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  • Plan B: Last chance to avoid financial system failure

    Plan B

    The Paulson plan will not work. This one has a chance.


    by Luigi Zingales (iTulip) Robert C. Mc Cormack Professor of Entrepreneurship and Finance, University of Chicago - GSB

    After pointing a gun to the head of Congress, threatening a financial meltdown in case his plan was not approved, Treasury Secretary Hank Paulson has finally arrived at the only logical conclusion: his plan will not work.

    Desperate for a Plan B, Paulson is slowly warming to the suggestion of many economists: inject some equity into the banking system. Unfortunately, it is too little and too late. The confidence crisis currently affecting the financial system is so severe that only a massive infusion of equity capital can reassure the market that the major banks will not fail, recreating the confidence for banks to lend to each other. The piecemeal approach of 100 billion today, 100 billion tomorrow used with AIG will not work. It will only eat up the money, without achieving the desired effect—without reassuring the market that the worst is over. Simply stated, nothing short of a 5% increase in the equity capital of the banking system will do the trick. We are talking about 600 billion. Unfortunately, even if the government is willing to spend this kind of money, there are three problems.

    First, to restore the necessary confidence, a capital infusion needs to reduce a financial institutions’ risk of default to trivial levels. This implies transforming the existing, outstanding debt (roughly two trillion if we just count the long-term bonds) into safe debt. A large fraction of the equity injected will not go to generate new loans, but to provide this insurance to the existing debtholders. How much? We can estimate it by looking at the credit default swaps, which provide us with the cost of insuring the debt against default. At yesterday’s prices, the cost of insuring the two trillion of outstanding long-term bonds outstanding would be more than 300 billion. Consequently, half of the capital the Government will invest in banks will not go to increase new loans, but to bail out Wall Street investors.

    Second, a capital infusion does not address the root of the problem, which stems from the housing market. If homeowners continue to default and walk away from their houses, the banking sector will continue to bleed and additional equity infusions will be needed. More importantly, the very bailout plan, and the animosity it generates, will induce more homeowners who are sitting on a house with a negative equity value to walk away. Many of them will think: “Why do I have to play by the rules when Wall Street does not?”

    This leads us to the third and most important problem. If we bail out Wall Street, why not bail out Detroit (probably another 150 billion) and Main Street? In fact, Senator McCain has already talked about buying out the defaulted mortgages to keep people in their homes. Even if we limit ourselves only to the subprime mortgages, we are talking about $1.3 trillion. Where do we stop?

    We need a different solution: a Plan B. A plan that minimizes the money the Government uses in bailing out Wall Street and Main Street to save our precious dollars for a stimulus package, which will be essential to restarting the economy.

    Rescuing Main Street


    Suppose that you bought a house in California in 2006. You paid $400,000 with only 5% down. Unfortunately, during the last two years the value of your house dropped by 30%; thus, you now find yourself with a mortgage worth $380,000 and a house worth $280,000. Even if you can afford your monthly payment (and you probably cannot), why should you struggle to pay the mortgage when walking away will save you $100,000, more than most people can save in a lifetime? However, when the homeowner walks away, the mortgage holder does not recover $280,000. The foreclosure process takes some time during which the house is not properly maintained and further deteriorates in value. The recovery rate in standard mortgage foreclosures (which will not take place in the middle of the worst crisis since the Great Depression) is 50 cents per dollar of the mortgage. I am generous in estimating that under the current conditions it might recover 50 cents per dollar of the appraised value of the house; right now, it is only 37 cents per dollar of the mortgage, which given a house appraised at $280,000 equals only $140,000 for the mortgage holder. In other words, foreclosing is costly for both the borrower and the lender. The mortgage holder gains only half of what is lost by the homeowners, due to what we economists call underinvestment: the failure to maintain the house.

    In the old days, when the mortgage was granted by your local bank, there was a simple solution to this tremendous inefficiency. The bank forgave part of your mortgage; let’s say 30%. This creates a small positive equity value—an incentive—for you to stay. Since you stay and maintain the house, the bank gets its $266,000 dollars of the new debt back, which trumps the $140,000 that it was getting through foreclosure.

    Unfortunately, this win-win solution is not possible today. Your mortgage has been sold and repackaged in an asset-backed security pool and sold in tranches with different priorities. There is disagreement on who has the right to renegotiate and renegotiation might require the agreement of at least 60% of the debt holders, who are spread throughout the globe. This is not going to happen. Furthermore, unlike your local bank, distant debt holders cannot tell whether you are a good borrower who has been unlucky or somebody just trying to take advantage of the lender. In doubt, they do not want to cut the debt for fear that even the homeowners who can easily afford their mortgage will ask for debt forgiveness.

    Here is where government intervention can help. Instead of pouring money to either side, the government should provide a standardized way to re-negotiate; one that is both fast and fair. Here is my proposal.

    Congress should pass a law that makes a re-contracting option available to all homeowners living in a zip code where house prices dropped by more than 20% since the time they bought their property. Why? Because there is no reason to give a break to inhabitants of Charlotte, North Carolina, where house prices have risen 4% in the last two years.

