A Glimpse of the Apocalypse

Today’s New York Times has a front page story that features the concerns of the Chinese premier over the US’s ability to pay the trillion US dollars it owes Beijing. They seek assurances that the money won’t go up in smoke. As a friend of mine much smarter than me once said, “They’ll get their dollars back. Can’t promise what those dollars will be worth.” The point is (obviously to economists) that the best way for a nation (from its’ point of view) to pay off deft is to inflate the currency.

Unfortunately, this is rarely the lenders’ view. Should the Chinese stop loaning us money, the price of our bonds would have to fall so someone would want them. Uncle Sam’s crazy bond blowout! Prices so low, it’s insane!

Brief note here. As the price of a bond falls, the interest rate goes up. The dollar denomination is what you get at the maturity of the bond, either months or years from now. Here’s how it works:

I loan you $90 for your offer to pay me $100 in a year. I earn $10 for my trouble, so I get (10/90=0.11) 11% interest.

Later, I loan you $80 for your offer to pay me $100 in a year. I earn $20 for my trouble, so I get (20/90=0.22) 22% interest.

Much later I loan you $70 for your offer to pay me $100 in a year. I earn $30 for my trouble, so I get (30/90=0.33) 33% interest.

Get it? The cheaper the loan (basically a 1 year $100 bond) the higher the interest. And while the full $100 has to be paid on all three loans, until the end of the year (the maturity), the first guy is screwed if he needs his money sooner, since no one will give him the $90 he loaned, just the $70 the last guy got.

Throw in the higher inflation inevitable with falling bond prices, voila! You see why the Chinese have their knickers in a knot. They can sell (or just stop buying) and the value of their holding will fall in dollar terms immediately, or they can hold on and have the value of the dollar decline, getting back at maturity the right number of dollars, but much less value in what they can buy with these new smaller dollars.

Got it? Good.

Basically, we all know that the US Treasury isn’t like Scrooge McDuck’s basement, with piles of cash and gold lying around. To fight the Iraqi war, bail out the banks and stimulate the economy, we’ll need to borrow the money from guess who?

As noted previously, most Americans never saw this thing coming. Imagine being Chinese! They didn’t have a market economy the last time a nasty spell came around in the early 80’s. Yours truly was moving furniture for $3 an hour with an Economics degree from Trinity College. My friend who cleaned the Slurpee machine at 7/11 wasn’t a Pakistani immigrant. He was a native Californian with a Doctorate in Physical Chemistry.

I’ll be 50 this month, so I remember the hard times and have been cautious about risk, markets and debt. Any American under 50 never saw it first hand. Any Chinese of any age has never been through this. It will become very political, very contentious and very dangerous when 100 million newly middle class Chinese get sent back to the rural villages.

May you live in interesting times.

The new reality

There’s no way in hell that the economy we enjoyed for the last 25 years is coming back. No amount of stimulus, tax cutting, free trading or anything else can bring it back. It was an unsustainable bubble created by a deregulated FIRE economy (finance, insurance and real estate), denial of risk and an unprecedented use of credit and debt. It’s amusing to watch the pundits slowly catch on, but only ever so slowly.

The economy of the last 25 years is no more going to bounce back in a year or two than the NASDAQ. It was widely believed in 2000 that the index would be back to its’ peak in a matter of months. I was literally laughed at for saying it could take a decade. Looks like I might have been too optimistic, since at under 1600 it’s off its’ peak of over 5000 by what, about 70%? How’s that Enron stock holding up?

So in my view it’s a given that credit will be very, very much more rare in the future. I’m not sure the credit card companies will be able to survive it, but the rest of us will manage to muddle through. Once again, one will have to save up to buy a car. Doesn’t say much for demand for new cars does it? Sorry Detroit.

Same for flat screen TV’s, video games, computers, MP3 players, cell phones and all the other extras we’ve come to believe we not only need, but deserve. Sorry China. Sorry Best Buy.

I expect to see a lot more cohabiting, and hopefully more niceness. When everyone is skating on thin ice financially, wouldn’t it be nice to see acts of kindness as self-insurance in the case that your situation falls apart? It’s going to be easier to crash in someone’s spare room and help with the rent if you did the same for them before your situations reversed themselves.

Here’s another thought somebody clever will come up with- a value menu at local restaurants. You know, rice and beans for a buck. Maybe takeout only. Maybe with donated ingredients. Food will definitely be viewed and consumed differently. The fast food industry is going to either adapt and change or go the way of the dodo.

The other thing will be housing. There already exists a huge number of foreclosed and vacant houses in America. It’s in nobody’s best interest for them to remain vacant. They represent a nearly worthless asset to the banks that seized them. I believe there’s a great business opportunity for someone to manage renting out rooms in foreclosed houses and getting people housed, as well as getting the banks something for their investment.

Hello? Underemployed real estate workers this is your opportunity!

Yikes! It's worse than I thought!

