The economy

[Ddrak]

Ok, it's news. The Fed seems to have done a knee-jerk to stop the market tanking, but isn't that going to push the already high inflation even higher? In essence, aren't they trading a small dive now for a full out crash sometime later?

Seems the US dollar is still in free-fall. Great for US manufacturers, but with a strongly import-based economy it's also going to drive inflation and cost of living way up. Doesn't smell good for the future.

The subprime thing still hasn't finished from what I can see - now it seems the ripple effects are hitting some of the more solid housing markets. Again, not particularly pretty.

So what's the way out? I strongly doubt anything Congress can do is going to have a lasting effect - kinda like a band-aid on a bleeding artery but they have to be seen to be doing something I guess (yay politics). I think the Bernanke overreacted and Greenspan would have just told people to suck it up.

Thoughts?

Dd

[Partha]

The rate cut is the height of stupidity - the problem is that the banks don't know how much money they've lost on these bad investments and the loans that won't get paid on time if at all. The Fed then decides to cut the loan rate? Banks won't be loaning money at this point until they figure out what they've lost, which might take months or a year.

Subprimes? 2 million more homes reset in 2008. That's not going to help a weak housing market anyways.

This is going to be a depression, sure as you're born. Americans have to relearn the values they picked up after the Great Crash, and the government is (once again) going to have to get much more involved in regulating the banks to stop nonsense like this, rather than just being a cushion for their unsafe practices. I expect us to start climbing out of it sometime in 2010.

EDIT: Want to add a comment from a financial blog I look at. I think it hits most of the high notes.

I completely agree Americans have been living beyond their means. Yet their standard of living today is lower than 30 years ago, and they require 2 incomes per houshold instead of 1 and still must borrow to survive. Why is that?

Usurious interest rates, various taxes on the middle class that eat up to 45% of income, collusive pricing practices in banking, energy, health, insurance, education and food. Oh, and off shoring the good paying manufacturing jobs and replacing them with jobs that involve serving fries and cleaning bed pans.

And not only was credit cheap, it was given to those who did not have the ability to pay, including illegal immigrants. This is called profiting by foreclosure. Legalized theft, which is what our regulatory environment is all about.

In some states, like NY, there is still on the books a law of fraudulent conveyance. Any loan made to someone without verifying they have the ability to pay it back, or establishing conditions which make the pay back impossible, can be declared null and void. The same tactics were used to cheat farmers out of their homes and property 80+ years ago, and so the law. It should be applied today with sub-primes and credit card debt.

And the solution to the current crisis is making credit cheap for the consumer?

Ask yourself who benefits from the incremental interest rate reductions over time. Those investing in bonds, which are mainly the banks, whose value increases as interest rates drop, giving them a way to shore up their capital as the Fed monetizes their bad loans. It has nothing to do with the consumer.

Even the so called bail out to taxpayers is nothing but a way to inject capital into the banks from the bottom up. The consumer is just a cash cow, no bail outs for them, when they can not pay their debt, their assets are seized (most can not even declare bankruptcy as corporations can due to the infamous 2005 bill to protect credit card companies).

The Fed is owned by the banks, and our government has been bought, and they act in the banks interests, not the consumer.

[Finglefinn]

I agree that this rate cut was amateurish at best and an all out panic at worst. But, most of the stuff both you and the author of that blog said there about banks is way off. It's quite a clandestine and pessimistic view of the banking industry. You two are obviously not a member of that industry nor do you understand it's intricacies.

Banks won't be loaning money at this point until they figure out what they've lost, which might take months or a year.

Dead wrong. Banks loan money every day no matter the state of the economy or their income statement. Most banks, even the biggest national and international ones, already know almost exactly what they will be earning for Q4 2007. I read their statements every day.

And not only was credit cheap, it was given to those who did not have the ability to pay, including illegal immigrants. This is called profiting by foreclosure. Legalized theft, which is what our regulatory environment is all about.

Our regulatory environment is all about legalized theft? Seriously, have you met a bank examiner? I laugh in your general direction.

Ask yourself who benefits from the incremental interest rate reductions over time. Those investing in bonds, which are mainly the banks, whose value increases as interest rates drop, giving them a way to shore up their capital as the Fed monetizes their bad loans. It has nothing to do with the consumer.