    How do we implement this? Thanks to two brilliant economists, Chip Case and Robert Shiller, we have reliable measures of house price changes at the zip code level. Thus, by using this real estate index, the re-contracting option will reduce the face value of the mortgage (and the corresponding interest payments) by the same percentage by which house prices have declined since the homeowner bought (or refinanced) his property. Exactly like in my hypothetical example above.

    In exchange, however, the mortgage holder will receive some of the equity value of the house at the time it is sold. Until then, the homeowners will behave as if they own 100% of it. It is only at the time of sale that 50% of the difference between the selling price and the new value of the mortgage will be paid back to the mortgage holder. It seems a strange contract, but Stanford University successfully implemented a similar arrangement for its faculty: the university financed part of the house purchase in exchange for a fraction of the appreciation value at the time of exit.

    The reason for this sharing of the benefits is twofold. On the one hand, it makes the renegotiation less appealing to the homeowners, making it unattractive to those not in need of it. For example, homeowners with a very large equity in their house (who do not need any restructuring because they are not at risk of default) will find it very costly to use this option because they will have to give up 50% of the value of their equity. Second, it reduces the cost of renegotiation for the lending institutions, which minimizes the problems in the financial system.

    Since the option to renegotiate offered by the American Housing Rescue & Foreclosure Prevention Act does not seem to have been stimulus enough, this re-contracting will be forced on lenders, but it will be given as an option to homeowners, who will have to announce their intention in a relatively brief period of time.

    The great benefit of this program is that provides relief to distressed homeowners at no cost to the Federal government and at the minimum possible cost for the mortgage holders. The other great benefit is that it will stop defaults on mortgages, eliminating the flood of houses on the market and thus reducing the downside pressure on real estate prices. By stabilizing the real estate market, this plan can help prevent further deterioration of financial institutions’ balance sheets. But it will not resolve the problem of severe undercapitalization that these institutions are currently facing. For this we need the second part of the plan.

    Rescuing Wall Street

    The plan for Wall Street follows the same main idea: facilitating an efficient renegotiation. The key difference between the Main Street and Wall Street plans is in the ease of assessing the current value of the troubled assets. It is relatively easy to estimate the current value of a house by looking at the purchase price and at the intervening drop in value (per the Case and Shiller index). In banks, however, the lack of transparency makes this estimation very difficult. To avoid having to come up with this estimate, which would be a difficult process and one fraught with potential conflict of interests, we are going to use a clever mechanism invented twenty years ago by a lawyer economist, Lucian Bebchuk.

    The core idea is to have Congress pass a law that sets up a new form of prepackaged bankruptcy that would allow banks to restructure their debt and restart lending. Prepackaged means that all the terms are pre-specified and banks could come out of it overnight. All that would be required is a signature from a federal judge. In the private sector the terms are generally agreed among the parties involved, the innovation here would be to have all the terms pre-set by the government, thereby speeding up the process. Firms who enter into this special bankruptcy would have their old equityhodlers wiped out and their existing debt (commercial paper and bonds) transformed into equity. This would immediately make banks solid, by providing a large equity buffer. As it stands now, banks have lost so much in junk mortgages that the value of their equity has tumbled nearly to zero. In other words, they are close to being insolvent. By transforming all banks’ debt into equity this special Chapter 11 would make banks solvent and ready to lend again to their customers.

    Certainly, some current shareholders might disagree that their bank is insolvent and would feel expropriated by a proceeding that wipes them out. This is where the Bebchuk mechanism comes in handy. After the filing of the special bankruptcy, we give these shareholders one week to buy out the old debtholders by paying them the face value of the debt. Each shareholder can decide individually. If he thinks that the company is solvent, he pays his share of debt and regains his share of equity. Otherwise, he lets it go.

    My plan would exempt individual depositors, which are federally ensured. I would also exempt credit default swaps and repo contracts to avoid potential ripple effect through the system (what happened by not directing Lehman Brothers through a similar procedure). It would suffice to write in this special bankruptcy code that banks who enter it would not be considered in default as far as their contracts are concerned.

    How would the government induce insolvent banks (and only those) to voluntarily initiate these special bankruptcy proceedings? One way is to harness the power of short-term debt. By involving the short-term debt in the restructuring, this special bankruptcy will engender fear in short-term creditors. If they think the institution might be insolvent, they will pull their money out as soon as they can for fear of being involved in this restructuring. In so doing, they will generate a liquidity crisis that will force these institutions into this special bankruptcy.

    An alternative mechanism is to have the Fed limit access to liquidity. Both banks and investment banks currently can go to the Federal Reserve’s discount window, meaning that they can, by posting collateral, receive cash at a reasonable rate of interest. Under my plan, for the next two years only banks that underwent this special form of bankruptcy would get access to the discount window. In this way, solid financial institutions that do not need liquidity are not forced to undergo through this restructuring, while insolvent ones would rush into it to avoid a government takeover.

