What's happening with the economy?

[88Mariner]

"Madness is rare in individuals - but in groups, political parties, nations, and eras it's the rule." (Friedrich Wilhelm Nietzsche).

I can't say I'm the most versed person in economics, but I would like to think I can trust my gut instinct and say that things are not great. I've read a mixture of opinions on what is been happening these last few weeks, and I'm still without a definitive answer. Some say this is the worst it will get, others, that it's just the start. Some say this is merely a re-adjustment phase, and others talk about how this is the 'big one'. Reading stories about how the dollar is literally worthless overseas makes me gravely concerned about what is happening right now, as I'm sure it follows the same for you, your spouses, friends, and families right now as well.

So, can anyone here tell me what's going on? Can anyone clear things up here? The lack of clarity is absolutely killing me.

[asdf_admin]

Re: What's happening with the economy?

bull and bear. ups and downs. supply and demand.

subprime.

[88Mariner]

Re: What's happening with the economy?

alright, let me rephrase that first statement. I'm not the most versed person in economics in the basis that I don't have a master's degree (or higher) in that field of study.

I haven't seen a bull in a while... so how does that fit into the explanation?

[asdf_admin]

Re: What's happening with the economy?

a few factors.

- the housing market has really slowed down. when you build a house, you support a huge economy. Think about the elements that go into a home. Think about all the things that go into filling a home. yep. a lot.

- oil. not a huge factor, but it does not help that prices keep going up. who pays? the consumer does. so what does this mean? inflation. Economies grow when the consumer has money. Companies create products so consumers can buy products. a very dependent cycle.

- subprime. got bad credit? don't make ends meat? let me give you a loan. subprime has been an issue for a few years. people have got houses when they could never afford it. This leads to repo's and etc.

the bull was last year. I yielded a +15% grown on my funds and stocks. Year to date I am down -5.5%. Sucks.

Look at the Apple stock. It was up around 200.00 towards the end of the year. Now it is down to around 130.00. YIKES!

[rubyraks]

Re: What's happening with the economy?

you should also add our pathetic deficit...

and while we're at it, let's not forget the horrendous balance of trade (we import way more than we export) causing a huge outflow of dollars to pay for it. This is predominantly being floated by the chinese who own more of america's treasury bonds and bills than anyone else. All this creates a very weak dollar, which for as weak as it is doesn't seem to be helping out with that balance of trade as it should (weak dollar makes our products cheap to other countries and their products more expensive to us).

Shall I keep going?

[Shpira]

Re: What's happening with the economy?

We are all fucked is all I can say on this topic. The more I read the more I am convinced in this. I don't think this is a "small" or normal market occurrence, on the other hand I am not sure its "the big one" either.
look at todays market performance of Barclay's and HBoS...we're fucked.

[Miroslav]

Re: What's happening with the economy?

It starts with what is referred to as the "business cycle". Broadly speaking, modern economies have always been vulnerable to alternating periods of expansion and contraction. We simply now find ourselves heading into a period of contraction, i.e. recession. We've been here before, and we'll be here again. While the specifics of the circumstances change, the causes always come back to human nature. And human nature doesn't change much, so we can be assured that these fluctuations will always happen.

Very simply, it works something like this: In business, people are always looking to allocate their capital into uses that produce the highest return for them. A fundamental principal of modern free markets is that in order to get a higher return than the risk free rate (think US government securities), you need to take on risk. As a business person, your job is basically to choose the forms of the risk you are willing to bear commensurate to the return that you seek.

Furthermore, people are always in competition with each other. Publicly traded firms everywhere are beholden to their shareholders and the bar is set high for them to produce results every quarter. And as one firm finds an opportunity to exploit a risky situation and produce an above-average returns, competitors quickly jump on the bandwagon and try to exploit that situation. And, as more people succeed in doing so, the return is no longer above average - it effectively becomes the average (btw, this is also why you have to take on risk to get a higher return; arbitrage opportunities vanish quickly in efficient markets because everyone immediately seeks to take advantage of them, immediately driving up the price).

So, this situation means two things:
1. competition causes the status quo risk/return profile to be re-defined upward over time.
2. as this happens there is a tendency to eventually take on too much risk - firms overinvest, market bubbles are created and popped, etc.