Rate reductions hurt banks. It squeezes their net interest margin. Most banks have a stable cost of funds. A reduction of the floating lending rate decreases the margin between the lending rate and the cost of funds. In the short term, a rate reduction on the consumer side will allow some people to better able to make their revolving debt payments. Coupled with the tightening of credit standards, for now, the reduction may lead to better repayments for the remainder of the year.

Treasury Bonds are typically not purchased by banks. They are purchased by domestic and foreign corporations, mutual funds and foreign governmental entities. Actually, that can be said for just about all types of bonds, except federal savings bonds, (a totally different type of monitary instrument than the bonds the author is referring to) which are usually purchased by domestic citizens.

The Fed is owned by the banks, and our government has been bought, and they act in the banks interests, not the consumer.

This one is a doozy. WTF? I mean seriously, does this guy even have a bank account? Since when did the government pass control of the Federal Reserve to the "banks?" Last time I checked, the Fed is the government. The Fed reacts to changes in the market and assists the banking industry in regulating and managing risk. The Fed does not hand out money. They do not have some kind of Fort Knox that banks have their hands into.

Also, when was the last time there was a serious, large scale threat to the FDIC and the insurance fund? Oh yeah, never. Does this guy realize how many banks the FDIC shuts down every year due to mismangement? It is actually a pretty surprising number. I believe the average is about 10 per quarter. There are already five governing bodies that regulate banks. They are the Federal Reserve, Federal Deposit Insurance Corporation, the Office of the Comptroller of Currency, the Office of Thrift Supervision and each and every State in the Union. We don't need another regulatory agency as a knee jerk response to the current situation.

[Finglefinn]

In response to your post Dd, I think the panic will be short lived. The Fed Board actually conviened a week before they were supposed to by phone, instead of in person, which speaks to it's panicy nature.

There are a ton of good things happening in the economy and a lot of bad things. Unemployment is still very low and lots of community banks that you the public never hear about, are doing very well. I also don't believe that inflation is increasing out of control.

I think because of the correction to the housing market, which I believe will last into next year, the overall inflation rate for 2008 will be less than 2%. The subprime industry has already been cleaned out except for the loans on the books that are going bad or have gone bad. That will take the next 12 months to stabilize. Owning a home will become the Great American Dream again, rather than the Great American Entitlement. Is there a government, I mean, taxpayer-funded bailout coming? Probably, but I don't think it will have a wide-spread effect on the stability of the economy.

Most banks are big enough and diverse enough to ride this out. There have already been some big casualties (Countrywide) and there are sure to be several more. The industry's merger frenzy will continue and things will settle out by the middle of next year, if not sooner.

Remember, this is a presidential election year, so there are more crazy things in the economy and more interesting reactions from everyone involved yet to come.

[Embar Angylwrath]

Fingle pretty much said what I was going to say about the realtionship between the banks and the Fed. He also gave a great primer on the margin spread between a bank's cost of funds and a bank's profit margin. When Fingle said banks have a stable cost of funds, what he was trying to say is that a banks' operating costs are relatively fixed. The rent on the building doesn't float with the interest rate, the employee wages don't float with the interest rate, etc. So when the interest rate drops, the less real dollars are realized on loans.

Partha (again) shows he's just so out of touch with reality. Waving the "depression" flag is a bit premature, and not really supported by the current economic trends. Recession? Yes, a good possibility. Which is why the Fed injected cash into the economy (the real result of lowering interest rates). I think they're hoping that a sudden infusion of funds (by sudden, I mean a 6 month to 1 year timeline), will prevent a recession. (IMHO, I think they are trying to soften the one they know is coming).

And as to the true effect of the rate reduction? I really don't think its going to help (or hurt) the economic status in a significant way until the housing market stabilizes.

And about the housing market.... most of those sub-prime loans were given to two types of borrowers 1) People who couldn't afford the house, and 2) speculators. As such, those loans tend to over-price the market by decreasing supply. What we're about to see is a correction to what the market should be. And the result? The people who never would have qualified for a house are back to renting, which is where they would have been had they not taken the loans, and the speculative market will adjust as some are washed out, go bankrupt, and are effectively prevented from tinkering with the market for 7-10 years. As prices come down, OTHER renters that didn't take risky loans will benefit as they see home prices drop, and become more affordable. They will be the beneficiaries of the correction.

Oh, and the rest of us that used our homes as ATMs, well, you can't blame the government for that, can you?

[Finglefinn]

But, those people who used their homes as an ATM via a floating rate 2nd or 3rd mortgage just saw their interest rate drop 3/4 of a percent! Your interest-only payment just went down! Maybe now they can pay their credit card bill on time!

