One of the fastest growing problems we now face is the amount of money that certain european countries owe. Two that are in the most debt: Greece and Portugal. They owe money to countries all over the world. Why is it a growing problem? Let's take Greece... Greece is now currently financing their obligations with more debt. In other words, the only way Greece can pay back loans that are due today, is to borrow more money... today (which the United States is currently doing, as well). The only way they can back the "maturing" loans is to borrow money to do so. Does this seem like a good idea? No.
As other countries continue to lend them more money, their chances of defaulting on some of those obligations will rise. When international organizations (like the International Monetary Fund, IMF) see that Greece may not be able to honor the loans they took out, their only solution is to lend them money so that they are able to pay back those loans.
Credit Default Swaps: In finance, there is a product that allows you, as a lender, can protect yourself against "counter-party credit risk". You can buy insurance, with a third party, on the loans that you give to your customers. If someone, who you lent money, can't pay you back, your insurance pays for the loan. This is called a credit default swap, CDS. The CDS is based on knowing what the probability of default is. Both buyers and sellers of CDS want to know what the exact chances of default are(in reality you can only guess this number, but estimating it is a pretty reasonable thing to do). Today, 6/16/11, the CDS market said that there is a 78% chance that Greece won't be able to pay off the loans they have.
What happens when a country cant pay back their debt? Everyone else stops lending to them. When that happens, the government can't fund the expenses. Government workers stop getting pay checks, pension funds dry up, social security checks stop being sent to Grandma, there is no more medicare/medicaid etc. etc. The country falls apart.
What happens when Greece defaults their debt? It spreads like fire through the international banking industry. Approximately $1 trillion dollars does not get paid back. Banks see a massive blow to their balance sheets. Some banks, that lent a large amount of money to Greece, will go bankrupt. This is the same idea that broke Lehman Brother's, which sent the country into a recession for 2 years. If multiple banks we're to fail, the problem clearly grows.
Thursday, June 16, 2011
Sunday, March 27, 2011
The Real Estate Problem.
Before the Crisis, your house was probably the "safest" and most profitable investment you had. It wasnt uncommon for a house to double its value from 1997 to 2007. Real estate was thought of a risk free deal. Everyone would say, "Invest in real estate 'cuz God ain't makin' any more of it!" But why was real estate so great? Why was it too good to be true? Why wont we ever see houses appreciate as fast as they did in the 90's and 2000's?.... Loose credit and Easy Money.
First of all: what does "Loose credit and Easy Money" mean?
Credit is financial word for borrowing. In economics, credit is used to transfer resources and create opportunities. This provides a mutually beneficial opportunity in that those who need money and don't have it, can have it. And those that have money and don't need at (at that specific moment) can lend it, making interest on that money.
To say that credit is "loose", means that it was too easy to borrow money. The consequence of this is that too many people qualified for credit cards, advances, loans etc. And over a decade or two of unqualified borrowing, a mountain of debt can build, which will eventually have to crash on itself. In theory, you're supposed to lend to only those who can repay the debt, which we sometimes fail to accomplish.
Freddie/Fannie and the American Dream
At some point during the last 50 years of American history, we decided that the American Dream meant owning a home. It seemed to become an increasingly important task for our government. We made it a goal to make as many Americans as possible home owners... The result being the birth of the subprime mortgage market. Throughout the 90's the federal government incentivized the housing market to give mortgages to less than ideal candidates. The government promoted programs like HUD and became the biggest player in the industry by sponsoring Freddie Mac and Fannie Mae. They guaranteed the value of subprime mortgages sold by private enterprises. This meant that a bank like TCF could grant a mortgage to a subprime candidate knowing that if the candidate failed to make the the payments, the federal government would bail them out. The result: Mortgages brokers, banks and the rest of the industry were granting subprime mortgages without regard to the risk. And I don't blame them. They knew that if the mortgage fell through, The U.S. GOV would pick up the bill.
Due to this, mortgages became easier and easier to come by. This policy may be the single most important reason for the financial meltdown, but it also had an effect on housing prices, a BIG effect.... they went up and up. Why? When more and more people qualified for mortgages, more and more people can afford houses. And when there are more people can afford houses, then there are more looking for and bidding on houses. When this happens, prices goes up. If you are selling your house and are dealing with 1 potential buyer, you don't have much of an opportunity to increase your price tag. When there are 10 buyers, you can easily increase that price. This caused housing prices prices to rise across the entire market. And they seemed to rise faster and faster each year.
Below is a graph that reflects actual data, despite it being drawn using a free paint app on my iphone. It compares the increase in GDP to the increase in housing prices. GDP is used a standard measure of how our entire economy grows. You notice how housing prices raise exponentially faster than GDP until the collapse, at which point they return to a growth similar to GDP. I say that the exponential growth before the collapse was a simple result of easy credit, or subprime mortgages. And unless we return to those standards, housing prices will never increase like they once did.