    Another problem could be that the institutions owning the debt, which will end up owning the equity after the restructuring, might be restricted by regulation or contract to holding equity. To prevent a dumping of shares that would have a negative effect on market prices, it is enough to include a norm that allows these institutions two years to comply with the norm. This was the standard practice in the old days when banks, who could not own equity, were forced to take some in a restructuring.

    The beauty of this approach is threefold. First, it recapitalizes the banking sector at no cost to taxpayers. Second, it keeps the government out of the difficult business of establishing the price of distressed assets. If debt is converted into equity, its total value would not change, only the legal nature of the claim would. Third, this plan removes the possibility of the government playing God, deciding which banks are allowed to live and which should die; the market will make those decisions.

    Tomorrow is too late

    The United States (and possibly the world) is facing the biggest financial crisis since the Great Depression. There is a strong quest for the government to intervene to rescue us, but how? Thus far, the Treasury seems to have been following the advice of Wall Street, which consists in throwing public money at the problems. However, the cost is quickly escalating. If we do not stop, we will leave an unbearable burden of debt to our children.

    Time has come for the Treasury secretary to listen to some economists. By understanding the causes of the current crisis, we can help solve it without relying on public money. Thus, I feel it is my duty as an economist to provide an alternative: a market-based solution, which does not waste public money and uses the force of the government only to speed up the restructuring. It may not be perfect, but it is a viable avenue that should be explored before acquiescing to the perceived inevitability of Paulson’s proposals.

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    Last edited by FRED; 10-13-08, 10:56 AM.
    Ed.

  • #2
    Re: Plan B: Last chance to avoid financial system failure

    This money thrown at the system has come from nations with large dollar reserves, i.e. ex-US.

    I fail to see how this is anything other than reflationary, and mildly, at that.

    Comment


    • #3
      Re: Plan B: Last chance to avoid financial system failure

      Originally posted by Luigi Zingales View Post

      Rescuing Main Street


      Suppose that you bought a house in California in 2006. You paid $400,000 with only 5% down. Unfortunately, during the last two years the value of your house dropped by 30%; thus, you now find yourself with a mortgage worth $380,000 and a house worth $280,000. Even if you can afford your monthly payment (and you probably cannot), why should you struggle to pay the mortgage when walking away will save you $100,000, more than most people can save in a lifetime? However, when the homeowner walks away, the mortgage holder does not recover $280,000. The foreclosure process takes some time during which the house is not properly maintained and further deteriorates in value. The recovery rate in standard mortgage foreclosures (which will not take place in the middle of the worst crisis since the Great Depression) is 50 cents per dollar of the mortgage. I am generous in estimating that under the current conditions it might recover 50 cents per dollar of the appraised value of the house; right now, it is only 37 cents per dollar of the mortgage, which given a house appraised at $280,000 equals only $140,000 for the mortgage holder. In other words, foreclosing is costly for both the borrower and the lender. The mortgage holder gains only half of what is lost by the homeowners, due to what we economists call underinvestment: the failure to maintain the house.

      In the old days, when the mortgage was granted by your local bank, there was a simple solution to this tremendous inefficiency. The bank forgave part of your mortgage; let’s say 30%. This creates a small positive equity value—an incentive—for you to stay. Since you stay and maintain the house, the bank gets its $266,000 dollars of the new debt back, which trumps the $140,000 that it was getting through foreclosure.

      Unfortunately, this win-win solution is not possible today. Your mortgage has been sold and repackaged in an asset-backed security pool and sold in tranches with different priorities. There is disagreement on who has the right to renegotiate and renegotiation might require the agreement of at least 60% of the debt holders, who are spread throughout the globe. This is not going to happen. Furthermore, unlike your local bank, distant debt holders cannot tell whether you are a good borrower who has been unlucky or somebody just trying to take advantage of the lender. In doubt, they do not want to cut the debt for fear that even the homeowners who can easily afford their mortgage will ask for debt forgiveness.

      Here is where government intervention can help. Instead of pouring money to either side, the government should provide a standardized way to re-negotiate; one that is both fast and fair. Here is my proposal.

      Congress should pass a law that makes a re-contracting option available to all homeowners living in a zip code where house prices dropped by more than 20% since the time they bought their property. Why? Because there is no reason to give a break to inhabitants of Charlotte, North Carolina, where house prices have risen 4% in the last two years.

      How do we implement this? Thanks to two brilliant economists, Chip Case and Robert Shiller, we have reliable measures of house price changes at the zip code level. Thus, by using this real estate index, the re-contracting option will reduce the face value of the mortgage (and the corresponding interest payments) by the same percentage by which house prices have declined since the homeowner bought (or refinanced) his property. Exactly like in my hypothetical example above.

      In exchange, however, the mortgage holder will receive some of the equity value of the house at the time it is sold. Until then, the homeowners will behave as if they own 100% of it. It is only at the time of sale that 50% of the difference between the selling price and the new value of the mortgage will be paid back to the mortgage holder. It seems a strange contract, but Stanford University successfully implemented a similar arrangement for its faculty: the university financed part of the house purchase in exchange for a fraction of the appreciation value at the time of exit.