[Klast Brell]

Is it just me or is there a feedback loop here. People can't pay their loans. Wall street over invested in sub prime proceeds to take a dump. Companies raise prices and lay off staff to bolster their stock price. Rising prices and unemployment makes it harder for people to pay their loans. Wallstreet takes another dump...

[Embar Angylwrath]

Is it just me or is there a feedback loop here. People can't pay their loans. Wall street over invested in sub prime proceeds to take a dump. Companies raise prices and lay off staff to bolster their stock price. Rising prices and unemployment makes it harder for people to pay their loans. Wallstreet takes another dump...

Its just you. You forget there are other securites besides bundled mortgages.

[Partha]

Dead wrong. Banks loan money every day no matter the state of the economy or their income statement. Most banks, even the biggest national and international ones, already know almost exactly what they will be earning for Q4 2007. I read their statements every day.

http://online.wsj.com/article/SB1200990 ... whats_news

The glum news from U.S. banks continued with steep declines in fourth-quarter profit at five large lenders, led by Bank of America Corp. and Wachovia Corp., while mortgage-related woes plunged regional bank National City Corp. to a steep loss.

The results capped a miserable earnings season for the banking industry, which was riding high until the mortgage meltdown triggered huge write-downs on investments, forced banks to begin hastily rebuilding loan-loss reserves, and exposed how far many lenders strayed from their roots during the housing boom. "It is back to basics," Bank of America Chief Financial Officer Joe Price told analysts in a conference call yesterday.

While all six banks said the performance of many businesses remains at least decent overall despite the weakening economy, deteriorating credit quality is causing loan-loss reserves to balloon in anticipation of further trouble. The six banks reported a combined loan-loss provision of $6.22 billion in the fourth quarter, up 181% from $2.21 billion a year earlier.

The banks have already written down 100 billion dollars - with more to come. And yet, you're seriously suggesting that when banks are in an obvious retrenching mode that they're going to expand the number and amount of loans? I've heard better stories, but they cost $8.99 at Barnes and Noble.

[Ddrak]

I think the Fed definitely panicked - they really wanted to keep rates the same or raise them to shore up the dollar but they were caught by the bottom about to fall out from MBIA and Ambac if they didn't do something to lower the cost of money for them. I don't think we've seen the end of those two's woes yet though, more like they've been given a temporary reprieve. Essentially they're the next in the line of the subprime fiasco.

The subprime blowout seems to just keep toppling things over like dominoes. I think the actual real estate end of it is pretty much exposed, but the number of banks that have left themselves exposed by bad loans either directly or indirectly is still a cause for concern - especially for the underwriting insurers of those loans. Similarly, the housing market itself is going to have a few more shakeups as people with loans they could afford suddenly find themselves paying off a mortgage that is twice the new value of their house - something which really makes you sit down and think about eating the foreclosure and walking away.

Inflation is starting to look like a real kicker unless the US can get the dollar under control. Cutting rates drives the dollar down, which raises oil prices and results in the whole inflationary spiral thing. All it needs to really kill things is some good old fashioned spats in the Middle East to flare up a bit (like picking fights with Iran). I could easily see the US Dollar falling to 0.5 Euro (and the Aussie dollar doing the same for anyone that cared) before things really bottom out. That would probably drive oil to around the $140-$150/barrel mark which isn't a great place for it to be for the US at least.

Overall, the market has been basically flat since 2000 and there's a hell of a lot of nervousness out there. I think a recession is pretty much inevitable (talking of a depression is a bit extreme), and it will be interesting to see how things float through it. I would honestly not be surprised to see a lot of the markets start moving to the Euro as a measure instead of USD, which would have a significant hit to the US economy as a whole just from an investor confidence point of view.

Klast's spiral is essentially an inflationary cycle, so he's right in the broad terms. It's not self-sustaining though, the dumps get smaller and the whole thing rides out because, as Embar said, there's other securities which act as ballast.

Dd

[Finglefinn]

The banks have already written down 100 billion dollars - with more to come. And yet, you're seriously suggesting that when banks are in an obvious retrenching mode that they're going to expand the number and amount of loans? I've heard better stories, but they cost $8.99 at Barnes and Noble.

