Fearing Fear Itself

Over the last several days, many readers have asked for my take on the economic crisis. I’m not an economist – my opinion is just that of an average person who has read a number of economics books and talked to a lot of people from all walks of life. Here’s my humble take on the situation.

From Franklin Roosevelt’s first inaugural address, March 4, 1933 (please, listen in):

I am certain that my fellow Americans expect that on my induction into the Presidency I will address them with a candor and a decision which the present situation of our Nation impels. This is preeminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing conditions in our country today. This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself — nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. In every dark hour of our national life a leadership of frankness and vigor has met with that understanding and support of the people themselves which is essential to victory. I am convinced that you will again give that support to leadership in these critical days.

Public Domain: Franklin D. Roosevelt, 1932 (NARA) by pingnews.com on Flickr!Over the last two weeks, I’ve read countless articles and heard countless podcasts talking about financial apocalypse, spreading fear around like mayonnaise on a turkey sandwich. Most of the suggestions are maddening – I’ve heard previously rational people talking about pulling all of their money out of FDIC-insured bank accounts and putting them under their mattresses.

All of this is based on fear, not fact. Over the last few months, several financial institutions have failed, but in each case, the resources of those institutions were immediately absorbed by other companies or, in a few cases, by governmental buyouts. No one has lost a dime in a bank account. No one has lost a single cent of insurance coverage. Many large banks – like Bank of America – have already taken their losses from the subprime mortgages and rolled right through them, and they’re strong enough that they see this as a buying opportunity.

We all know the general storyline by now – these failures were the result of investing too much in bad mortgages. The truth is that no one knows how serious the actual problem is. No one. The ludicrous plan that Paulson proposed last week served one purpose alone – it gave him tons of cash to make sure that the banks run by his cronies wouldn’t outright fail. The truth is that he doesn’t know how bad it actually is. Neither does Bernanke. Neither do you, and neither do I.

The panicked talk, the whispered statements about apocalypse – they’re fear. Nothing more, nothing less.

I don’t claim to know what the “best” plan for resolving the situation is. My level of information about the true nature of the economic situation is extremely limited – and so is yours.

I’ll tell you what I do see, though.

I look out my window here in Iowa and I see the ongoing harvest of one of the largest soybean and corn crops ever – not the cropless Dust Bowl of the 1930s.

I don’t see a single person with a bank account that has lost their deposits, like my grandfather’s family did circa 1932.

I see people going to work, working hard and producing value for their wage, coming home, and buying the things that they need to keep their family going, which puts money directly into the economy.

I see unemployment barely over six percent, not the 25% rate at the time of FDR’s address.

I see industrial production still rising – in 1932, it had fallen by more than half in just three years.

I see a dollar that’s actually strengthening, not weakening, while the price of oil is down sharply from its highs earlier this year.

In short, I see a lot of things that make me optimistic about our ecnomic situation, a pretty stark contrast from the fear being peddled by some. I’m actually much more reminded of 1987, when banks were failing thanks to the Savings and Loan crisis and Black Monday, when the Dow dropped 22% of its value in a single day. We haven’t yet seen anything as worrisome as that, in my opinion – and that was just a drop in the bucket compared to the 1930s.

To put it simply, I’m still not worried a bit, and when I see the fear being bandied about, I’m reminded of FDR’s words.

So what have I been doing with my money as of late?

What I’ve Done With My Money

1. I haven’t taken a dime out of any bank

I haven’t seen any FDIC-insured bank account fail, and none have in the history of the FDIC.

2. I actually maxed out my Roth IRA contributions earlier this month

Almost all of that money went into broad based index funds – namely, Vanguard’s Target Retirement 2045 fund.

3. I haven’t made a single change in any plans I’ve had for investing other than the early Roth IRA buy

I’m still following my own game plan.

Ask Yourself:

If you make any irrational moves, like pulling all of your money out of stocks, does someone profit from it?

Of course they do. Your brokerage will make a fee from the sale, and a happy buyer out there will be glad to buy that stock from you at a nice discount. Fear is the best salesman, after all.

My Advice: Don’t Panic

Don’t make any hasty decisions

Sit back and get informed – and don’t just rely on one source for information, either. Get a bunch of different angles on what’s happening, from liberals and conservatives and moderates alike. If you’re worried about your money, do your own research and find out reasonable things to do with it. Take a serious look at what people who really know what they’re doing are doing with their money – in the last two weeks, Warren Buffett has invested $3 billion in General Electric stock and $5 billion in Goldman Sachs stock (an investment bank … weren’t we supposed to be afraid of those?) – he sees this current situation as an opportunity to buy, not sell.