      The reason for this sharing of the benefits is twofold. On the one hand, it makes the renegotiation less appealing to the homeowners, making it unattractive to those not in need of it. For example, homeowners with a very large equity in their house (who do not need any restructuring because they are not at risk of default) will find it very costly to use this option because they will have to give up 50% of the value of their equity. Second, it reduces the cost of renegotiation for the lending institutions, which minimizes the problems in the financial system.

      Since the option to renegotiate offered by the American Housing Rescue & Foreclosure Prevention Act does not seem to have been stimulus enough, this re-contracting will be forced on lenders, but it will be given as an option to homeowners, who will have to announce their intention in a relatively brief period of time.

      The great benefit of this program is that provides relief to distressed homeowners at no cost to the Federal government and at the minimum possible cost for the mortgage holders. The other great benefit is that it will stop defaults on mortgages, eliminating the flood of houses on the market and thus reducing the downside pressure on real estate prices. By stabilizing the real estate market, this plan can help prevent further deterioration of financial institutions’ balance sheets. But it will not resolve the problem of severe undercapitalization that these institutions are currently facing. For this we need the second part of the plan.
      I think this is a great idea, but I question how it would be accomplished given the sliced and repackaged nature of mortgages mentioned above. How would the partial default (forgiveness) and subsequent equity interest be divided amongst the tranches?

      Here's an idea: Sell the "50% equity" holding on the open market and give the proceeds to the mortgage issuer. Then it's a cut and dry partial default and the lower tranches realize their loss immediately. The homeowner could even bid for the 50% equity, perhaps tapping retirement funds to retain 100% equity in the home.

      The second problem I see is that of second mortgages and HELOCs. Wouldn't the forgiveness hit them the hardest, possibly wiping them out completely? In the hypothetical example above, the house would likely have an 80% first ($320k) and a 15% second ($60k). Since second mortgages subordinate, that $60k is of no consequence to the issuer of the first. They are legally entitled to the first $320k of any sale or foreclosure. In this proposed forced renegotiation, they would expect to receive the full $280k, as well as the partial equity stake. The HELOC would be wiped out completely, perhaps seeking recourse as a credit card might, depending on the state.

      Another feature I would add is that the homeowner would be required to stay in the home for a minimum of 5 years. This would allow the bank's equity stake to recoup some of the losses and prevent flipping.

      I also don't see the big need for limiting participation based on Case-Shiller. If you live in Charlotte you should have positive equity, and the program would not benefit you. Nobody would give up 50% of future equity gains unless they are getting a significant reduction in principal and payment.

      Originally posted by Luigi Zingales View Post
      Rescuing Wall Street

      The plan for Wall Street follows the same main idea: facilitating an efficient renegotiation. The key difference between the Main Street and Wall Street plans is in the ease of assessing the current value of the troubled assets. It is relatively easy to estimate the current value of a house by looking at the purchase price and at the intervening drop in value (per the Case and Shiller index). In banks, however, the lack of transparency makes this estimation very difficult. To avoid having to come up with this estimate, which would be a difficult process and one fraught with potential conflict of interests, we are going to use a clever mechanism invented twenty years ago by a lawyer economist, Lucian Bebchuk.

      The core idea is to have Congress pass a law that sets up a new form of prepackaged bankruptcy that would allow banks to restructure their debt and restart lending. Prepackaged means that all the terms are pre-specified and banks could come out of it overnight. All that would be required is a signature from a federal judge. In the private sector the terms are generally agreed among the parties involved, the innovation here would be to have all the terms pre-set by the government, thereby speeding up the process. Firms who enter into this special bankruptcy would have their old equityhodlers wiped out and their existing debt (commercial paper and bonds) transformed into equity. This would immediately make banks solid, by providing a large equity buffer. As it stands now, banks have lost so much in junk mortgages that the value of their equity has tumbled nearly to zero. In other words, they are close to being insolvent. By transforming all banks’ debt into equity this special Chapter 11 would make banks solvent and ready to lend again to their customers.

      Certainly, some current shareholders might disagree that their bank is insolvent and would feel expropriated by a proceeding that wipes them out. This is where the Bebchuk mechanism comes in handy. After the filing of the special bankruptcy, we give these shareholders one week to buy out the old debtholders by paying them the face value of the debt. Each shareholder can decide individually. If he thinks that the company is solvent, he pays his share of debt and regains his share of equity. Otherwise, he lets it go.

      My plan would exempt individual depositors, which are federally ensured. I would also exempt credit default swaps and repo contracts to avoid potential ripple effect through the system (what happened by not directing Lehman Brothers through a similar procedure). It would suffice to write in this special bankruptcy code that banks who enter it would not be considered in default as far as their contracts are concerned.

      How would the government induce insolvent banks (and only those) to voluntarily initiate these special bankruptcy proceedings? One way is to harness the power of short-term debt. By involving the short-term debt in the restructuring, this special bankruptcy will engender fear in short-term creditors. If they think the institution might be insolvent, they will pull their money out as soon as they can for fear of being involved in this restructuring. In so doing, they will generate a liquidity crisis that will force these institutions into this special bankruptcy.