Your quotes are things I read every day. You clearly do not understand the leap you are making with the above statement. Banks are always trying to expand their lending portfolios because those activities generate the most income, no matter the disposition of the economy. And trust me when I say this, residential mortgages make up only about 25% of an average bank's lending portfolio. There is a lot of other kinds of lending banks do that do not revolve around consumer lending and generate really good income.

"It is back to basics," Bank of America Chief Financial Officer Joe Price told analysts in a conference call yesterday.

"Back to basics" means a number of things, but essentially, it means they are going to tighten their credit standards and do more core banking business. I'll explain:

1. Most bank's primary goal in 2007 and for the forseeable future is to grow core deposits, meaning those organic personal and business deposit relationships of $100,000 or less. This is the #1 funding source banks have for lending activities. The second part of this item is brokered deposits, or high rate CDs and the like. You will see these 5%+ CD rates vanish. In fact, most of them are gone already. A lot of community banks are not committing to any CD's of less than 6 months right now that are over 3.5% interest rate, which just happens to be the Fed rate as of yesterday.

2. Speculative lending, especially centered in residential development activities will probaly vanish until residential inventory levels drop down to 3-6 months supply. If you are a residential developer, you will probably have a very hard time getting an acquisition and development loan in 2008, even if you are a good borrower.

3. Commercial lending centered in industial and non-real estate activities will flourish in 2008 and also become highly competitive. If you are a successful small business owner, expect to be visited by your local community bankers fairly often this year. If you have plans on expanding your production this year, expect banks to be very accomodative on rate, fee and loan structure.

4. Overall, credit standards are going to tighten. A marginal business that could have borrowed money last year will probably not get a loan this year. There will be very little start-up funds available outside the ususal and customary SBA lending outlets. There is money out there for new businesses, but the backup plans (i.e. guarantors) are going to have to be very strong.

I do this kind of stuff every day and we have spent the better part of the last two months discussing these types of strategies for 2008. Every bank is in the same boat, from the smallest $50M community bank to the largest national $500B banks, trust me.

[Embar Angylwrath]

I think the thing Partha doesn't understand is the losses the huge banks are taking, are a result of them paying too much for bundled mortgages on the open market. Most mortgages are bundled (diversifying the risk of defaults) and the resold as a package. The big banks are taking it in the pants not so much because they made tons and tons of shitty loans themselves, but because they BOUGHT tons and tons of shitty loans on the open market. Sure, they made some of the loans themselves, but they bought an enormous amount loans made by other, smaller banks and finance institutions.

As a side note, you can see how compliacted this is, as some homeowners have recently won court cases against banks that try to foreclose on them. They successfully challenged the bank's rights to the property, because the banks couldn't prove ownership of the property, due in large part because the mortgages have been sold-bought-sold-bought so many times, no one has clear title to the property.

http://www.nytimes.com/2007/11/15/busin ... nted=print

[superwalrus]

I think there needs to be tighter regulations on lending, lending practices, etc.

Don't allow people to borrow so much.

Don't let people borrow from one person to pay off a different lender.

Assess huge fines and penalties against lenders that target suspect groups for credit cards / loans.

We live in a world today where people just overextend themselves. Yes, it is their fault for doing it, but its also the fault of the lenders who know better to begin with.

Walrus

[Kulaf]

I love that line from the blog that Partha posted insiuating that it now takes two incomes to do what used to be done with one. It's an old tired line that fails to recognize one thing......our workforce doubled. Yes that's right.....all of those women that entered the workforce in effect diluted salaries. So where one bread winner made enough to feed a family.....with more competition for jobs and a higher supply of workers......salaries dropped or stagnated.

[Finglefinn]

If you think US banks have it bad, check out this story about France's 2nd largest bank:

Rogue Trader's Fraud Led To $7.1 Billion Loss: Societe Generale

[Ddrak]

And now the Fed knocks another 50 points off...

Dd

[Finglefinn]

Yeah, Prime is at 6%. If you have good credit, some cash lying around but you want to borrow some real money to expand your small business, now is the time to do it.

[Embar Angylwrath]

I heard that SBA loans were tightened up and harder to get too. Is that true from your experience Fingle?

[Ddrak]

Yeah - it's a great time to borrow if you have solid credit. The real problem is inflation is definitely going to jump up now - I'd guess it hits 6% by mid year.

Dd

[Ddrak]

And I just wanted to add that despite being taxed just the same as everyone else in the country, the House and Senate bills specifically exclude me from any refund, so I hope you all choke on yours.

Dd