First of all: what does "Loose credit and Easy Money" mean?
Credit is financial word for borrowing. In economics, credit is used to transfer resources and create opportunities. This provides a mutually beneficial opportunity in that those who need money and don't have it, can have it. And those that have money and don't need at (at that specific moment) can lend it, making interest on that money.
To say that credit is "loose", means that it was too easy to borrow money. The consequence of this is that too many people qualified for credit cards, advances, loans etc. And over a decade or two of unqualified borrowing, a mountain of debt can build, which will eventually have to crash on itself. In theory, you're supposed to lend to only those who can repay the debt, which we sometimes fail to accomplish.
Freddie/Fannie and the American Dream
At some point during the last 50 years of American history, we decided that the American Dream meant owning a home. It seemed to become an increasingly important task for our government. We made it a goal to make as many Americans as possible home owners... The result being the birth of the subprime mortgage market. Throughout the 90's the federal government incentivized the housing market to give mortgages to less than ideal candidates. The government promoted programs like HUD and became the biggest player in the industry by sponsoring Freddie Mac and Fannie Mae. They guaranteed the value of subprime mortgages sold by private enterprises. This meant that a bank like TCF could grant a mortgage to a subprime candidate knowing that if the candidate failed to make the the payments, the federal government would bail them out. The result: Mortgages brokers, banks and the rest of the industry were granting subprime mortgages without regard to the risk. And I don't blame them. They knew that if the mortgage fell through, The U.S. GOV would pick up the bill.
Due to this, mortgages became easier and easier to come by. This policy may be the single most important reason for the financial meltdown, but it also had an effect on housing prices, a BIG effect.... they went up and up. Why? When more and more people qualified for mortgages, more and more people can afford houses. And when there are more people can afford houses, then there are more looking for and bidding on houses. When this happens, prices goes up. If you are selling your house and are dealing with 1 potential buyer, you don't have much of an opportunity to increase your price tag. When there are 10 buyers, you can easily increase that price. This caused housing prices prices to rise across the entire market. And they seemed to rise faster and faster each year.
Below is a graph that reflects actual data, despite it being drawn using a free paint app on my iphone. It compares the increase in GDP to the increase in housing prices. GDP is used a standard measure of how our entire economy grows. You notice how housing prices raise exponentially faster than GDP until the collapse, at which point they return to a growth similar to GDP. I say that the exponential growth before the collapse was a simple result of easy credit, or subprime mortgages. And unless we return to those standards, housing prices will never increase like they once did.
Tuesday, February 22, 2011
What's wrong here?
This, obviously, is my first post. I can't sleep after a disastrously bad day of flying, so here's what I was thinking while in bed. I don't even know if I will end up publishing this, but I want to get my thoughts written. Also, I'm not going for some beautifully written blog, full of poetry and consonance, so don't get distracted with my bad grammer.
What are our problems with the economy?
1) Unemployment - We currently have unemployment at 9%, a number that is most likely inaccurate (due to the terrible weather during January 2011, across the country, which prohibited hundreds of thousands of people from traveling - say to the unemployment line). My guess is that 2011 will be plagued with unemployment at 9 - 10 %. Additionally, underemployment is around what, like 17%? 17% of this country is not getting enough work. In order to have jobs, we need consumers to spend, which brings me to my next point.
2) Consumption - 2/3's of GDP is personal consumption. I believe this this THE most important contributor to economic recovery. If the people in this country decide to start spending, you WILL see economic growth. When personal consumption recovers, the jobs will soon follow. The problem, though, is that in order to get the people of this country to spend, the people need to have a job. So unemployment depends on consumption, and consumption depends on unemployment.
3) The housing markets - Both commercial and retail housing markets are the most depressed and dead industries right now. Housing prices continue to fall. Despite the overall positive economic news that we've seen in 2011, there has been ZERO improvement in the housing industries. I also think that there are millions of homes that have yet to go into foreclosure. If this is true, prices will continue to drop as supply for existing homes increases. So the retail housing prices, across the country, are down by about 30% from the glory days of 2006/2007, however the commercial industry is down about 40%! People don't talk about this enough, considering that the commercial real estate market is valued in the trillions of dollars. One of the more interesting things that I read in FORBES mag. is that despite these price troughs, the corporate lenders issuing these mortgages keep them on their books at original value (which for so many homes, is much higher than today's price). Most would agree that this is not a good thing.
