Mar 8 2009

Where Taxpayer Dollars Go To Die

Kal @ 19:23

A.I.G., Where Taxpayers’ Dollars Go to Die By GRETCHEN MORGENSON Published: March 7, 2009  - A nice discussion of  why A.I.G. has been so expensive and some thoughts on just how dangerous derivatives (CDS, Credit Default Swaps) are, both to the issuer and to us as the guarantors of last resort.

“DERIVATIVES are dangerous.”

That simple sentence, written by Warren Buffett, begins an enlightening discussion in Berkshire Hathaway’s most recent annual report. Mr. Buffett’s views on derivatives, gleaned from his own unhappy encounters with them, should be required reading for all United States taxpayers.

Why? Because we own almost 80 percent of the American International Group, the giant insurer whose collapse was a direct result of derivatives it sold during the late, great credit boom.

A.I.G. nearly barreled off the cliff last September, when it couldn’t meet its obligations to customers who had bought a version of derivatives called credit default swaps. Such swaps are like insurance policies; bondholders buy them to protect themselves from default on various forms of debt.

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Category: Accounting | Conventional Economics | Economics | Politics

Mar 6 2009

Follow The Money

Kal @ 22:28

"Follow the money" was the key to unraveling the Watergate conspiracy. And it seems to be to be good advice for the banking crisis also.

By many accounts there are outstanding over 60 trillion dollars in outstanding Credit Default Swaps and other derivatives. [Update: That number is seriously short. I did a correction post Derivatives Revisited] The US Treasury and Federal Reserve keep pouring money into failing banks and AIG. Where will it stop? Do they intend to pay the full 60 531 trillion dollars?

Yesterday the Federal Reserve Official assured us that the financial system will collapse if the names of the "Counter Parties" to these quasi insurance policies are exposed. I am not so interested in the names as in the classes of counter parties. And I would like to know the total exposure from all of the various insurance companies and banks and anyone else we are bailing out.

It does not seem to much to ask, how much total will we be expected to pay? Big round numbers would do just fine.

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Category: Conventional Economics | Economics | Politics | Recession | Sustainability

Feb 28 2009

Bank Bailouts Make Things Worse

Kal @ 10:42

There is an interesting and thoughtful article at The Oil Drum titled: Through the Looking Glass: Thoughts on the Financial System, Fertilizer Prices, and Our Food System. The author calls himself "Steve from Virginia." He lays out in great detail how he thinks pumping money into the banking system is both causing and accelerating deflation.

The main idea is that deflation has the effect of increasing the principle of a loan because the loan has to be repaid with more expensive dollars. The higher the rate of deflation and the longer the time period, the lower the chances that any given loan will be repaid. Under those circumstances no rational bank can lend, because the money they lend would be less and less likely to be repaid as deflation drives the borrowers deeper and deeper into debt.

Driving this entire process is a mysterious force called 'supply and demand'. When there is a large amount of currency (supply) relative to the smaller amount of goods or services (demand), prices for the goods and services increase. While this is happening, money never reaches the masses and workers who consequently cannot afford to buy the increasingly expensive goods. The businesses are unable to SELL the increasingly expensive goods; the businesses price themselves into Chapter 11.

Businesses either refuse the liquidity and risk insolvency or make use of the liquidity which drives up prices ... and risk insolvency! This 'Heads-I-Win-Tails-You-Lose' mechanism caused many bankruptcies during the Great Depression.

The Masters of the Bad Loan Universe call this liquefaction Re-inflating the Economy. They don't realize they can only inflate PARTS of the economy--the wrong parts. Here, liquidity simply spreads deflation farther and faster. 

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Category: Conventional Economics | Economics | Employment | Guaranteed Wage

Feb 27 2009

The Cow Theory of Economics and Accounting

Kal @ 14:00

John Carney at The Business Insider Clusterstock, gets a lot of mileage out of cows. On 5 February:

AIG Implodes: The Two Cows Version

"Still confused about how AIG lost its shirt by going into the securities lending business big time? We understand. It's terribly complex and full of words that make your eyes glaze over."

So we decided to break it down into the simplest terms Wall Street transactions can be explained: the two cows story.

You have two cows.

John Paulson borrows one cow so he can sell it for $100. He gives you $10 as collateral.

You buy your neighbors cow for $100, which you finance by taking out a $90 loan from the bank and use John's $10 to make up the rest.

You brag to everyone about your financial health. You have assets--two cows you own, plus one Paulson owes you--worth $300, and liabilities of just $100.

