What's Going on in Washington?
13/01/2009 04:25 PM
The US economy is having a meltdown. What happened? In the past 9 days a lifetime deregulator, John McCain has gone from the "Economy is Strong" to erratic and near panic behaviour.
The president seems clueless. He is ignored by everyone. He has had a mantra over the last few months of "The economy is strong". He has to eat those words. Instead of arguing about the economy slowing or is the US in a recession or not, President Bush says the US needs $700 Billion to shore up the financial markets.
He wants to buy up bad debt. Washington Mutual Bank collapsed yesterday.... the largest bank in the history of the US economy to go under. The CEO of that bank will receive $13,000,000 for three weeks work on the job. He's a new guy and very rich now.
What's hidden by all this is the fact that the 'sub-prime' loans have scattered themselves to Europe and Asia. Banks there have taken a piece of them. It would be silly to think that Canadian financial institutions have not had a taste of these too. The world economy is one giant jungle..
When did this all begin? Sadly, you have to go back to the Great Depression to get the answers. The world-wide loss of faith in institutional free market capitalism did not fully recover until after the war, well into the 1950s. That thermometer of Wall Street strength, the Dow Jones averages was 350 in 1929 and it did not pass that number until 1954.
The average person just did not buy stock then. If you talk to anybody who lived through that time, those in their 70's and 80's, they will tell you that their parents and everyone they knew had a fear of the market and big banks.
We all lost that fear in the age of MBAs and Financial Engineering. Greed crept in and we have begun to value things that don't have value. People in charge, brokers and wheeler-dealers don't really add value to what's going on, they learn how to subvert the system to gain advantage.
After the great depression FDR put in some strict controls over Wall Street. Some of these measures were copied world-wide. The Securities and Exchange Commission became the guard and safety valve of world finance as the money flowed in and out of the US. Those laws, rules and guidelines have eroded and have become obsolete as the financial engineers created ever more complicated packages.
While there were rules governing Mutual Funds to protect the small investor in the United States, the Big Guys created hedge funds that had 30 to 1 leverage ratios and more. That meant that they could buy a stock for $1 when the cost at the time was $30
The oddest practice is the 'hedge short', however, wherein a buyer can reap profits, if a stock and therefore a company by implication goes down. Here is an example of that
Assume that shares in XYZ Company currently sell for $10 per share. A short seller would borrow 100 shares of XYZ Company, and then immediately sell those shares for a total of $1000. If the price of XYZ shares later falls to $8 per share, the short seller would then buy 100 shares back for $800, return the shares to their original owner (paying a fee for having borrowed the shares) and make a $200 profit (minus the fee for having borrowed the shares). This practice has the potential for losses as well.
For example, if the shares of XYZ that one borrowed and sold in fact went up to $25, the short seller would have to buy back all the shares at $2500, losing $1500. Because a short is the opposite of a long (normal) transaction, everything is the mirror opposite compared to the typical trade: the profit is limited but the loss is unlimited.
Since the stock cannot be repurchased at a price lower than zero, the maximum gain is the difference between the current stock price and zero. However, because there is no ceiling on how much the stock price can go up (thereby costing short transactions money in order to buy the stocks back), an investor can theoretically lose an arbitrarily large amount of money if a stock continues to rise. Also, in actual practice, as the price of XYZ Company began to rise, the short seller would eventually receive a margin call from the brokerage, demanding that the short seller either cover his short position or provide additional cash in order to meet the margin requirement for XYZ Company stock.
The practice of huge margin buys was what made Wall Street topple in 1929. It has come back in an unregulated way by these special hedge funds and even more complicated ways that are hidden from us, which are owned by big investors and not the small guys. They require by US law that the investor have a net worth of a certain amount, say, $1,000,00. The fund is managed by a third party who gets a cut of the profits. The profits can come from betting high or low and doing well.
It's much like the spread in NFL and CFL football betting. Your favorite team does not have to win or lose, it just has to agree with the spread
It should not matter that some big wigs with too much money gain or lose money, but it does. They have become so big and so entangled with the 'normal' financial markets, that when they quiver, there is a giant earthquake in the world markets.
The current sub-prime loan mystery was caused by another form of greed. If the ordinary person can be convinced that real estate prices will always go up, even over the short haul, then much profit can be made by trading these instruments around. Unfortunately, a complex set of circumstances that involve multiple wars and energy prices have created a financial storm that may become 'perfect'
This is not just a US problem, it is a world problem as was the Great Depression. It is not just the Trillion dollars that will be expended (700,000,000, but they are guessing), it is what won't be done.
The US is wounded and infected with risky investments and debt. The big wigs are making money on the down side as they did on the up side. The tax base in the US will have to take on this burden along with the war debt which is estimated to be 3 trillion dollars echoing over the next 20 years. The 700 Billion amounts to an immediate tax of $2300 for every man, woman and child in the US.
The new president will have nobody on base in the ninth inning with two out and 2 strikes and be facing Nolan Ryan in his prime. Good luck!