      An alternative mechanism is to have the Fed limit access to liquidity. Both banks and investment banks currently can go to the Federal Reserve’s discount window, meaning that they can, by posting collateral, receive cash at a reasonable rate of interest. Under my plan, for the next two years only banks that underwent this special form of bankruptcy would get access to the discount window. In this way, solid financial institutions that do not need liquidity are not forced to undergo through this restructuring, while insolvent ones would rush into it to avoid a government takeover.

      Another problem could be that the institutions owning the debt, which will end up owning the equity after the restructuring, might be restricted by regulation or contract to holding equity. To prevent a dumping of shares that would have a negative effect on market prices, it is enough to include a norm that allows these institutions two years to comply with the norm. This was the standard practice in the old days when banks, who could not own equity, were forced to take some in a restructuring.

      The beauty of this approach is threefold. First, it recapitalizes the banking sector at no cost to taxpayers. Second, it keeps the government out of the difficult business of establishing the price of distressed assets. If debt is converted into equity, its total value would not change, only the legal nature of the claim would. Third, this plan removes the possibility of the government playing God, deciding which banks are allowed to live and which should die; the market will make those decisions.
      I don't know much about bankruptcy, but allowing the wiped-out stockholders to pony up additional cash to buy out the bonds at face value doesn't sound like a good deal for the stockholders to me. Isn't this completely dependent upon the company's debt/equity ratio?

      Jimmy

      Comment


      • #4
        Re: Plan B: Last chance to avoid financial system failure

        Originally posted by jimmygu3 View Post
        I think this is a great idea, but I question how it would be accomplished given the sliced and repackaged nature of mortgages mentioned above. How would the partial default (forgiveness) and subsequent equity interest be divided amongst the tranches?

        Here's an idea: Sell the "50% equity" holding on the open market and give the proceeds to the mortgage issuer. Then it's a cut and dry partial default and the lower tranches realize their loss immediately. The homeowner could even bid for the 50% equity, perhaps tapping retirement funds to retain 100% equity in the home.
        good Idea i think

        Originally posted by jimmygu3 View Post
        The second problem I see is that of second mortgages and HELOCs. Wouldn't the forgiveness hit them the hardest, possibly wiping them out completely? In the hypothetical example above, the house would likely have an 80% first ($320k) and a 15% second ($60k). Since second mortgages subordinate, that $60k is of no consequence to the issuer of the first. They are legally entitled to the first $320k of any sale or foreclosure. In this proposed forced renegotiation, they would expect to receive the full $280k, as well as the partial equity stake. The HELOC would be wiped out completely, perhaps seeking recourse as a credit card might, depending on the state.

        Another feature I would add is that the homeowner would be required to stay in the home for a minimum of 5 years. This would allow the bank's equity stake to recoup some of the losses and prevent flipping.
        good point, I guess second mortgage holders will get screwed, someone has to.

        Originally posted by jimmygu3 View Post
        I also don't see the big need for limiting participation based on Case-Shiller. If you live in Charlotte you should have positive equity, and the program would not benefit you. Nobody would give up 50% of future equity gains unless they are getting a significant reduction in principal and payment.
        the article said only postcodes with price declines more than 20% would be offered the plan, also, homeowners have a choice if they wan to take the plan too, but the bank has to offer it to homeowners in distressed suburbs



        Originally posted by jimmygu3 View Post
        I don't know much about bankruptcy, but allowing the wiped-out stockholders to pony up additional cash to buy out the bonds at face value doesn't sound like a good deal for the stockholders to me. Isn't this completely dependent upon the company's debt/equity ratio?
        this is point I think, if the bank is poor the stock holders wouldn't shore up the liquidity and therefore being forced into the bankruptcy is justified, if the bank is solvent they would support the liquidity....they're saying put you're money where you're mouth is

        Jimmy[/quote]

        Comment


        • #5
          Re: Plan B: Last chance to avoid financial system failure

          Losses are losses.

          1) Insure all deposits in banks (not investment banks)
          2) Insure all short term loans in circulation (interbank market).
          3) Pick a bunch of retail (non fancy) banks and say these banks will never go bust.
          4) Allow private equity/capital to feed on the weak banks and restart the new cycle of banking.

          Jim Rogers said: In 1966 all of Japans banks went bust, the pain was quick, the new start up banks became the back drop for 20 years of excellent growth (then it went wrong for another reason in the 1990s).

          The housing market is like any market it cant be fudge to go in a direction it doesnt want to. Rising unemployment cant be stopped.

          Bailouts of any other type is just buying time, which may be ok, but its not the fix. There will be losses.

          I just read that the FASB is changing the accounting rules ASAP(http://www.financialweek.com/apps/pb.../REG/810069981)

          .."Q3 earnings may surprise due to mark-to-model accounting: analyst"..

          Whats next !!