And one more thing. Even in the darkest heart of the Great Depression, 75% of Americans had a steady job with a steady paycheck, which they steadily used to buy the things they needed. Those years also produced the Greatest Generation and an economic steamroller that ran through the last half of the Twentieth Century like a tidal wave.

It was true 75 years ago. It’s true now.

The only thing we have to fear is fear itself.

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  1. Rachel says:

    Amen, Trent. Excellent post.

  2. Sarah says:

    Bravo Trent. An excellent post summarizing what a lot of people are thinking but might not have the eloquence to put into writing.

  3. David says:

    Trent: too bad you are not on TV tonight instead of Joe and Sarah. America needs to hear what you have to say.

    Regarding the $700B bailout…my idea, which is so simple it will never fly, is to have Uncle Sam buy the homes from the homeowners. Let them produce their closing docs, and pay back their equity. Let them keep paying the ARM teaser rates (so that the suckers who bought those CMO’s continue to get paid, but at lower-than-market interest rates). And then they can rent the homes at market rates. Winners? a) homeowners, who can get equity back out. b) bankers, who keep their debt out of default. c) neighborhoods, which see occupied homes that prop up neighborhood values. d) Joe Taxpayer, who now owns some probably overpriced homes, but that is better than $700 Billion of bad debt.

    Trent, fellow readers: help me figure out what this misses?

  4. David says:

    Too many indefinite pronouns…sorry.

    Let me clarify:

    Let them (homeowners) produce their closing docs, and (Government) pay back their (homeowners’s) equity. Let them (Government) keep paying the ARM teaser rates (so that the suckers (banks, hedge funds, insurance firms, mutual funds) who bought those CMO’s continue to get paid, but at lower-than-market interest rates). And then they (Government) can rent the homes (back to citizens) at market rates.

  5. caryn verell says:

    positive thinking! that’s what i like…

  6. Frugal Dad says:

    It is a shame that this so-called financial turmoil is happening so close to an election cycle. I have a feeling both sides are adding fuel to the fire in an effort to make the other side look bad, and collect new voters for their own party.

    The real shame is that the knee-jerk reaction of politicians (on both sides) could end up costing tax-paying Americans big time!

  7. Kevin Wright says:

    Trent,

    Great post and thoughts. Like you have said in other posts, this market downturn means that there are some bargains out there for investing.

  8. Shanel Yang says:

    Thank you, Trent. At last, a voice of reason! You put it all together just right. : )

  9. Troy says:

    It is interesting you bring up Warren Buffett.

    It is true he has invested 8 billion on the last two weeks. However, this is AFTER the govn’t announced a bailout plan.

    Mr Buffet also stated several things in the past week.

    1) The situation is bad. a “Financial Pearl Harbor”
    2) We are on the edge of a financial cliff
    3) He stated if the bailout/rescue does not pass, which he desperatly wants to pass, things would get “really really really bad”
    4) he also said he would be willing to invest 1 percent (7 billion) in the bailout plan because it will “most certainly be profitable” for the taxpayers.

    You also need to ask yourself WHY Buffett invested, and WHY those two companies gave him such great terms. 10% returns plus warrants. Take a guess on why? Because they desperatly needed the money because they were in trouble.

    So I agree with you on not panicking. However, calling the plan ludicris is shortsighted. Supporting your view with Warren Buffets recent moves is even more shortsighted. The plan is the reason behind his recent investments.

  10. Sunshine says:

    Right on!

  11. Jim Rogers says:

    Trent:

    To throw a bit of formality at this problem, we’re talking about irrationality in markets. Not making rational decisions has a similar effect to not having as much (or as good) information as some other decision maker within the market. That throws the entire nature of economic theory out of whack.

    Similar sentiments are being expressed on Wall Street. James Chanos, who made his name being the first big hedge to short Enron (back when everyone though the company was the best thing since sliced bread) says as much in the following article: http://dealbook.blogs.nytimes.com/2008/10/01/for-chanos-the-market-problem-is-irrationality/

  12. Your Friendly Neighborhood Computer Guy says:

    Great to hear someone take this whole “meltdown” with a grain of salt. To me, it feels like something that’s going on “up there” at the top, and really hasn’t had any effect on me. In fact, I see this as the perfect opportunity to buy a home or invest, as rates will surely start going up soon.

