Sunday, January 24, 2010

The Economy is Improving; What Happened and Why

Let's talk about our current economic condition. I've been looking around and learned a few things I'd like to share.

I believe this recession (2008 through 2009), that some are calling the "Great Recession"* was caused by the federal government.

I was going to say that Wall Street "fat cats" helped as well, but I believe they were doing what everyone wanted them to do, maximize profits, follow the rules that the government imposes on them, and honor their contracts. This benefits everyone.

The reasons for the recession are multifaceted, but the prime mover in this debacle seems to be the FEC's Financial Accounting Standards Board's (FASB) modification their "mark to market" rules in Financial Accounting Standards (FAS) number 157, which forces investment firms to estimate and report the value of their holdings, for taxes, investor information and other purposes, to current market values. This makes sense on the surface, but if there is a market slow down, such as the subprime market hitting the skids, where their holdings cannot be easily liquidated, the value goes down.

In the subprime situation, many loans were adjustable rate loans and started adjusting upwards as the prime lending rate went up in mid 2004 through 2008. (Coincidence? I wonder if Mr. Bernanke had any part in this?)

Here is what I believe happened

A real estate bubble soars upward with easily available credit due in part to a low prime rate and subprime loans, peaking in 2006.

- By 2004 there were trillions of dollars in mortgages and investments in the subprime loan markets, backed by Fannie Mae and Freddie Mac, two "quasi governmental" organizations that guarantee the loans.

- The Federal Reserve increases the prime lending rate (money the Fed loans to banks and others) from 2.00% in 2001 to a peak of 6.25% in June of 2006.

- Throughout the same period, investment firms obtain and repackage mortgage loans into security derivatives and sell them to investors around the world and making profits all over the place. As long as the money is flowing, such as mortgage holders making their payments; no problem.

- Through 2006, subprime mortgage holders' payments increase with many doubling and tripling. Many who could just barely make their payments now cannot afford them and mortgage holders default and and banks foreclosure.

- In 2007 the housing market becomes saturated with over priced real estate. Many are denying that it is a serious problem.

- Investors who bought properties as investments, such as those who "flip" them, find the market flooded and real estate values are tanking. They start walking away from the debt.

- New terms, "illiquid", "toxic Assets" and "derivatives" become every day words in the general American population.

- In September 2007, the Federal Reserve starts lowering the prime lending rates.

- FASB tightens the asset estimation and reporting requirements of FAS 157. They became effective for businesses with fiscal years beginning after November 15, 2007. Under the stricter requirements, firms that invested in these toxic assets, had to report the loss of billions of dollars is their assets.

- Over 100 companies fold due to the now illiquid assets they were stuck with.

- Markets around the world that invested in these (once) high yield derivatives lose capital causing a panic in our federal government. (if those countries fail, who will loan this government more money?) Representative Barney Frank (D-NY) runs around denying it was his fault.

- The federal government start picking winners and losers in the financial services and investment companies. While loaning funds to some financial institutions, the government decides not to assist Lehman Brothers Holdings, Inc., the competitor to Treasury Secretary Henry Paulson's former employer, Goldman-Sachs (GS). GS, who turned a profit from the subprime meltdown, would later receive $12.9 Billion in bailout funds from the Troubled Asset Relief Program (TARP).

- In September 2008, Secretary Paulson pushed for bailouts of $700 Billion (TARP) to shore up the now almost defunct financial markets in this country and abroad. He got it done and President Bush signed it.

- American International Group, Inc. (AIG) receives Bailouts totaling $122.8 billion by the end of 2008, with more to follow. Nobody can say where the money went.

- The Obama pre-administration complains about executive bonuses being paid by companies that received taxpayer hope dollars.

- General Motors (GM) is laying off employees; In 2008 GM was down 13,000 salaried employees since 2000 & 40,000 hourly jobs are gone since 2006 (NY Times). They were closing plants and reporting that they will not have enough operating capital to pay their employees and creditors. Along with Ford and Chrysler, they are asking for a bailout. GM received $9.4 Billion in December 2008 (CNN Money), and more bailout money was to come.

- As businesses fail, being unable to secure funds to continue to operate due to a "bad banking environment", millions around the world became unemployed. This causes more foreclosures, lost homes and lost investments, many of these investments were retirement accounts. Many who were planning to retire now must continue to work (if they can find a job).

- In March 2009 President Obama says he does not want to run the automobile industry, but fires GM CEO Rick Wagoner (Politico), tells GM what vehicles to produce, and insists that GM downsize, destroying thousands of jobs. GM totals 40,000 more layoffs for 2009 alone (LA Times).

- In March 2009 President Obama instructs GM on how to run its business or he will cut off the bailout funds (Business Week).

- GM files for chapter 11 protection under the bankruptcy laws after receiving bailout funds several times, being nationalized the President of the United States. The federal government then claimed a sizable percentage of GM stock and gave the remaining stock to the UAW.

The net result of the change to FAS and the failure to properly mange Fannie and Freddie: subprime market crash, stock market crash, housing market crash, worldwide recession, the loss of millions of jobs, millions lose their homes, and the US Deficit is tripled with hope dollars. Our government nationalizes some banking and automobile manufacturers, acting like 1959 Cuba or 1971 Venezuela, and the list goes on.

This is how we find ourselves trying to climb out of a recession in 2010. The mortgages that were "owned" during this period had their values drop as much as 50 percent making them "upside down', meaning investors and home owners owed more than the property was worth. Many investors and owners started walking away from this bad debt. The debt was guaranteed by Fannie Mae and Freddie Mac, two quasi-governmental entities that now held trillions of dollars in debt from these loans.

The good news

Realizing what they have done (primarily from the discussions of Steve Forbes) but continuing to blame former President Bush, they changed the mark to market rules last April (FAS -157, 2009), easing the rules and stabilizing market prices and the economy is improving.

This is why I am of the opinion that the US Congress caused and allowed this recession through...

- handing off the power to regulate markets to the FEC, who produced poorly thought out market rules instituted with their failure in the Enron debacle in mind.

- decades of intimidating financial institutions to give loans to people who in all likelihood would be able to make the payments for very long.

- turning their backs on the indicators (from as far back as 1998) and prompts from the Bush administration to reign in Fannie Mae and Freddie Mac hopefully before it became too late. Committees refused to hear the advice, senators promised filibusters if any interference with their plans to lend money in an exceptionally risky manner, with charges of racism and other bogus claims to prevent any change to the status quo (which is ironic as now, while in the majority, the Democrats are labeling the Republicans as the "party of no").

Hey, maybe we should give the health care insurance industry to a board or commission created by these guys. What could go wrong?


*No doubt trying to equate it to the actual Great Depression to bypass President Carter's "great recession"

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