          Comment


          • #6
            Re: Plan B: Last chance to avoid financial system failure

            "...Thus, I feel it is my duty as an economist to provide an alternative: a market-based solution, which does not waste public money and uses the force of the government only to speed up the restructuring."

            hmmm. we are suffering from a "market-based" problem (ie, too little regulation)... the solution is hardly to be found through less regulation and more financial smoke and mirrors.

            I don't even believe in "free markets" - markets exist now the same as they did in medieval times - acolytes attempting to find favor with the king; although these days the king is no longer a God's chosen representative. the King now is our central bank.

            and just like in medieval times, the kings gold is being shoveled into his supporter's pockets

            how many times have I reminded self-styled economists that Milton Friedman, at the end of his life, admitted he was wrong - inflation is not monetary phenomenon. but neither is it a "too much money chasing too few goods". inflation is best defined according to it's historical usage - proximity to the king, in times of war. where the king and his gold tread, prices spike.

            I believe the boom since 2001 has been 100% dependent on the growth of the derivatives market - global growth has been fueled from the crumbs of this 500 Trillion dollar monster; and as "economists" and "market players" wake up to the fact the derivatives monster is dead, the wake up call that follows will be worse than market dislocation...

            its time to "unfinancialize" our perception. the days of financialization are over. it's back to life Main St for those of us who survive this "monetary" collapse

            doom and gloom

            Comment


            • #7
              Re: Plan B: Last chance to avoid financial system failure

              Interesting ideas, might well work tho I'm not qualified to say. It seems that in the last few weeks many economists have ventured forth to offer possible solutions to the crisis. Most revolve around a common set of themes - equity injections, special forms of bankruptcy, etc, but differ in details that could end up having significance. It doesn't look like there is time for the public or public representatives to figure out which is the "best" plan. This form of crisis by its nature requires eve-of-disaster decision making.

              As a lay-person the thing that bothers me about this is, why wasn't there a well thought out plan already in place? It's not as if this sort of thing hasn't happened before. If special forms of bankruptcy might be needed for banks in a liquidity crisis, why don't they already exist?

              It's not just policy-makers who are at fault here, but also economists. When push came to shove, the profession was not able to stand up and say with one voice, "We know how to solve this - we figured it out years ago". What the hell were all those Nobel prizes for, anyway?

              Comment


              • #8
                Re: Plan B: Last chance to avoid financial system failure

                Originally posted by FRED View Post
                Thus far, the Treasury seems to have been following the advice of Wall Street, which consists in throwing public money at the problems. However, the cost is quickly escalating. If we do not stop, we will leave an unbearable burden of debt to our children.
                The unbearable debt to our children you are speaking of was already given when we all decided to buy homes we could not afford, buy cars and other items on credit and spend money in useless wars.

                All those "plans" will do nothing to solve that problem. Only way out is to hyperinflate or start with new money. But the problem is that the have's won't willfully accept that they are in the same empty boat as the have nots.
                Last edited by Tulpen; 10-14-08, 11:48 AM.

                Comment


                • #9
                  Re: Plan B: Last chance to avoid financial system failure

                  The underlying reason for the sudden collapse in the worlds banking system is the need to reappraise the value of securities every time the interest rates change and the borrowers of money have to renew their financial package. This was no problem at all as long as the underlying value was always upward. But once the underlying asset values start to fall, the system automatically declines the reapplication and the borrower is rejected from the system; causing a default. As we see above, the owner of the security is no longer in the loop so the system has no choice but to systematically decline and thus as the asset values continue to reduce, the number of defaulters rise, the system automatically collapses. It is these automatic defaults that are driving the collapse.

                  Imagine please. You bought a new vehicle three years ago and now the car dealer, (not the finance company); has come back to you to insist that you pay more money for the vehicle. You would say they are crazy. The car has had three years use and is worth less money. You will say immediately that free market rules demand that you owned the vehicle entirely, from the moment you signed the deal. That the car dealer has absolutely no right to demand more money for the vehicle and you would be correct.

                  I make this point as this is exactly what is happening with financial deals made in your financial market place. Your financial system is not running under free market rules. If all financial transactions were set fixed at the moment of the deal taking place, without any changes to the deal afterwards, the financial system would be stable and there would not be a collapse of values and confidence. So the only way out of this is to change the rules to those for a free market. When you do that, you will immediately put a stop to the automatic collapse of the entire system.

                  All you need to do is insert a rule to say:

                  All transactions, including any financial transactions, made in a free marketplace must be to free market rules and thus cannot be changed in any way, downstream of the deal being made.

                  Now let me show you why I have come to the conclusion that the core reason for the collapse of the present system is our failure to create a free marketplace for finance. The present system is not a free marketplace and exhibits all the elements of a monopolistic feudal system.

                  Let us see a simple free market in action.

                  You are all familiar with a free market. A free market is open to anyone. Naturally depresses the potential for excess. Always has change occurring as prices rise and fall according to demand. Never stops evolving as the natural competitive rivalry swings the balance of opportunity to and fro. Today’s winner is often tomorrow’s loser and vice versa.