4) The State and The Fed - Its not the fact that the deficit is out of control right now, its the fact we aren't doing anything to fix it. We cannot ignore a debt figure that is close to, if not beyond our annual GDP. Could you imagine having a credit card balance equal to a years salary? Im just saying. Guys and Gals, we will have to pay for this debt some way or another and that means taxes are going up! If you compare today's debt level to the debt level of around or near WWII, its nothing new. The problem here is that we don't have a WWII size project to help with production. We managed that debt level because we we're producing a far higher level of goods and services during WWII. Personally, I think that today's WWII should be cold fusion. If the U.S. was somehow able to rally, pull together, and isolate cold fusion, ALLLLLL of our financial issues would be gone; we could save the environment, and it would absolutely make the United States the most powerful and rich country in the world.
Addtionally, the states, taken individually, are broke. For some reason I think of the municipal bond market when I hear that. Could it be realistic that municipalities will default on fixed income debt obligations? Another thing we have to keep in mind is that as our states and our country maintain debt of this size, interest rates across the board will increase. Treasury rates (especially on the long end of the curve) will increase. A more extreme consequence is that the U.S. credit rating (S&P, Moody's) could be downgraded.
5) Weather and Revolution - because of these two, we have seen quite the scare in commodities' prices. Right now, I don't think anyone really knows where the price per barrel (of oil) will be in August of this year. On top of the oil fears, food prices are skyrocketing. Both bad weather and all the political turmoil in he Mid East are to blame. It's a bad problem for the U.S. but its a TERRIBLE problem for the emerging markets and developing countries across the globe. Now I'm not suggesting that it would be better to supress a revoltion for economic stability, I'm simply saying that there could be some bad consequences because of it.
What are our problems with the economy?
1) Unemployment - We currently have unemployment at 9%, a number that is most likely inaccurate (due to the terrible weather during January 2011, across the country, which prohibited hundreds of thousands of people from traveling - say to the unemployment line). My guess is that 2011 will be plagued with unemployment at 9 - 10 %. Additionally, underemployment is around what, like 17%? 17% of this country is not getting enough work. In order to have jobs, we need consumers to spend, which brings me to my next point.
2) Consumption - 2/3's of GDP is personal consumption. I believe this this THE most important contributor to economic recovery. If the people in this country decide to start spending, you WILL see economic growth. When personal consumption recovers, the jobs will soon follow. The problem, though, is that in order to get the people of this country to spend, the people need to have a job. So unemployment depends on consumption, and consumption depends on unemployment.
3) The housing markets - Both commercial and retail housing markets are the most depressed and dead industries right now. Housing prices continue to fall. Despite the overall positive economic news that we've seen in 2011, there has been ZERO improvement in the housing industries. I also think that there are millions of homes that have yet to go into foreclosure. If this is true, prices will continue to drop as supply for existing homes increases. So the retail housing prices, across the country, are down by about 30% from the glory days of 2006/2007, however the commercial industry is down about 40%! People don't talk about this enough, considering that the commercial real estate market is valued in the trillions of dollars. One of the more interesting things that I read in FORBES mag. is that despite these price troughs, the corporate lenders issuing these mortgages keep them on their books at original value (which for so many homes, is much higher than today's price). Most would agree that this is not a good thing.
4) The State and The Fed - Its not the fact that the deficit is out of control right now, its the fact we aren't doing anything to fix it. We cannot ignore a debt figure that is close to, if not beyond our annual GDP. Could you imagine having a credit card balance equal to a years salary? Im just saying. Guys and Gals, we will have to pay for this debt some way or another and that means taxes are going up! If you compare today's debt level to the debt level of around or near WWII, its nothing new. The problem here is that we don't have a WWII size project to help with production. We managed that debt level because we we're producing a far higher level of goods and services during WWII. Personally, I think that today's WWII should be cold fusion. If the U.S. was somehow able to rally, pull together, and isolate cold fusion, ALLLLLL of our financial issues would be gone; we could save the environment, and it would absolutely make the United States the most powerful and rich country in the world.
Addtionally, the states, taken individually, are broke. For some reason I think of the municipal bond market when I hear that. Could it be realistic that municipalities will default on fixed income debt obligations? Another thing we have to keep in mind is that as our states and our country maintain debt of this size, interest rates across the board will increase. Treasury rates (especially on the long end of the curve) will increase. A more extreme consequence is that the U.S. credit rating (S&P, Moody's) could be downgraded.
5) Weather and Revolution - because of these two, we have seen quite the scare in commodities' prices. Right now, I don't think anyone really knows where the price per barrel (of oil) will be in August of this year. On top of the oil fears, food prices are skyrocketing. Both bad weather and all the political turmoil in he Mid East are to blame. It's a bad problem for the U.S. but its a TERRIBLE problem for the emerging markets and developing countries across the globe. Now I'm not suggesting that it would be better to supress a revoltion for economic stability, I'm simply saying that there could be some bad consequences because of it.
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