I read a good majority of this thread and I am still confused. If some charitable person would like to help me out, I would greatly appreciate it as I have a shift tomorrow at a McCain victory office and sure as rain...this will come up.
The way I see it is:
-What comes up must come down. The banks that were making all of the shady loans were depending on bailouts to shield them from a poor decisions. Now that they know that Crusader Rabbit will not come to the rescue, a correction will occur over time as their lending practices come back to a “trust but verify” policy.
-Interest rates may be reduced to make sure that credit is available to those who deserve it?
-During the Clinton admin, the forces that existed set policy so that more people could qualify as first time homeowners no matter their financial reality and Bush really didn’t fix it.
-The sky is not falling. We have had many stock market bumps before, the market is self correcting if you just limit government from sticking too many fingers into the pie.
I openly admit that I am a stock market idiot. It gives me a headache if I think about it too much. But I would appreciate help with honing these talking points for soft McCain supporters who may be a little nervous in light of the news today. The campaign is not really very good about helping volunteers react in real time to the issues. Thanks
You’re leaving out a LOT of stuff along the way. It is OK to be singing the lead from “Annie” (ie, “The Sun Will Come Out Tomorrow...”) during other market downturns, but not this one.
For the financial sector of the US, the sky is, in fact, falling. Hard. They’re being done in by their own hubris and “financial engineering” that discounted the frequency and severity of risk, and now several years of accumulated risk and easy Fed monetary policy is coming unwound all at once. There were huge errors of financial modeling and mathematics in the midst of some of their assumptions, but let’s leave that out for now. Suffice to say, there are a bunch of people on Wall Street who are far too enamored with their supposed intellect.
Further complicating the matters are “counter-party risks” especially from derivative contracts on debt instruments. The “shadow banking system” has been churning out derivative contracts without consideration for the systemic risk they create for years. Warren Buffett was right when he called derivatives “instruments of financial mass destruction.” The various banks have sold these instruments in a round-robin way such that good banks are tied to bad banks via these counterparty agreements and derivative contracts; the result is that even good banks are going to take losses due to the failure of bad banks.
In fact, there are regional banks in the US that had substantial quantities of Fannie/Freddie preferred stock that had upwards of 20%+ of their balance sheet wiped out when the Treasury took down Fannie/Freddie and suspended the dividend on the Fannie/Freddie preferred.
The central problem with derivatives is that when the blow up, they often blow up big. A derivative trades for only a small fraction of the value of the underlying bond/stock/future contract, but when the crap hits the fan, you’re often required to cough up the full value of the underlying security. In this case, it is credit default swaps that are blowing up as Lehman goes bankrupt. And then the Fannie/Freddie receivership invoked the “default” option on the CDS contracts on Fannie/Freddie debt - about $1.4 trillion (notational value) of these instruments. Let’s say that only 5% of the notational value was at real risk when Fannie/Freddie went under - that’s still $70 billion dollars some outfits have to come up with to settle the contracts.
Adding to this problem is that the Fed has a limited visibility into the derivatives market. The derivatives market(s) don’t have the same reporting requirements as many other markets, so the Fed is dealing with incomplete information as to the consequences and counterparty risks until they see a fund or bank on the doorstep of death.
This is not a “stock market bump.” This is the end of the banking paradigm of the last generation - we’re seeing the end of the investment bank as a stand-alone finacial entity. There are only two investment banks still standing now - Morgan Stanley and Goldman Sachs. Due to mortgage debt exposure, leverage and counterparty risks, it is unlikely that both of them will survive to the end of Q12009.
THE central problem of the Bush administration in this is that the GOP-controlled Congress held an investigation into Fannie/Freddie in 2002. They had results back in 2003. They had the wind at their backs to act in 2004. And they lost their nerve - they got bought out.
Fannie and Freddie needed to be taken down and hammered flat back in the 2004-2005 timeframe, and the Bush administration left the GOP Congress high and dry, stranded, because Bush was preaching this idiotic “ownership society.” Once ANYONE read the accounting reports on Fannie/Freddie, they would have dropped that idiotic mantra and started preaching “sound banking.” But no, the Bush administration was hand-in-hand with the liberal Democrats on this one, making sure that everyone and their dog could qualify for a house - even if there was no way in Hades that they could actually, you know, afford the payments.
The Fed also bears a huge responsibility here. The Fed kept interest rates far too low for far too long, and made money “cheap” and induced the bond market to go chasing crazy ideas in pursuit of the last fractional percent of yield on debt instruments. This is why so many investment banks, hedge funds, foreign banks, etc went piling money into sub-prime mortgage bonds - they yielded just a little bit more than the “safe” mortgage debt bonds.
The US banking system has not seen this level of turmoil and failure since 1932-1935.
As of last night, the Federal Reserve indicated that they will even accept equities as collateral for Fed PDCF and TSLF loans. The Fed has NEVER accepted equities (stocks) as collateral - never in their entire history.
The Fed also suspended a rule (called rule 23A) that prohibits commercial banks from funding their brokerage affiliates with commercial bank deposits. This rule was put in to prevent the depositors in a commercial bank from losing their deposits due to losses in a trading operation on the broker/dealer side of a bank.
What does it tell you when the Federal Reserve makes two such unprecedented moves?
It tells me that the Fed realizes that they’re no longer the “lender of last resort” — they’re quickly becoming the “lender of only resort.”
The single biggest problem I have with the McCain campaign is that they have no recognition of the real issues in this bank sector implosion. They have no financial expert who appears to be keeping the campaign up to speed on the implications of these developments. Right now, neither does Obama, and Obama has no history or experience as to the trickle-down effects of a banking crisis. McCain does, because he saw the effects of the S&L crisis of the 80’s.
This is going to make the S&L crisis of the 80’s look like a mere speed bump.