                  A free market in anything demands that the seller can always get the best price of the day, most usually via an auction, where goods and services are sold in lots at the fall of a hammer. That sale price is determined by creating an opportunity for the maximum number of potential buyers to immediately bid based upon the perceived worth, (of their purchase), to them downstream from that purchase. We call that a free marketplace. The moment the bid is accepted the sale takes place; payment is made and immediately the ownership of what is being sold changes.

                  This is important. If the seller retained ownership, the free market would not work as there would be an obligation upon the buyer that transferred value created by the buyer back to the seller beyond the power of the market to adjust.

                  The immediate transfer of ownership is thus a fundamental aspect of a free market.

                  The seller has to accept the price the market will deliver that day for the concept of the free market to work. The price paid must be the market price of that day. The buyer has priced his bid based upon their knowledge of the cost of whatever onward process they have in mind. The price to the final consumer is adjusted accordingly. If that buyer fails to sell on at their final market price, then they cannot afford to go back and buy more at that price and must adjust their bid accordingly.

                  This is the essential element. Paying too much to the original producer may secure the supply, but suppresses the onward sale of the finished product at the end marketplace. It is this natural check and balance that keeps the whole process of rivalry competitive. The only way to win over the long term is to keep your margins to the minimum that will secure a steady income. Raise prices too far and you are automatically excluded by another that prices below you. Reduce prices too much and you cannot continue to pay your way. Your money runs out before you can replace the original deal with another.

                  It is the decisions made at the time of purchase that make for viability downstream. You cannot gain an unfair advantage in a free marketplace.

                  I charge that government has an absolute duty to see that at all times; a fully competitive free marketplace is maintained for anything and everything that is traded in society. We all know the rules for a democracy but what is a free market? What should the rules say? Have you ever seen them writ large on a wall? I cannot find them so let us create some here and now.

                  1. A free market is any place where anything may be legitimately bought or sold.

                  2. No one who is a legitimate producer of product or service for sale, nor, anyone who is a legitimate user of the product or service, downstream of the sale; can be prevented from buying or selling goods or services.

                  3. All sales and purchases must be to the highest bid at the moment of sale.

                  4. Ownership must immediately pass to the purchaser.

                  5. No seller can be permitted to influence any transaction beyond the sale.

                  6. You cannot deal against the market outside of the market.

                  7. It is the duty of everyone associated with the creation of free markets to see that there are as many as possible independent producers of all goods and services provided to society.

                  8. Any restriction upon the number of independent producers of goods and services acts against the interests of a free society.

                  So, for example, if we want to purchase a ton of potatoes, we proceed to the fruit and vegetable market, walk through the door, make our selection and pay the going price for that market that day. The ownership of the potatoes immediately passes to the purchaser upon the seller receiving their price.

                  The seller has no further lien upon the potatoes. This is very significant.

                  We all know about such transactions. They repeat in our everyday lives. But it is important to recognise the basic principles. For a true free market to operate the legitimate seller of the goods must not:

                  • At the same time control the legitimate purchaser and thus be able to exert undue influence upon that purchase; the price paid at the auction.

                  • Retain ownership of that which was sold.

                  • Be able to in any other way influence the progress of the competitive process downstream of the original purchase.

                  An excellent example of where these rules must apply is to money loans termed for less than repayment. By that I mean to describe a loan where it will take, say, 30 years to repay the loan in full, but the rate of interest paid changes downstream of the instant of the sale of the loan. After say, three or five years, the rate of interest changes to a higher rate; increasing the cost of the money loaned. There are two important points to be made here.

                  1. Changing the interest rate downstream of the sale of the loan denies all the precepts of a free market by permitting the seller of the money to change the deal to suit their market conditions downstream of the sale. Thus the seller exerts undue influence downstream of the sale to control the market against the interests of the wider society.

                  2. Because there is a need for due diligence when creating that new deal, downstream of the sale, the asset purchased with the loan has to be re-valued and it is this revaluation that has driven the values upwards in good times, (and thus creating additional profits for the financial institutions by permitting them to take a proportion of this additional value as additional interest on the loans), but which is the devil in the detail when the asset values fall. Any reduction in the value creates an automatic default. But when the overall marketplace value falls as we see today, these automatic defaults swamp the entire system and the whole banking system collapses.

                  I firmly believe that it is this specific action, changing the interest rate downstream of the sale of the loan; that lies at the very heart of most of our monetary problems today. In particular, introducing uncontrollable financial instability; the potential for automatic defaults if the underlying value of any asset purchased with the money loaned changes.

                  The practice distorts the free market, making it impossible for any purchaser to control their costs for the long term. This is no different to the auto dealer asking for more money for the purchase of the vehicle several years after the vehicle was sold. This is not legitimate competition. Not a free market.

                  Now I turn to speculation.

                  In rules 1 and 2 there was a very specific reason for my delineation of the legitimate producer or user. If you take a look at the simple street marketplace selling food to the local community you will see that if say, a hundred thousand others stood between the seller of the product and the final purchaser and traded the same product between themselves without any intention of actually taking delivery as a legitimate user; that marketplace would not, ever, reflect the true free market conditions, but would instead, reflect the speculative power of the other thousands to drive the price in whichever direction they wished.

