The Understated Effects of "Cash For Clunkers" and Other Government Idiocy

Funny you should bring that up, since those banks that took advantage of the lessened restrictions turned out to be in stronger position as the crisis deepened.

You know with all this insanity going on I hear people saying-"Those who don't learn from history are doomed to repeat it." Well it's more like -"The one thing history teaches us, is that we don't learn from history." The current state of financial affairs is proof of the latter statement.

They were all bankrupt. The $150 billion bailout of AIG was funneled to the big banks who were counter-parties to the AIG risks. Had not the Federal Reserve saved Goldman and friends, the system would have shut down and the whole derivatives market would have collapsed, leading to a completely bankrupt banking system - which it was. This the most disgusting part of the whole thing. The bankers that engineered the whole collapse had to be saved to save the banking system, and in the process those at the top gave themselves super bonuses to boot. And then guys like you cry for more, as millions of people who suffered are just trying to dig themselves out of the mess.

The only way to prevent this from happening again is to make sure the banks do not piss away our savings by speculating on stuff that has no economic value and giving the top tier bonuses in the process. It was simple highway robbery - by the free market capitalists. They are laughing all the way to their Swiss bank accounts, which they are now desperately trying to seal shut.

Rich

Well no, data has shown that unified banking institutions were much stronger and offered less risky securities than those who avoided such a path. That is why JPMorgan Chase and BoA were much stronger than the other major banks.

That is why JPMorgan Chase and BoA were much stronger than the other major banks.

BoA and JPMorgan Chase got the 2nd and 4th largest bailouts in the TARP program, respectively.

Take a look at how they compare even to Goldman Sachs.

Troubled Asset Relief Program - Wikipedia, the free encyclopedia

And, Mr. FtP, I have yet to see you comment on how you can possibly think that the problem with credit default swaps was too much regulation rather than too little. Do you understand what they are??

It is a hedge, an insurance policy, and I know they play an important role in risk management, fluidity, and the accurate pricing of securities. They lessen the risk of purchasing bonds of financial institutions, making it easier for these firms to raise capital and improve their financial situation.

More to the point, however, is the question: Since when do we start by assuming regulation and try to prove that it is not necessary?

Insuring a home or a life where there is a desire to keep the life and home from destruction, is completely different than insuring junk bonds that the owners want to destroy, in order to collect the insurance. This is exactly what happened! There was no regulation on the insurance (as there is in all legitimate insurance industries), and you basically had the mafia taking out insurance on someone that was targeted for a hit. Regulation in insurance has always been considered essential. There was none under the Bush administration.

Rich

So you are saying that junk bond holders insured these bonds for more than the value of the bonds plus payments? Sounds like a silly idea, but I will be willing to read an article.

It is a hedge, an insurance policy, and I know they play an important role in risk management, fluidity, and the accurate pricing of securities. They lessen the risk of purchasing bonds of financial institutions

More to the point, however, is the question: Since when do we start by assuming regulation and try to prove that it is not necessary?

Nice try, but you're just a tad wrong here, just a little teeny tiny item about how they were actually used and about their risk.

You have described how CDS originally started. That's not even remotely what they turned into. They ended up turning into extraordinarily high risk wagers on the life and death of companies. The rate of return was incredibly high when companies were doing well. But investment banks, AIG, hedge funds, etc bought them up by the bushel -- and as soon as companies began to fail en masse (as a result of the subprime crisis), the investors had not even remotely enough capital to pay out. Worse yet, companies were buying CDS using high leveraging!

What we know is that the CDS market collapsed and brought down the entire international investment structure with it.

We also know that there is no open exchange, like a stock market or commodities market, in which CDS are traded.

We also know that there was no way of placing value on a CDS.

We also know that there was no requirement for transparency, so it was never known who owned what.

We also know that there was no stipulation about how much capital a CDS investor needed to have (unlike virtually all legitimate insurance plans).

At what point during this explanation were issues with CDS a cause of the crisis and not a symptom of a over-leveraged extremely weak economy finally rectifying itself?

At what point during this explanation were issues with CDS a cause of the crisis and not a symptom of a over-leveraged extremely weak economy finally rectifying itself?

There can be no doubt that government activity is the prime player of the subprime crisis

...and that the economic downturn as a whole was basically the result of lending and consumption far outweighing production and causing prices to be far out of equilibrium.

It seems to me that, when an economy is blown up into such a pricing bubble, a boom in CDS and other securities that are based in mispricing would be inevitable. Furthermore, anytime there is such a boom, a good number of defaults can be expected.

I would like to see one shred of evidence that an alternate, more regulated derivative of risk and pricing gaps would have faired any better.

