Great Depression II, part II.

[White Magic]

I thought maybe we'd make a fresh start.

I really like this commentary I found on the Freakonomics blog.

Greed, Stupidity, Delusion — and Some More Greed
By John Steele Gordon
A Guest Post

Looking just at the Friday closes, it was one of those ho-hum weeks in the stock market. The Dow had ended the previous week at 11,421.99, and last Friday it closed at 11,388.44 — down 33.55 points — a measly 0.29 percent.

To be sure, in between the two closes things got a tad volatile: down 504 points on Monday, up 141 on Tuesday, down 449 on Wednesday, up 410 on Thursday, and up 368 on Friday — all on huge volume (with a record on Thursday of 10.2 billion shares). And in this remarkable week, the landscape of American capitalism changed profoundly. Great names like Merrill Lynch and Lehman Brothers will disappear, and government responsibility for backing up the financial system will increase considerably as the administration asks Congress for $700 billion in borrowing authority to handle the situation.

What happened? Simple: panic. Vast amounts of assets in the financial system became unsellable as no one knew what they were worth, and thus they were useless as collateral for loans. As a result, highly sophisticated bankers refused to lend to other highly sophisticated bankers overnight; Ma and Pa Mainstreet rushed to take their money out of uninsured money-market funds and put it in Treasury bills paying practically nothing, and in gold, which pays nothing at all (and indeed costs money for storage or insurance).

The world’s financial system came perilously close to seizing up — like an engine without oil. Had that happened, the consequences would have been very nasty indeed. Let us hope that the market’s bets on Thursday and Friday are a sign that the government is getting a handle on things.

But the first thing to do in a panic is … don’t panic! “If you can keep your head when all about you are losing theirs,” you’ll be fine.

There have been headlines that this is the worst economic crisis since the Great Depression. No. It is a financial crisis.

The underlying American economy is not in bad shape. Unemployment is at 6 percent; that’s a little high by the standards of the last decade or so, but not by longer-term standards (unemployment reached 10.8 percent as recently as 1982). In 1933, it was over 25 percent (and actually far higher, with many working part time). In 1933, G.D.P. was little more than half of what it had been in 1929.

G.D.P. has grown smartly in the last five years, even in 2008. Farm mortgages were being foreclosed at the rate of 20,000 a month in 1933. The nation’s farmers have never been so prosperous as they are today. When F.D.R. was inaugurated on March 4, 1933, banks were entirely closed in 38 states and restricted in the other 10. Over 5,000 banks had already failed by then, and had taken the savings of millions with them. Today, millions of families have substantial savings, retirement funds, and equity in real estate. In 1933, exports were one-fifth of what they had been in 1929. American exports are booming today.

In 1933, we were a country of haves and have-nots; today, we are largely a country of haves and have-mores. The poverty of the sort seen in the immortal photographs of Walker Evans simply does not exist today.

How we will get out of this mess is becoming clearer, and Congress will have to act very quickly. But the members of Congress stared into the abyss along with the rest of us last week, so my guess is that even they will act responsibly for once.

But there is no doubt at all about how we got into this mess.

To be sure, there is plenty of blame to go around. Greed, as it periodically does when traders and bankers forget the lessons of the past, clouded judgments. Some very smart people talked themselves into believing in the repeal of one of the fundamental laws of economics: risk will always equal potential reward. The idea that risk can be eliminated and high yields guaranteed is as idiotic as the idea that gravity can be suspended. Remember Long-Term Capital Management? Ten years ago it figured out how to eliminate risk using highly sophisticated computer programs and rolled up annual returns averaging 40 percent — until it collapsed in a heap.

Credit ratings agencies such as Moody’s and Standard and Poor’s gave good credit ratings to securities they didn’t understand.

But at the heart of the problem is Congress and its deeply corrupt relationship with Fannie Mae and Freddie Mac. Congress was equally at the heart of the savings and loan disaster 20 years ago and, obviously, learned nothing from it. (For a history of what led to the savings and loan collapse, see here.)

Fannie and Freddie, two of the largest publicly traded financial institutions on earth, are headquartered in Washington, D.C., where the next-largest non-governmental financial institution is probably a local credit union. Big financial companies are headquartered in New York and other cities where capitalism is practiced. That should tell you a lot about Freddie and Fannie: they were political to their fingertips.

Being “government sponsored entities,” they were able to borrow at lower interest rates than other profit-seeking companies, had less regulation, had lower capital requirements, and had an “implied” guarantee on their huge debts. This was supposed to translate into more money available for mortgages, but was used instead to roll up big profits and, not so incidentally, big bonuses for their top management — which came not from the financial world but from the political one.