Okay, I knew there was going to be a really nasty, long and slow recovery for the financial system, and I’ve been accused of being Chicken Little more than once, but all I can say is Holy Fucking Shit. My bud, Eric Janszen (third smartest man in the world) posted a bit over on iTulip that explains why none of the injecting, pumping and flooding of cash into the financial system can do any good. The piece requires a rudimentary knowledge of economics as well as financial and monetary policy, but the guts of it are as follows.

I made much the same case a few days back but when Eric tells it it’s more compelling and scary. Basically, the major banks shared their risks by buying and selling each other credit default swaps (CDS) so if their bets went bad, somebody would bail them out. An excellent metaphor in a comment on Eric’s post states that it was like a bunch of swimmers tying themselves together far at sea for safety, and then immediately take on more weight than they can handle, thus all sinking together. Basically and collectively they owe more money than there is in the world, something like most of a quadrillion dollars. That’s $1,000,000,000,000,000.00.

Hence the “Holy Fucking Shit” comment above. That’s about $150,000 for every man, woman and child on earth, or about three million dollars for every American. That much money simply does not exist. The American, and therefore global financial system is dead. Kaput. Finished. And no bailout is going to help.

Man! This thing is unwinnable. If you have any dollars at all, and live in a first world country, this stuff is really important to learn and understand.

The size of the problem

The problem with this financial tsunami is getting the average dude/chick on the street to grasp just what madness the monsters of Wall Street and Greenwich have put us in and just how hard it will be to get out of. Plain and simple, debt is not wealth. But it was treated that way for the last 25 years, and the result if all the borrowing and crazy, highly leveraged (that means borrowing by the truckload) derivative deals.

The sub-prime mortgage is peanuts compared what these Wall Street wizards have come up with. Remember, the motivation here is that you get a big chunk of winnings if you win, and at worst you lose your job if you don’t.

Think about it. Someone hands you $100 in a casino, and tells you can keep 20% of the winnings, and if you lose you have to leave the casino. Logically, you want to make the highest paying bet, no matter the odds. I’d drop it on roulette; it pays 17 to 1. So you take a shot and win 20% of $1800, or $360. Sweet! You made more than you bet. Now add in the concept of being able to borrow $10,000 because you have that original bet. Win now and your personal payday is $36,000. Lose now, and you don’t just leave the casino, you owe it $10,000.

That almost exactly what happened on Wall Street with something called a credit default swap, or CDS. It works like insurance for corporate bonds, but you buy them whether you have the bond or not. Like buying life insurance on someone else. There are an estimated $65,000,000,000,000 (sixty-five trillion dollars) worth of these out there, and nobody is sure who or where they are. To compare, every mortgage in America adds up to about $13,000,000,000,000 (thirteen trillion dollars).

When the CDS market collapses (as it must) the net losses are FIVE TIMES the effect of every home in America with a mortgage gets foreclosed and never sold again. Fun stuff, huh? Now get this; the CDS market is only about 10% of the total derivatives market, estimated at $650,000,000,000,000 (six hundred trillion dollars).

To sum up, the toxic loans, deals and derivatives on the books of the world’s banks, pension funds, college endowments are worth fifty times the value of every mortgage in America. The current economic decline cannot end until this debt goes away. One teeny problem is that there isn’t this much money in the world. This is so much more than any sub-prime mortgage, and the next asshole who tells me it’s the fault of lefty do-gooders helping poor people houses they couldn’t afford and political contributions by Fannie and Freddie is gonna get hit.

Timeframes to fix things

My brother posted a comment that really is worth a full on rant. It was also the inspiration for the short prohibition rant, so thanks for that, Bubba. The chattering class and the Sabbath gasbags seem to be treating the current economic crisis as something that can be turned around by Christmas. If we just figure out which lever to pull, everything will be fine and we’ll be refinancing our houses for flat screen TVs and all will be well with the world. No, no, no, a thousand times no.

Anyone who’s been listening to me the last, what 4 or 5 years, knows I expect the end of capitalism and our living standards as we’ve know them the last quarter century. Anyone under 50 has never been an adult in a REAL recession, and I can tell you they suck big time. I got out of college and started looking for work the exact month unemployment hit its post WWII peak at almost 10%.

Let me tell you that sucks big time. The guy cleaning the Slurpee machine at 7-11 had a PhD in physical chemistry. No shit. I moved furniture for $3 an hour for six months, with a freshly minted BA in Economics from a snotty New England college, hustled my ass off and got nothing but hundreds of rejection letters.

Anyway, compared to the 1930’s and the shit coming down the pike, that was a walk in the park. In the immortal words of Bob Marley, a hungry mob is an angry mob. When was the last time you saw a mob of hungry Americans? Sure there are pockets of poverty that bad in America, but when it’s all you’ve ever know, it’s different. I’m talking former real estate agents, former bankers, former hedge fund quants, real live hungry, angry, no make that furious, previously spoiled and entitled upper-middle class Americans actually spending days, weeks and months without nearly enough to eat. How pissed will they be? How pissed would you be? I know how pissed I’d be, and I’m not even the violent type.

