisted in many prior discussions,(pre RT) to mean that markets should indeed be free... free of regulation. I can't buy that.

Maybe when you get a chance, you could address the level of "freedom", and we could get on the same page.

a true free market relies on self-regulation and a common sense approach to adjusting for mishaps. yet it cannot protect against simple greed. as It has stated, regulations are required to protect to protect not only the consumer, but the system itself.

In this particular case, the problem would be solved by allowing interest rates to float naturally, just as prices do. Remove this ability from the Fed, and allow banks and financial institutions to judge their own risk. When they're risking their own money, they'll do a much better job than the government will.

This would, of course, also require pretty much dismantling Fannie Mac and the FHLBs...but that would be a good thing as well.

Sometimes it helps to realize how we got to where we are in order to figure out where we are apt to go. I know it is all the rage to do the party partisan thingie and blame it on "the other party" in the hope of scoring voter points, or to pretend that a free market was in operation and somehow "ran amok", but both are borne of willful ignorance or intentional attempts to deceive the populus -- again for political gain.

It is not difficult to see what steps were taken to transfer power from the people to the government (that is to say those who control government and those who government serves) and how that resulted in the culmination of the current economic situation.

In 1913 the government passed income tax legislation that put its hand into the pocket of almost every worker in America. Government now had access to a reliable source of funds that could not be easily denied to it by the populus.

Also in 1913 the government created the Federal Reserve and a fractional banking system. It now had the power to create money without relying on an increase in worker's taxes. It now had a magical money machine.

In 1933 President Roosevelt and the hagfish of the New Deal made it illegal for Americans to own over 100 dollars in gold coin or bullion, confiscating any amount over that limit. This of course, completely stripped the people of the power to control government-created paper by demanding redemption of the paper currency in gold. The great slide toward today had begun in ernest.

The culminating achievment in this monumental transfer of power from the people to a centralized and colossal federal government happened in 1971 when the government went off of the gold standard that was still in place relative to foreign governments. The transition to a completely fiat, credit-based money was completed.

The ability to access funds in conjunction with Keynesian economic policy (vs actual economics) meant that throughout much of the 20th century the people were subjected to a hidden tax in the form of inflation, increased government distortion of various markets (especially housing and other forms of real estate) through subsidies, selectively directed tax advantages, and industry-specific favorable regulations. The resultant distortions that resulted were then countered by the government through the implimentation of Keynesian theory, preventing market forces from quickly correcting for years of government created imbalances.

A really, really bad thing about government pumping money into the system to counteract these periodic corrections is that the corrections were never allowed to complete their work, meaning that each attempted market correction simply accumulated, thus ensuring that one big recession would be eventually followed by an even bigger recession resulting in even bigger countermeasures taken by the government. The formula with a fiat money system is simple -- flood the market with money, the few who can afford to get in at the front end and make a killing prior to the onset of the next round of inflation which is absorbed by the majority on the back end of the ride.

The latest cumulative mess has as its source a government that pumped out massive amounts of fiat money, artificially reduced interest rates, and made huge somes of money easily available. Add to this the "too big to fail" collectivist crap that was a tacit acknowledgement to those so designated as such, that they could get away with stupidities and risks that they would never have attempted under a system in which market forces were allowed to operate without hinderance, and you have the inevitable bubble-based market we have enjoyed repeatedly over the decades. People will follow their human nature -- especially when induced to do so by government action.

Believe it or not, things really are that simple.It only gets complicated when folks try to rationalize their positions or actions or when they inject political bllhst.;-)
Yours,
Issodhos

I suggest that all who have come to be addicted to this thread, might enjoy this perspective... Whether you agree or not. The Bernie Madoff Solution

The article covers a lot of what's going on today, and ends with this:


Read the article for the background.

ISS...
now you've done it... I'm into the Fed, and after reading the entire Government document... I agree with you, and RT.. That this is a giant game that is unnecessary and counter to the interests of the country and, indeed, the world.

To say that the Federal Reserve System down't work isn't really true. As you say, it works for those who get in on the beginning of whatever the latest crisis is... whether the S&L, or any of the other bubbles. It's always the banks and brokers and the rich that get bailed out, leaving the people to pick up the debt.

So now, we're into the next... and the very biggest bubble of them all. I Trillion already gone, and the second trillion to follow. And NOW... according to some scuttlebutt on the "street", the actual cost to make the system whole, may total 5 Trillion. (MSNBC panel discussion).

The whole problem that we're facing now boils down to the problem with collateralizing debt, and as I believe, having the debt lose it's identity. This happened when CDO's were treated as cash... (my analogy)... When the CDO's were split, and lost their identity.. AND, when the traders accepted a risk rating as collateral... then, the game was over. Add to that, the problem created when traders tried to insure their bets with "insurance" Credit derivatives... then compounded the nonsense by re-insuring the risks by swapping the insurance...

THEN you have the impossible mess we're into today.

We're worried about 50 billion and Mr. Madoff...

How about a possible 5 Trillion and the heads of our government, 535 Gongressmen, and who knows how many thousand lobbyists, and banks and corporations and rich people who have kited their fortunes on the backs of Americans.

And so... you are right:


Now to the next question. With the new government poised to spend the next Trillion... how long do you think it will take the people to catch on?