  13. Scott says:

    Excellent article Trent! Finally, someone who is not running around screaming ‘The sky is falling’. Keep up the good work.

  14. SteveJ says:

    Vote for Trent!

  15. Trent Trent says:

    I don’t think a plan to support banks is inherently ludicrous. I think Paulson’s original three-pager was ludicrous. It basically said “Gimme $700 billion to do with what I want with no oversight.”

    I feel mixed about the current plan that passed the Senate. I like the FDIC limit increase and I do see a need to make sure the credit market doesn’t fail, mostly for municipal governments. Given the limited information I have, I would have probably voted “no,” but I’m not on the Senate Banking Committee and I don’t have near the data they have.

  16. Joe says:

    “spreading fear around like mayonnaise on a turkey sandwich”

    Did you happen to write this article while thinking about lunch? =)

  17. Battra92 says:

    Personally I really hope this senate plan doesn’t pass. First they snuck around the Constitution where it says all spending bills must originate in the house and they have added so much pork and too much power to one man.

  18. Cathy says:

    Mr Buffet put a lot of money into those companies because he’s a businessman, and getting a hell of a deal. His advice is quite famous – buy when investors are nervous, and sell when they are giddy. This was a buying opportunity for him, not some sort of philanthropy. GE and Goldman Sachs accepted his terms because 8 billion dollars in a weak economy is hard to turn down. This down economy is favorable to those who have a comfortable load of cash on hand. The bailout is absolutely the reason behind his investments – they were incredible buying opportunities for him. Too bad the government couldn’t have shaped a plan that would allowed us to be shareholders in the banks with terms as favorable as the ones Mr Buffet negotiated.

  19. Margaret says:

    The rumours of the “next great depression” have started up here as well. So I see this as a great time to get what little investment money I have into my RRSP and into some index funds. This may end up being the best investment opportunity of my life. I have recently been pondering whether I am better off paying off credit cards or cutting back on the payments and getting a 37% tax refund on the remainder by putting it in our RRSPs and getting it into the market. We’re going to have a serious look at my husbands job stability here, and if it looks good, I think this is the time to get some money into the markets.

  20. Lucy says:

    It’s refreshing to hear this take on the economic crisis. Thanks Trent.

  21. Bamboozled says:

    I would never “vote for Trent”. His advice has already cost me 20% of my portfolio. I started investing in mutual funds because ‘there’s no wrong time to invest’.

    Thanks, Trent. You’re awesome.

  22. iDave says:

    Aaaah. Some sense with our dollars and cents, as Dave Ramsey likes to say. Nice job, Trent. I thought about the Depression the other day – how it lasted more than 10 years, how my grandparents struggled to get by, and this isn’t the Great Depression. Yes, we’re hurting, and yes, people are losing their home – but if I hear “Depression” one more time I’ll puke. We appreciate your level-headedness, Trent.

  23. FL says:

    “No one has lost a dime in a bank account.”

    That’s just not true. Remember the woman who lost 20,000? Sure, she was over the FDIC limit and ought to have known better. But your assertion is still false.

  24. moneyclip says:

    What I noticed in this deal is there’s been little to encourage people to save. Savings should be the backbone of any sound national economic scheme, and yet all I see is talk on credit and freeing up more so people can get out there and spend more. We can’t continue to keep digging our own financial graves. Eventually there’s a point where it will implode and we’re going to be very very sorry.

    I don’t know if that point is now, I certainly hope not. But with the way the economy is run now I don’t see how it can be sustained by borrowing from places like China to buy Chinese goods. As I’ve read before it’s like being in hock up to your ears to the company store. It’s financial slavery all over again.

    Where is the president telling people to save, live frugally, improve their personal finances, invest in IRAs and index funds, to buy treasuries and stop wasting money on frivolous things? I haven’t yet to hear a word come out of that man’s mouth that resembles anything remotely like this… why not?

    I guess I am being too heavily influenced by “Empire of Debt:The Rise of an Epic Financial Crisis” by William Bonner. But what I see is America mired in a nasty cycle of imprudent finances and then this housing sub-prime mess, Wall Street getting slammed, and the stock market going on a roller coaster.

    Maybe I aught to heed Trent’s advice and just chill.