                  Again, the farmer buying a contract to supply corn, say, in a year’s time, makes a trade where, ultimately, he is the supplier to a user who will manufacture a product, such as bread, also in that next year. But if you permit perhaps millions of trades by anyone who is not either the farmer or the final user, you introduce complex distortions to the final market price that are not predicated by the decisions of either the farmer or the final user. The market is thus distorted by speculation.

                  Today we see many trading speculatively and such practices are so widespread, they are frequently bragged about.

                  “Sept. 3 (Bloomberg) -- Dot-coms? Done that. Property? Oil? Corn? Been there, got the T-shirt and nursed the losses, as well. One thing we know for sure about today's global economy is that there is always an investment bubble somewhere. If you get in early enough, you can make a fortune riding the boom.” Five Places to Look for Next Investment Bubble: Matthew Lynn http://www.bloomberg.com/apps/news?p...Rhk&refer=home

                  I believe this aspect of the misuse of a free marketplace is of particular interest. Today, speculative trades of financial instruments have reached astronomical levels and have deeply destabilised money markets. Similarly; the same applies to commodities such as food and oil. Non legitimate speculators make a mockery of a free marketplace and constantly drive the formation of new price bubbles in otherwise free markets.

                  The free marketplace must be a true marketplace, where the original producer sells to the final user. Once you permit anyone else, outside of the true free marketplace to come between the two legitimate parties to the trade to speculate simply for profit made in the trade itself, rather than as a primary producer or user, you open the door to the compete abuse of the free market; where a trade is not made to purchase for actual use, but simply as a way of influencing the price to the final user. Rules 5 and 6 must be firmly applied.

                  Competition, real, legitimate competition, not artificial speculation, not being able to change the deal against the interests of legitimate competition must be seen as being the fundamental foundation stone; the principle purpose of a free society. For that to occur you have to have as many as possible legitimately competing in that market; any market, all markets. The more you artificially swamp legitimate competition with speculation, the more you eventually reduce the natural quality of your nation. The less competitive you become and the opportunity for anyone, from whatever background, to rise to the top and succeed consequentially reduces. Failure will become endemic. In such an uncompetitive environment, it is an easy illusion to believe that the few that are succeeding are all that can succeed. This is the great delusion created by any feudal society designed specifically to keep the group at the top exclusively their own.

                  Feudalism is an economic system where the most powerful use their economic power to swamp and distort the legitimate free marketplace by false trades and speculation. Feudalism naturally excludes success for the majority. Keeps control of the marketplace in the hands of a few.

                  Legitimate competition must be established in every marketplace, particularly the markets that channel new investment into the wider society. Freedom, as we all know, does not necessarily stem from democracy, it stems from free markets.

                  This is a condensed and reworked edition of a recent post on iTulip which may be found here:

                  http://www.itulip.com/forums/showthread.php?t=5166

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                  • #10
                    Re: Looking for dollar store lighters

                    Originally posted by wangjiahua
                    Does anyone know where I can buy these types of lighters in the U.S. ?
                    It's the black one on this website. . . . .
                    http://www.liangdianup.com/dollarstore_1.htm
                    Any type of "metal flip top" lighter will do. I am looking for them at
                    the right price to sell in my dollar store.
                    Does anyone know how to contact Fred and get him to delete this spam crap? It's making a mess of the "New Posts" link, since this sh*thead is posting this message to every thread.

                    Comment


                    • #11
                      Re: Looking for dollar store lighters

                      Originally posted by Andreuccio View Post
                      Does anyone know how to contact Fred and get him to delete this spam crap? It's making a mess of the "New Posts" link, since this sh*thead is posting this message to every thread.
                      You see that little Red caution sign up at the right hand corner of each poster's post. Click it and send a message, to report spammers, lack of civility, etc.

                      I already did one on the cigarette lighter guy.
                      Jim 69 y/o

                      "...Texans...the lowest form of white man there is." Robert Duvall, as Al Sieber, in "Geronimo." (see "Location" for examples.)

                      Dedicated to the idea that all people deserve a chance for a healthy productive life. B&M Gates Fdn.

                      Good judgement comes from experience; experience comes from bad judgement. Unknown.

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                      • #12
                        Re: Looking for dollar store lighters

                        Originally posted by Jim Nickerson View Post
                        You see that little Red caution sign up at the right hand corner of each poster's post. Click it and send a message, to report spammers, lack of civility, etc.

                        I already did one on the cigarette lighter guy.
                        Thanks for letting us know.

                        We now add 30 to 50 new members per day.

                        100s try to get in but are spammers.

                        Every few weeks one out of 1,000 gets through our time-intensive human filter.

                        Unfortunately, soon we will have to charge a nominal fee, like $9.95 per year, to registered members so we can filter out the huge volume of spammers and keep this area spam free.
                        Ed.

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