A third of the country goes vegetarian.

You thought your two cows were worth $200 and now they are worth $140.

You express confidence in your financial health. Your assets are now worth only $200--your two cows plus the one John owes you--but your liabilities are still only $100. If necessary, you could sell the assets at this distressed price and pay off all your loans.

You hold onto your cows because you are sure the market is "dislocated." Some day someone will want to eat beef again.

The rest of the country goes vegetarian. Your two cows are now worth $2 each to guys who want to make dog food.

John Paulson buys a cow in the market for $2 and he gives it to you as repayment of the loan. You now have three cows worth six bucks.

John wants his $10 back.

The bank calls. It wants its $90 back.

You call the Federal Reserve and ask for a bailout.

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Category: Accounting | Conventional Economics | Economics

Feb 21 2009

Can Americans Learn to Cooperate?

Kal @ 21:41

This is a post that appeared in The Oil Drum written by RogerK. It talks about the objective of achieving what I have called Steady-State Economics versus infinitely expanding economics.  It is kind of long and dense, but he explores a way of organizing society in a more just fashion. And it says very well some of the things I have been thinking.

The Anti-Economy: How the Pursuit of Private Fortunes is Destroying Community Wealth

Ever since I became aware that oil depletion was a near term problem I have devoted a considerable amount time and intellectual energy thinking about possible ways to structure an economic system so that it does not require constant growth for 'healthy' functioning. If human beings are going to be around on this planet for the long term then growth in resource consumption must to come to an end. I know, of course, that many regular readers of TOD believe that economic growth and growth in resource consumption can be decoupled, if not completely so, then at least sufficiently so that we can comfortably get richer for many decades into the future without mussing the hair of the biosphere. Of course given the fact that a highly respected biologist like E. O. Wilson estimates that species extinction rates have probably already risen to 1000 times prehuman levels, one could argue that we have already gone beyond the 'mussing' stage to the 'falling out in chunks' stage with respect to the state of health of the global coiffure. However, it is not my intention in this essay to try to prove that these optimistic assessments about the extendability of the economic status quo are false. I am simply going assume that a complete decoupling of economic growth from resource consumption is impossible, so that, sooner or later we must stop expanding our total economic output.

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Category: Conventional Economics | Politics | Resource Depletion | Steady-State Economics | Sustainability

Feb 18 2009

Economic Point of View - The Answer Depends on Your POV

Kal @ 11:29

It all depends, it all depends, it all depends upon; it all depends upon your Point of View. I think that little refrain was learned on the school playground. It is even taught in one form or another in Economics 101. Everyone knows that a lot of things depend upon your point of view. Most of us ignore this knowledge and adopt the "one true" POV.

Conventional economics has its own One True Point Of View (OTPOV). Actually there are a whole series of them. People are economic units who will always act in their own self interest. Markets will adapt intelligently to changing conditions. The economy can continue to grow indefinitely. No doubt you can add to the list. It is this later one, the Continuously Growing Economy One True, that has led to most of our current problems. It is the one that got Jimmy Carter in trouble when he suggested there may be limits to growth, and along came Ronnie Reagan who helped us believe in our denial of reality (Morning in America), and in the process wupped Jimmy Carter's ass.

Now along comes "The new ecological accounting is variously called 'dynamic equilibrium', 'steady-state' or 'biophysical' economics".

In the 1970s, World Bank economist Herman Daly wrote Steady-State Economics to outline the future of ecological economics. Daly makes a distinction between 'sustainable growth', which is 'impossible', and 'sustainable development', which is natural. "The larger system is the biosphere and the subsystem is the human economy," says Daly. "We can develop qualitatively, but we cannot grow beyond the biosphere's limits."

These two diametrically opposed points of view can cause a good bit of confusion when considering priorities, as with the yesterday signed stimulus package.

On the one hand there is conventional economics, wherein getting the economy moving again by use of government spending is a good thing.

On the other hand there is Steady-State Economics, wherein much of what we have been doing should simply be discontinued and a new paradigm adopted. I wrote about this last week: Stimulus Bill Passes - Main Issues Not Addressed

Depending on my POV at the moment, the stimulus package was either: a), a good first step, or b), a monumentally stupid waste of additional resources on trying to prop up a failed system.

Sometimes I argue a case (often with myself) from one POV, sometimes from another. As a matter of convention on this blog, I will try to make that POV explicit.

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Category: Conventional Economics | Economics | Politics | Resource Depletion | Steady-State Economics