  25. me says:

    Trent, the American middle class has been actually hurt by the economic policies of the last two administrations which have moved us from a debtor, money lender’s driven nation and has intentionally let our manfacturing and other industries wallow.

    Right now there problem is two pronged:: basically wall street is hugely overvalued, enron type mess – to help wall the street the fed is printing more money – you sure as hell better preapre for that.

    on the consumer side – americans have a negavite savings rate and have been using their homes as ATMs if homes go to where they SHOULD be (see traditional ratios of median income and median home price) a lot of people will be saddled with enormous debt they can’t pay or will have to work the rest of their lives to try to pay down.

    As mentioned real wages for the middle class have been declining. No on in congress proposes to do anything to change the pardigm- invade the world, invite the world, engage in lopsided ‘free trade’ with our creditors

    We are a debtor nation, and if the bailout goes through are great great grandchildren will be paying for a our follies.

    – avoiding reality is not an option anymore, americans have been doing that long enough.

    http://www.latimes.com/features/books/la-et-rutten16apr16,0,4337030.story
    ‘Bad Money’ by Kevin Phillips
    . Banking is not the creator of our prosperity but is the creation of it. It is not the cause of our wealth, but it is the consequence of our wealth.”

  26. beth says:

    Well said, Trent. Living in one of the hubs of the housing meltdown, where we are also now seeing 7% unemployment (and growing), it’s easy to forget that most of the rest of the country barely notices (and we’re a pretty polarized swing state to boot).

    My folks’ houses in the Midwest haven’t lost any value; their jobs are more than secure; and they can still get a loan from the local S&L with no problem.

    It’s good to hear from someone who isn’t totally panicked.

  27. me says:

    one more point “4) he also said he would be willing to invest 1 percent (7 billion) in the bailout plan because it will “most certainly be profitable” for the taxpayer”

    Laughable. Like future tax cuts and temporary taxes – this never happens.

    Also trent remember that after 29 crash stocks and real estate did not recover until the 1950s – 1960s and 70s in some areas (like New York)

  28. Carolyn says:

    Bravo, Trent, for being a voice of common sense, reason, and factual data. What you wrote was eloquent and persuasive.

    Not that we should expect anything less. Thank you.

  29. me says:

    “First they snuck around the Constitution ”

    today’s exercise:

    Search it thoroughly, and you’ll find nothing in the U.S. Constitution that authorizes the Federal Government to create an institution like the Federal Reserve, let alone to encourage home lending.

    In fact, the question is rather an uncomfortable one. Ron Paul recently asked Ben Bernanke where he got constitutional authority to create money out of thin air, and Bernanke said that Congress had delegated to the Fed Congress’s constitutional power to coin money.

    But of course, the Fed doesn’t coin money—it prints paper. And the Constitution doesn’t empower Congress to delegate its powers. (But that’s another battle that supporters of the Constitution lost long ago.)

  30. Cathy says:

    @moneyclip:

    I’ve been saying the same thing myself. Why are they freeing up more credit? Personally, I rid myself of credit card debt forever, and no amount of enticing is going to change my mind otherwise. I’m paying for my next car in cash from the trade in of my current car, plus money I’ve saved. Lack of credit isn’t deterring me from buying a car. Lack of money is. Seems to me they are trying their damned hardest to keep me from saving.

  31. jb says:

    Thank you for the dose of sanity.

    While it *is* a good time (it always is) to ensure that you have your emergency fund in order, the level of panic is just ridiculous. Furthermore, the media (and I don’t just mean the cable “news” channels) are putting their own spin on it. Note the headlines about the “failure” of the House to pass the $700B bailout. If Congress would “fail” more often the government would be in much better financial shape.

    Heck, I knew a *lot* of people unemployed during the 2003/2004 recession. At the moment I don’t know anyone (involuntarily) unemployed. So, in some ways the economy is reasonably good.

    All the reports of “the credit markets are frozen” seem pretty ludicrous. I used a credit(!) card to buy gas this morning, and say many others using credit cards. Heck, my HELOC hasn’t been frozen yet — although I do basically expect that any day now.

  32. me again says:

    Love it how you have moderated out comments that actually refute what you are saying… first sign of real fear that you’re wrong is surpressing or ignoring reasoned refutations of your ‘arguments’

  33. Finn says:

    I believe some people over the federally insured limit have lost money in their bank accounts. Doesn’t detract from the overall message, however.