Franklin Raines, Fannie C.E.O. from 1999 to 2004, had been budget director in the Clinton White House. He cooked the books at Fannie to increase his compensation (more than $50 million). Jamie Gorelick, vice C.E.O., was number two at the Clinton Justice Department before going to Fannie Mae. She made $26 million. Jim Johnson, a perennial Washington big-foot, was chairman from 1991 to 1998. He too, according to an official government report, cooked the books to increase his compensation and failed to publicly reveal how much he received.

The Wall Street Journal editorial page has been giving chapter and verse for years on why this was a disaster waiting to happen (Pulitzer Prize judges, please note). The Bush administration tried way back in 2003 to change the system. It got nowhere. Alan Greenspan, then the chairman of the Federal Reserve, frequently noted the danger of Fannie and Freddie’s weak capitalization. He was ignored. Congressman Mike Oxley, then chairman of the House Financial Services Committee, introduced a bill in 2005 to correct the situation. Lobbyists from Fannie and Freddie succeeded in gutting it to the point that Rep. Oxley pulled the bill.

Why were Fannie and Freddie so successful at maintaining the status quo? Check it out.

Senator Chris Dodd — formerly ranking member and now chairman of the Senate Banking Committee, with oversight over Freddie and Fannie — recently said on Bloomberg Television: “I have a lot of questions about where was the administration over the last eight years.”

Excuse me? Just where the hell were you, Senator? Oh, right. You were standing in line at the bank in order to deposit the political contributions Fannie and Freddie were lavishing upon you. At least they got their money’s worth — until the party ended and the American people got the bill.

Members of Congress — aided and abetted by their many waterbearers in the media — wonder why their collective approval rating is about on par with colon cancer’s. The reason is simple enough: Congress is the sick man of Washington; a textbook example of the truism that institutions tend to evolve in ways that benefit their elites, at the expense of the people they were created to serve.

[osu99jp]

O'Reilly blasts Barney Frank on Fannie & Freddie.

YouTube Video

[Tedesco]

O'Reilly is an asshole. Whatever point he is trying to make gets lost in his yelling.

[bearcat428]

i'm glad someone tried to call frank to the carpet. frank has no credibility and is suffering no consequences for this mess because he's a dem. in fact the media interviews him and quotes him like he's an outsider trying to fix the problem when he's the goddamn chairman of the house finanace committee! the guy lies constantly! he said fannie and freddie were strong two freaking weeks ago! in the last two years he didn't know they were cooking the books? hell yeah he did, what did he do? nothing, they were pushing their agenda at the expense of the american people.

[White Magic]

Update time.

Franny and I had one of our little sparring sessions on here back in July that I'd like to take a second to revisit. It involved Gold. I think everyone should own at least a little precious metal because our government has demonstrated that they are increasingly incapable of managing the value of our currency, which has no intrinsic value, only value by government fiat.

There was a commentary from Motley Fool's Nick Kapur. I recently stumbled across this rebuttal, also on Motley Fool.

I realize it's a rookie mistake to get too awfully excited about any kind of short term results in the world of finance, but since our little sparring session here are some numbers to consider:

DJI on July 17th -11,446.66
DJI today - 8,579.19
25% loss

On 7/14 Franny said:

There are some great bargains though... Cisco, RIMM, GM anyone?

Cisco on July 14th - $21.30
Cisco Today - $17.19
19% loss

RIMM on July 14th - $197.84
RIMM Today - $59.03
70% loss

GM on July 14th - $9.38
GM Today - $4.76
50% loss

GOLD
July 17th (the day the Nick Kapur article was posted) - $958.80 an ounce
Today - $916.10

4.5% loss!

If only gold could have been up over this period I would have ended up looking a lot better.

AND... I realize all of these trends will no doubt reverse and Franny will have his day to call me an idiot, but here are the numbers as of today. We can revisit them on a quarterly basis if that would be interesting to anyone.

I'm pretty sure Mr. Kapur has not posted any commentary to Motley Fool since his gold article though.

[Franny]

Gold is not a good LONG term investment. The bubble will burst. Sorry Dude.

You can find my original statement.

LONG term investment = 10+ years. I have no problem with Gold as a short term investment.

[White Magic]

Franny,

Why will this "bubble" burst? Drop some education on the people.