Perhaps you simply want to make sure that people cannot profit from overpriced assets?

Do you really think we need to have government come in and tell people that they can't buy insurance from entities that can't pay insurance?

You are not under law allowed to sell insurance without guaranteeing capital reserves to pay claims. You've got a problem with this??

Right: because insuring that GM does not go under does nothing for the employees of GM who are anything but wealthy and powerful. Doesn't help them at all :rolleyes:

I don't think the employees would agree with you. They would say, I think, that they need their jobs, and their health benefits, and their pensions, even if you don't think they do. How would you answer?

2) If the economy was "extremely weak", it was not recognized at all until it collapsed. People talked euphemistically of "bubbles" without truly understanding how they could topple the whole thing. College education has its own price bubble. Credit cards have a price bubble. Health care has a price bubble. It happened to be the real estate bubble that catalyzed this whole thing.[.QUOTE]

Actually I can point out several free market economists and financial advisors who did predict that the economy was in for a huge downturn years ago.

More to the point, how does this point help the argument that regulators would be the answer? If no one was able to recognize the problem or understand the interconnectedness of the whole thing, what could have regulation or regulators done to stop it?

It is quite obvious that what institutions were in place with authority over market functions, Fannie and Freddie, the Fed, the SEC, just about any government entity did their fair share of making matters worse.

What would change about that?

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3) Leveraging is indeed a major problem, but investors wouldn't have leveraged themselves so much unless they had confidence that they were making good bets. In other words, they had no idea how much risk they were exposing themselves to.

I think the idea of the government as overseer and guarantor had a lot to do with poor risk assessment too. We are on our way towards ensuring that the global economy still discounts risk at a ridiculous rate.

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4) It is ludicrous to blame the leveraging solely on the low federal funds rate, because treasury bonds have always been much less lucrative than high yield derivatives. An 8% return on a mortgage-backed security is a lot better than a 1.5% or 2% return on a treasury bond, so the fact that treasury bonds are below 1% now can't really be seen as the problem.

The Fed Funds rate is the basic determiner of the speed of money in the US economy. Every percentage of movement in the Fed Funds rate is magnified in higher yield securities and derivatives because liquidity is assumed. An abnormally low Fed Funds rate fuels overconsumption and over-investment, leading eventually to overproduction and then a general glut like we are seeing now.

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That is true, but again, the problem was that no one had a way of preventing or even monitoring this dysequilibrium!

And how does additional regulation fix this?

This is the point, market forces maintain disequilibrium only when external (ie government) forces cause it to. The more intrusion there is, the more disequilibrium there is, and because we cannot manage to estimate disequilibriums we do not know they exist until it is too late.

Those who predicted this disaster predicted based on general principles that were being violated, not on studying specific economic data and predicting some threshhold.

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The problem is that you have many many many individual actors who add up to an enormous interrelated system; and the actors who are making decisions in what they perceive as their own best interest are not acting in the system's best interest.

What is an economic system's best interest?

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You are not under law allowed to sell insurance without guaranteeing capital reserves to pay claims. You've got a problem with this??

I think if someone would like to purchase insurance from someone they should be allowed to do so. I fail to see why government should step in to tell someone they are taking too much of a risk. I would expect the courts to step in and enforce a contract, but if default occurs, it occurs.

Where do we draw a line between what risks someone can take with their own finances and what risks someone can't take?

---------- Post added 08-20-2009 at 02:42 PM ----------

richrf;84509 wrote:

Hi Paul,

I agree with all of what you said.

In addition, you cannot take out any insurance on anything, unless you have an economic interest in what is being insured. I, for example, cannot take out an insurance policy on anyone outside of my immediate family - for obvious reasons. Similarly, I cannot take out insurance on another person's home, because I have no economic interest. What if someone started to take out insurance on homes in some run down area hoping that they would be burned down?

Well, this is exactly what happened with CDS. What's more the companies were being burned down by owners of the CDS policies, by utilizing naked shorts - that is short sales of stocks that did not exist. A totally illegal practice that was permitted by the SEC under the Bush administration.

The way the CDS were being written was a recipe for disaster. There was no economic interest. There were no reserves. There was no experience history (unlike all other kinds of insurance). It was a pure gamble - and they were gambling with people's savings! This is the key point. They were gambling with our money and they lost it.

No one in the Fed thought of these systems of gambling. It came out of Goldman Sachs and AIG. The Feds should have stepped in and stopped it because it was multi-trillion dollar gambling with saver's money. They didn't! They let it all happen with totally predictable results.

Rich

Aedes, I thought your savings were unaffected.

Ultimately that is what speculation is: informed gambling. You should, however, look up the law of large numbers and then apply that to the pricing mechanism of securities.