How can an American administration react in the face of widespread, I mean really widespread, Dustbowl style poverty and hunger? I’m one hell of a lot more optimistic about Obama/Biden handling it than Bush/Cheney. (Concentration camps? Americans at Gitmo?)

Think about it, we can’t just have thousands of Americans living on the streets, on a constant prowl for food. Churches have always pissed me off by their very existence, as they represent a waste of resources for a guy who doesn’t need a house, being empty 99% of the time and NOT providing for people who really need shelter. Maybe to keep their tax-exempt status, the churches would be required to offer up half of their total floor space for people needing a roof over their heads.

I can hear the squeals of complaint about socialism and God helps those who help themselves and why don’t they just get jobs. Such has become the state of the church in America. If anyone cares to actually read the New Testament, I can’t think of anything Jesus would more approve of, but I guarantee not 1% of American Christian churches, in a nation housing crisis and in the midst of Great Depression 2, will open their doors to people needing a place to crash. On second thought, the Unitarians would, but they aren’t “real” Christians anyway.

Imagine thousands of acres of tents, pallets of MRE's, virtual refugee camps right here in the good ol' US of A. Imagine the politics of this country would change in a way that will make the last election look like a reelection.

Bottom line here is that we are in for a very rough 8 or 10 years, that very few living Americans can recall or even imagine. I wonder how we’ll get through it? We’ll certainly see the best and the worst of people, cuz nothing brings out one’s true nature like true need.

Full on Depression, part deux

It’s remarkable how much of the punditry has been getting this economy so wrong for so long and people keep booking them as experts, people buy their books and take their advice on faith. They are condescending and so often so wrong. Here’s a Fox News tidbit: “The Dow Jones industrial average is down more than one-third from its high a year ago. The stock market lost 89% of its value from its peak during the Great Depression.”

Okay, we’re down 50% now (the article was from last month) after a single year, but from 1929 to 1932 it went down 89%. Apples to apples my journalists Chernobyls. Let check back in 2 years, shall we? Next, of course, it’s not the GD ‘cause there aren’t soup lines. A more accurate assessment would have ended that sentence with the additional word, “yet”.

Next comes “buy and hold” as an investment strategy for US equities. I got out in the 90’s and never got back in. Let’s see, I got out of stocks just about 10 years ago this month. If I had bought and held, how would I be doing? Considering the fact that it was mostly WorldCom stock, it would have dropped to zero.

How about the Dow Jones? 99% of financial advisor would tell a 55-year-old man in 1998 to be in stocks in a big way. At 65, this year, there have to be a hell of a lot of people feeling like they played by the rules, but got screwed anyway. Not even counting interest and it was not a clever move.

Here’s an average guy doing pretty well. Let’s see what he’s got. In 1998, he buys a modest $250,000 house with a 30 year fixed mortgage at 9%, with 20% down. He has a solid $100,000 in his retirement fund (above average in US), and feels better and better about life as retirement approaches. Actually, he’s feeling downright smug. Flash forward 10 years.

As the kids needed to pay for college, it was handy to refinance as the value of the home shot up, reaching $600,000 a few years back. No need to stuff as much money into the retirement fund, since we’re feeling house rich. Make contribution of $2,000 a month and enjoy the rest. You’ve earned it. Time to refi for that sporty little Mercedes he’d been eying, and the feeling that with the house getting so valuable, the $500,000 in total mortgage and home equity lines of credit was handle able.

$100,000 in the Dow on November 27, 1998 would be worth $80,909 by last night’s close. The Dow went from 9334 to 7552 in those 10 years. The $2000 annual contributions get him almost all the way back to the $100,000 he started with back in 1998, but ravaged by fees and inflation.

Now the house, valued at $350,000 is seriously underwater with $500,000 in loans on it, and his almost $100,000 retirement fund can’t cover the gap. Welcome to the new retirement folks. Entering retirement with a net worth well below zero is going to be a bitch. And common. And heartbreaking for people who just did what they were told to.

We need a better social safety not to mention a social contract, and some of the big winners of the last quarter century are going to have to cough it up to pay for it. The rich bastards talk a good game, but they’ll fold like a house of cards the first time pictures like this surface. Visualize the scene of a public barbecue. Children playing, people drinking beer and sharing potluck. Men are taking turns with the handle on the spit. There are a few cops and the ambulance guys are there and it’s all pretty festive. That’s when you notice the body on the spit over the coals with the apple in it’s mouth is the field dressed body of the abusive rich bastard who closed the local factory and sent the work to China to save a few pennies on labor. No jury anywhere in the new America would convict anyone involved. The arrogant few who have been raping America these last decades talk tough, but the tough talk stops when they stop to realize what real class warfare looks like.