Market Watch: Viva La Resistance!

Today, I am going to delve into a more serious and analytical post rather than my rantings on single life and football. Currently, the country is in a state of turmoil as the free markets that have built the face of capitalism are spiraling out of control. Banks continue to fail due to poor risk management and aggressive CEOs who were only concerned about their own financial packages.

This day was a long time in the making. While I am no economist or expert, I would like to express my opinions on what happened and why this new solution is a good step towards stabilizing the market though peoples concern about the plan are well founded.

Politicians our shouting that the $700B bailout package is a push towards socialistic and nationalistic polices that our brethren in France are world renowned. While I am a pure free market believer, in this state I believe the government must step up to steer the country out of the current state of influx. Even the founder of free market economies Alexander Hamilton in the 1700s stepped in during his time as the secretary of treasury to stabilize the market that has been responsible for our dominance across the globe.

Now for those of you who are not familiar with why the banks are failing, let me take you on a short and simple explanation for the current driver that is sending banks to the grave. CDOs - we hear that term thrown out time and time again as the driver, but what are CDOs? CDO stands for Collateralized Debt Obligations. So what is a CDO? Well lets say you have a large pool of mortgages that have been lent out by Bank A. To minimize risk on the Bank's balance sheet Bank A would combine all of these loans it has outstanding and create a type of security subsequently selling off pieces of these mortgages to investors primarily Hedge Funds and in return would collect a fee. The reason banks would do this is because if a lot of the loans go bad and they had kept them on their own balance sheet, since they are a regulated entity, per accounting rules they must take large losses writing down the assets. Therefore, if they sell off as much of the debts it has, it can reduce its risk to credit defaults.

Simple enough, and sounds like a great idea, so what happened? Greed is what happened? The CEOs of Bank of America, Merrill Lynch and others decided that they needed to boost their own returns so they could pump up stocks and in return help fuel their G4 jets as they fly around the world, on the backs of American money. Therefore in order to enhance their own profits, they kept underwriting these CDOs despite market saturation, and instead of selling them off, they retained the assets on their own balance sheet. Here we go! Now as the market began turning, the ARMs began resetting, people could not afford to pay their own mortgages, defaults skyrocketed, and Banks were holding onto assets that had to be substantially written down thus taking losses quarter after quarter, till there was no money left.

So how did we get here? In the world from 1999 to 2001 the US was recovering from the tech bubble bursting and 9/11. We were spiraling into a recession that was sucking out wealth and hindering George Ws' ability to fight for reelection due to the floundering economy. Therefore, the FED (Federal Reserve Bank) under the direction of Alan Greenspan, decided to lower the Feds Funds Rate and in turn increase the money supply across America. The FFR is the interest rate that banks can borrow at, therefore, if banks can borrow at a lower rate, they can lend to John Q Taxpayer at a lower rate. That means simply as Randy Moss would say: Straight Cash Homey!

Every one stood in line at their local bank hands open asking for money, 5 year ARMs oh my! Americans stood in line and invested in the only asset available and that they understood, Real Estate. Banks in return kept feeding the frenzy by giving money to uncreditworthy people also known as sub prime. 80 to 100% loan to value was the name of the game, don't worry about the LTV with real estate appreciations we will make out in the end the Banks thought.

I remember just before I finished college, I read this huge spread on the Wall Street Journal, specifically about the Real Estate bubble, and Greenspan telling us to tread softly. Right after that I moved up to Chicago, and all my friends were talking about how great Real Estate was, and how much they and their friends were making. I, not knowing a whole lot, but believing Greenspan, told them to be cognizant of what money they "really" were making. During this time people talked about "unrealized" gains they were making on real estate appreciation, but in the end that isn't cash baby. It's like me buying a Cartier watch then going to the pawn shop and saying, its worth 2Gs the market says so, good luck getting $200 in return. Until someone pays for it, the value is not real, and most Americans truly did not understand this, and continued to use their equity in their homes to lever up and reinvest in the Real Estate market.

The frenzy continued as credit was available to anyone who was asking, until the bottom fell out and foreclosures became more common than an article on Britney and K-feds baby drama. Banks had to start kicking out the people who could never afford to pay for the house they lived in. These people had 1 YEAR to clear out, and in that year, these people tore up the homes, and sent their keys to the bank at the end, which now is affectionately called jingle mail. Now the assets that were backing these mortgages are worth next to nothing, because there is no one to buy it and how are you going to take out the shit stains all along the carpet from the homeowners dog. Liquidate, Liquidate, Liquidate, pennies on the dollar. Now are the assets that are being written down actually worth nothing? Probably not. As former chairman of the FDIC stated the problem is not the write down itself, but rather how far it is being written down. How can we mark to market CDOs when there is no actual market to value the CDOs? However, per BASEL accounting rules we have to mark to market, there goes the neighborhood. So now who is going to save them now?

No one really, the banks crumbled, until the other banks who were left standing, with government aid, gobbled them up at substantial discounts.

So now back to the fundamental question of this post? Why does the $700B bailout make sense for the United States? The reason we cannot allow natural free market economies play out is because it was monetary policy that forced us in this position anyway. During the tech bubble burst, people were panicking because a substantial amount of their wealth was disappearing due to an over priced tech market. The NASDAQ crash was the FREE MARKET appropriately revaluing the price for technology. During the 90s none of us knew what technology was and we continued to invest in companies we didn't really understand, but believed in its future value. The reality was those companies were worth nothing, and once the market realized this it CORRECTLY repriced the entire market.

I believe a recession was necessary and important at that time because it is a natural check and balance on American wealth. However, the President at the time was going to be facing a reelection, and overall sentiment was moving away from concern about terrorism to concern about the economy. The brain trusts in DC sank the Feds Fund Rate to historical lows, next to nothing to flood the market with excess capital. The excess capital needed to be invested somewhere, and they in turn lent money to the American people who flooded the Real Estate market. Overvalue, Overvalue, that is what happened. The plan which was made in panic, painted us in the current corner we are in now. So why do I believe the government should intervene now with the bailout, because government intervention was the cause of our current state of affairs. To fix the free markets we must reverse the government intervention 10 years ago with another government intervention. So when one negative takes out the other negative, mathematically speaking, we should get a positive! If not I guess I will learn to sew and I will find a job in China, then I will see if communism works instead.