  34. me again says:

    I will try this one more time:

    a. for the past two administrations real, middle class wealth and wages has been falling.

    b. many sectors of the ecnomony have been in slumps for years SPECIFICALLY because of policies in washington, driven by money from new york.

    c. further entrusting these people with 700+ billion dollars is going to make things worse.

    Trent you don’t seem to grasp that there was a real real estate bubble – homes are way way over valued vs. traditional median home, median income ratios, and now, you can say we’re in a US treasury ‘bubble’ and the Fed, to help wall street will further ‘screw over’ the middle class and create inflation and cut deals with foreign banks that will long term hurt us. there is plenty to ‘worry about’ and ‘fear’ -

  35. just an opinion says:

    I have to agree with Tony, I wouldn’t cite Warren Buffet’s 8 billion as a generally positive sign. Mr Buffett took advantage of an extraordinary opportunity which is not avaiable to the average investor. (disclaimer: i am an owner of Berkshire Hathaway). A great investment for us, but one that was forced out of GE & Goldmans desperate liquidity positions.
    This might sound as if I am joking, but if I was the government, I would have enlisted Warren Buffett to negotiate the so called bail out, and I would have cut him in on the results (1/2 a point?) Mr Buffett has proven with the GE & Goldman deals that he negotiates hard and doesnt leave money on the table. Our leaders have proven that they are overmatched when it comes to negotiating with Wall Street.
    Finally, what we are panicing over now is small potatoes. A larger concern, by a factor of approximately 60, is the 42 TRILLION dollars in unsecured liabilities we face going forward due to social security etc. As any diver can tell you, panic wastes air. PANIC WASTES AIR. What we can do today is live prudently, extend our arms to those who need help, acknowledge and build on our love for others, keep hope in our hearts.
    easier said than done, of course.

  36. Vanessa says:

    @moneyclip

    well said – I’ve been thinking the same thing!! At what point do people stop borrowing and start living within their means and saving? Isn’t borrowing what got everyone into this mess to begin with?

    @ Trent – right on! loved your post :)

  37. one more time says:

    lets see, don’t panic because the same people who have been screwing over the middle class want more of our money?

    Why do you buy into the mainstream media argument that opposing them, or pointing out the collapse is ‘panic’ ?

    Just a few weeks ago Paulson and Bush were saying everything is spiffy A-ok, now they tell us if we dont’ fork over 700 billion all is going to hell.

  38. Bryan says:

    Sound and wise advice as usual Trent – I think a lot of people already subconsciously realize that there’s no need to make any rash financial decisions no matter what the spinmeisters say. But the way you laid it all out on paper is very convincing, especially for those who might need a little friendly nudge in the direction of less panic.

  39. Heidi says:

    While you make some good points, I’m afraid that the vast majority of the public screaming against the bailout just wants to let the big cats on Wall Street fail, and don’t understand how it could affect them.

    A lack of available credit is a real threat, even to those who don’t use it. Their employers use it, often for payroll. I’m not convinced this is an immediate problem, but if someone smarter than me is, I think they should do something about it. I agree that we shouldn’t be handling the Bush Administration a blank check, but doing nothing could also be disastrous.

  40. MattPatt says:

    I’m almost with you, but then I get to your last paragraph:

    “And one more thing. Even in the darkest heart of the Great Depression, 75% of Americans had a steady job with a steady paycheck, which they steadily used to buy the things they needed. Those years also produced the Greatest Generation and an economic steamroller that ran through the last half of the Twentieth Century like a tidal wave.”

    Not to be insulting, but do you actually *know* anyone who’s a member of the so-called “Greatest Generation?” Because I assure you, my grandparents and their age peers have always made it very clear when they talk about those times that they’d never in a million years desire to live through it again. I think you’re glossing over quite a bit of economic and physical suffering here. To me, it’s borderline crazy to insist that such a huge amount of economic and physical suffering is okay because it builds character. (Also, let’s not forget that this “Greatest Generation” also fought World War II, which is a burden that most of these “economic crises build character!” arguments seem to forget.)

  41. Kristine says:

    One thing regarding the unemployment figures- under Reagan they were changed to not include people who have been out of work longer than unemployment insurance lasts. So the jobless who have slipped into poverty are not included- they are considered- “no longer looking for work”-regardless of circumstance. The real unemployment figure is suspected to be in the double digits.