In our particular case, the risk has mainly occurred in the housing sector. And it all goes back to something called asset-backed securitization. Securitization is actually broadly used and is used for many things, including firms' accounts payable, car loans, student loans, inventory, etc. Best way to explain this is to look at the old way and the new/current way that this works:

Old way: You buy a house. You talk to your mortgage broker and bank. They make you pass credit screenings, put down a down payment of 5-10%, and then take a mortgage loan for the rest. The bank gives you the loan and keeps the value on its books. You make payments to the bank until it's all paid off.

New way: You buy a house. Mortgage brokers, working together with banks, let you get that house with fewer screenings (or maybe none), zero money down, and a low interest rate (which they'll raise later) - even if you're a poor shmuck who really shouldn't be buying a $400k home. Why? Mortgage brokers are incentivized to sell as many houses as they can - and they don't care if you can repay it because they don't actually give you the loan. Banks give the loan because they've come up with this neat trick that lets them securitize your mortgage with a bunch of others.

Your mortgage is now part of a pool of mortgages in a security whose underlying risk is measured by statistics - distribution of homeowner incomes, loan amounts, likelihood to default, etc. Now the bank can literally sell chunks of this security to other institutional investors and banks in exchange for cash. These investors will take on the risk in exchange for earning the mortgage payments as their return. As basic portfolio theory will quickly show you, the diversification of a large amount of homeowners will serve to reduce the standard deviation of the portfolio return, thereby mitigating risk. Note too that the parceling out of the security among multiple investors also enables risk diversification. The asset-backed securities are non-recourse, which means that investors can not go back to the bank and request payment in cases something goes wrong with the deal. It also enables the banks to not record the entire deal on their books. This gets much more complex, of course - banks may sell it the securities tranches of varying risk, depending on the return you want to earn. Or they may add certain credit enhancements to it, such as the use of insurance companies that will guarantee some form of the income from the security (all the stuff you've heard about AMBAC, etc.).

Notice what has happened here: Before, the bank had to give you money and record it on their books. That cash they gave you was no longer available to them until you repaid it. They bore the risk of your potential non-payment. Now, the banks give you money and get it back immediately from the people who invest in their asset-backed securities. And remember they don't have to record the deal on their books. So they've transferred the risk away and can turn around and effectively redeploy that same cash again...into more risky mortgages, which will again be securitized. This system lets banks redeploy their cash at a much higher velocity than ever before.

Now again, all these banks are in competition with each other. They all are driven to take advantage of this money-making opportunity right away. Investors are in competition with each other. They are also eager to invest in these new securities, which they see as "relatively safe", thanks to the high-tech securitization/diversification process. Home owners are happy because they can buy more home than they ever could before with their meager paychecks. Builders, realtors, and mortgage brokers are happy because they can sell more homes than ever before. Everyone is happy and everyone is making big bucks for a little while.

And all of this works great, as long as banks don't give too many loans to people who are too risky and as long as home prices keep skyrocketing. But all the competition causes banks to extend more and more loans to people who pose an ever-greater risk of never repaying them. And then eventually homeowners get squeezed by other factors such as inflation and start defaulting on the loans en masse. That's when you end up where we are now. Now everyone is losing money and the magnitude is so great that it's spreading to all parts of the economy - banks lose money so they don't give loans, companies can't get loans so they can't expand, home builders can't sell houses so they slow down...it spreads through the economy like a disease. And it will simply take some time for all the losses to be realized and for the whole system to "reset" again.

In summary, all of these "smart", sophisticated financial gurus on Wall Street overdid it and, in their zeal for increasingly higher returns, took on too much risk. It turns out that they didn't properly understand the underlying risk of the assets they were buying and selling. And it all happened because of greed and arrogance. Modern capital markets have brought us much wealth, but you can't take the human nature element out of the story.

Human nature will always trump smarts and sophistication again and again. And so we'll always end vascillating from good times to bad times. Never forget that next time some Wall Street finance expert tells you that the business cycle is dead and that we can always keep ratcheting up the risk with "sophisticated" financial tricks without any cosequences. There is no free lunch.

[Steve Graham]

Re: What's happening with the economy?

greedy rich people keep fucking the common working stiff over and over

[lilsensa]

Re: What's happening with the economy?