[Franny]

I really don't want to get into another pissing match about Gold. I said it was a bad long term investment, and I'm sticking to it. All I have is history on my side:

GOLD VS S&P

SCENARIO ONE — 30 YEARS

If you invested $1,000 in the stock market in 1977 and let it grow, you would have $36,180 after 30 years (column E).
Alternatively, if you bought $1,000 of gold in 1977, you would have 6.21 ounces of gold. In 2007, your gold would be worth $5,192 (column F). Clearly, investing in the stock market wins.

SCENARIO TWO — 20 YEARS

Stock market: $9,193
Gold: $1,719

Now sure, Gold has outperformed the S&P for several years now, it's having a good run - but history shows that it can't even keep up with inflation and there are BIG dips. As far as an impending bubble - I think it is just like anything else - you have to be very wary of anything that doesn't follow a normal trend. That's why I ditch stocks that shoot up too quickly. Only time will tell. When we're 59 1/2 we can revisit this thread and we'll compare the S&P (if it exists ) vs Gold. And remember with those numbers - Gold does not pay a dividend - ever.

[Tedesco]

According to a client of ours, the Gov't. has suspended the sale of gold? WM, do you know anything about this? According to him he couldn't sell any gold because he couldn't get any from the feds.

[White Magic]

You have a quote, but no mention of who you are quoting. Is there a link that goes with that?

Assuming for a second that your information is correct (I have my doubts, but will check) you're also making the mistake of looking backward to try and validate your prediction of a future event (The gold "bubble" bursting). I asked you to explain this bubble bursting comment - What do you see happening in the future that will adversely impact the price of gold?

And I almost hate to go here.... but the notion that gold doesn't pay a dividend - ever, is a really horrible and inappropriate aside. Lots of stocks don't pay dividends either, but that doesn't mean they are bad investments. I once had a finance professor explain dividends from this perspective: A dividend payment is a failure by company management to find a more productive use for those funds. Rather than return money to investors in the form of a dividend management could be using it to aggressively grow the company by investing in equipment, infrastructure, hiring more employees, etc. Paying a dividend is like punting.

Better knocks on gold investment is that it costs money to store it and that it costs money to insure it, but I'm not here to make your case for you.

Still love to hear about what's going to burst that bubble.

[White Magic]

Originally Posted by Tedesco

According to a client of ours, the Gov't. has suspended the sale of gold? WM, do you know anything about this? According to him he couldn't sell any gold because he couldn't get any from the feds.

The US Mint has temporarily stopped selling Gold Eagles because the demand has been so crazy. You can still get physical gold elsewhere though.

[Franny]

What do you see happening in the future that will adversely impact the price of gold?

I'll only ask you this - then make an attempt at escaping this thread....

Why is a barrel of oil - like $85 now? What was it like 3 months ago? $145+

If the shit is priced too high - demand certainly is going to plummet. Remember when I told you about the housing bubble (at 20 mile house). You got very upset with that statement. The same shit could happen with Gold. We shall see. But with the way the world economy is, we could all very well throw away 30 or 40 years of financial history out the window.

[White Magic]

Originally Posted by Franny

I'll only ask you this - then make an attempt at escaping this thread....

Why is a barrel of oil - like $85 now? What was it like 3 months ago? $145+

Crashing world economies have that effect on oil. People drive less. They go less places where they spend less money. They buy less, so things have to be shipped less. The supply/demand equation has shifted in a lot of other ways over the course of the last few months. Offshore drilling bans are being lifted. People are practically screaming, no actually screaming (Drill here, drill now) for alternatives to imported oil. The oil producers are starting to wake up to the fact that they have effectively killed the goose that lays the golden egg. Their best customers are hellbent on not buying from them anymore. So they're not asking as much for a barrel of oil these days.

[Franny]

I do want to say one last thing about gold...

This global economic "meltdown" will probably spur a big surge in Gold investment. People are totally confused about where to put their money. They don't have the same confidence they did after the 87 crash because the dynamics are so different. People don't have real cash to pick up these bargain stocks. Gold could very well go on a big run for the next few years as this continues. I'm not saying this to protect myself from any White Magic charts or graphs showing Gold's great performance, the game has just changed - literally in the last 2 weeks. Hell, 1 week.

I think we can all agree that diversification is the key. Adding some precious metals to your portfolio is sound advice, but expecting to be rich in 30 years from that investment is a risky strategy.

[White Magic]

Originally Posted by Franny

I think we can all agree that diversification is the key. Adding some precious metals to your portfolio is sound advice, but expecting to be rich in 30 years from that investment is a risky strategy.

This is all I have ever said! I'm glad we're now on the same page.