^Agreed..Cock sucker mother fuckers....

[Shpira]

Re: What's happening with the economy?

LOL...
well explained Miroslav

[toasty]

Re: What's happening with the economy?

good analysis, Miroslav

- subprime. got bad credit? don't make ends meat? let me give you a loan. subprime has been an issue for a few years. people have got houses when they could never afford it. This leads to repo's and etc.

The thing about this, too, is that it has effects that are so much broader than just the folks that are having their homes repo'd:

1. It obviously blows for the people that lose their home
2. It's no picnic for mortgage holders who foreclose, either, as they would, all else being equal, prefer the stable stream of income to the hassle of unloading a foreclosed property.
3. The rest of us see the value of our homes diminished as the glut of foreclosed homes selling below FMV drive down the value of our homes, resulting in less equity (or worse).
4. Also, in neighborhoods like mine where there is significant rehabbing going on, demand goes down -- why buy a rehabbed property in a neighborhood that is "coming back" when you can get a great deal on a property in a new or established neighborhood?

and it continues to ripple outward, etc., etc.

[CactusBeats]

Re: What's happening with the economy?

- oil. not a huge factor, but it does not help that prices keep going up. who pays? the consumer does. so what does this mean? inflation.

All excellent points so far everyone. Anyone heard of the Olduvai Theory? Some of it sounds alarmist, but I tend to think there is something to this theory. When oil prices get high ($250 to $1000/barrel or more), maybe $10/gallon and up, this economy may be turned on its head. This relates less to the actual topic here and more to what may happen within the next 10 years, maybe less time than that.

Market forces are all supposed to save us from this. Example - the dawn of new renewable technologies as oil becomes more prohibitive. Maybe yes, maybe not, probably somewhere in between. Also, it seems like more and more oil is being dicsovered and more that was not accessible, is becoming accessible with new technologies. Nevertheless, with China & India trying to build a middle class, demand is going to massively outstretch supply at some point in the not so distant future. Wars over oil will become more common. You can probably imagine some crazy scenarios just like me.

I just wouldn't want to be the one 300 years from now trying to explain to a group of teens about how these people used up vast amounts of oil driving SUV's and whatnot. Basically trying to explain how one of the greatest natural resources was squandered in a very short time. Then hearing the teens ask, "They did what?? What the f**k??" Kinda sad really, how we will be remembered. That is, if there are any people left to remember our sorry asses at all. I hope I am wrong.

[Miroslav]

Re: What's happening with the economy?

^^ I dunno man... I agree that oil has its drawbacks and that we should develop new forms of energy, but let's be real: it's not like over the past 100 years we have realistically had an option not to consume oil - unless you prefer to live in a straw hut and personally club your food for dinner. The entire way of life you personally enjoy right now would have been impossible without oil. I suspect that people of the future will understand this.

[CactusBeats]

Re: What's happening with the economy?

^^ I dunno man... I agree that oil has its drawbacks and that we should develop new forms of energy, but let's be real: it's not like over the past 100 years we have realistically had an option not to consume oil - unless you prefer to live in a straw hut and personally club your food for dinner. The entire way of life you personally enjoy right now would have been impossible without oil. I suspect that people of the future will understand this.

I don't disagree with anything you say here Miroslav. The way I see it we as a society have made a choice not to improve efficiency standards or to invest in technologies that can improve efficiencies when we easily could have. Europe's standards are ahead of the US's. We in the US only pay pennies on the dollar the real cost of burning fossil-based fuels. There are externalities involved in burning these fuels that we never even think about. Our grandchildren and their grandchildren will be paying these externalities. I just think its sad how little we consider future generations into the picture. That is a choice on our part today.

I am not at all saying we shouldn't have been burning oil. I just think there are thousands of ways we could be using it more wisely. On the bright side, the small increases in price we've seen are beginning to motivate people to think about this more. I do think we are about to see many improvements. We just need to keep Texas oilmen away from the White House and Washington in general. Good luck! lol

[Miroslav]

Re: What's happening with the economy?

^^ gotcha...I'd agree as well. I certainly suspect that sustained prices like these will spur serious alternative energy development in our lifetimes...but unfortunately, not without a good dose of short-term pain.