    Being 20 years from retirement, I have also left my money alone and continue to contribute. But initially I divided by investment type (small, mid, large, bonds, domestic, foreign, etc.) but after that- I chose the top 5 or 6 performers in each sub-category! As a result I am diversified not only in investment type, but by company. So if an investment firm tanks, it only effects a small portion of my portfolio. My account manager thought I was nuts at the time, but now it seems pretty smart! I have to admit- my quarterly is half an inch thick!

  42. Lisa says:

    I don’t think the problem is necessarily at the consumer credit level yet, unless you wanted a low down payment loan for a large percent of your monthly income.

    But, at least here in CA, there are a number of businesses who have seasonal Halloween and Christmas businesses, with good credit, who are not getting the same amount of credit they had last year. Some had planned to expand, but based on the credit, they actually are opening less of their seasonal stores. This will result in less jobs this season.

    Also, here in CA, it will be hard for us to borrow for the state government to stay solvent. That is definitely not entirely the fault of the credit crisis, but the credit issues are a factor.

  43. Kate says:

    I wonder about the timing of this “disaster” so close to the election. The situation has apparently existed for quite awhile and nobody said or did anything about it before.
    Also, Sept. 30 was the end of the third quarter, which no one has mentioned in all the talk of the stock dive earlier this week. I imagine a lot of hedge and mutual fund managers were selling off a lot of their underperforming stocks on Monday to make their numbers look better, since trading was expected to be light Tuesday due to the religous holiday. The market made back almost all its previous day’s losses by Tuesday and had a very small dip the following day.

  44. stoph says:

    Thanks for that article Trent, I definitely feel inspired.

  45. gr8whyte says:

    There’s no longer any we’re-in-the-same-boat connection between upper management and employees. It should be made law that the highest-paid person in a US company can be paid in total no more than 30X the lowest-paid. Housing bubble? What about the management salary bubble? It’s absolutely insane to pay millions in salary/benefits/parachute to upper management while the lowest-paid have difficulty making it in today’s economy and why I find the G$700 bailout unpalatable because the clowns who broke the banks will walk away with millions.

    In his interview with Charlie Rose, Buffet said the bailout has to be done, speed is essential, oversight is fine, he trusts Paulson, Paulson should be given a free hand, bad assets must be bought at market value (meaning low $ for stressed assets) and he wouldn’t mind taking a 1% stake in the bailout. Buffet should be allowed a 1% stake because he’ll make sure it’ll be done right and his participation may encourage more long-term investors to jump in with him (lowers taxpayers’ exposure/cost).

    I’m for the bailout based on Buffet’s actions and opinion. Don’t like it but it’ll have to do.

  46. Sean says:

    “The ludicrous plan that Paulson proposed last week served one purpose alone – it gave him tons of cash to make sure that the banks run by his cronies wouldn’t outright fail.”

    Trent, your body of work shows you to be a smart guy, so I’ll just attribute this quote to lack of specific knowledge.

    The bailout is absolutely necessary. Perhaps not Paulson’s specific implementation of it (and certainly not the lack of oversight in his original proposal), but something must be done. Of course we aren’t in another Great Depression–the idea is to prevent us from getting there.

    You mention a lot of things that make you optimistic about the economy (low unemployment, people spending money, etc), and you’re absolutely right. Most of the foundational elements of our economy are sound (thus McCain’s much-derided line about the fundamentals of our economy being strong). But that’s not enough.

    To use a metaphor shamelessly stolen from my father (who happens to be an economist), if the people of our country, employment, and infrastructure are the body of our economy, money is its lifeblood. The problem, then, is that the mortgage-backed CDOs and related derivatives that we’ve heard so much about are clogging our country’s arteries.

    It’s tempting to say, “Hey, those banks were foolish enough to buy these things. Let them fail!” Give it some time, we might think, and the problems will eventually work themselves out. The blood will start flowing again.

    This is true… but like a body, in the meantime, the lack of blood flow will have seriously damaged the underlying economy.

    The idea is to preserve those economic fundamentals from the problems caused by some greedy idiots on Wall Street. It might be a tough pill to swallow (they’re the grasshoppers, we’re the ants, right?), but it’s a necessary one.

  47. Sara R says:

    I’m mainly concerned about inflation. Inflation is created by money creation, which is what the Congress and the Fed are doing. The government doesn’t have the money for this bailout, which means they will ultimately have to print it, which will eventually lead to severe inflation. A hyperinflationary recession would be much worse than the Great Depression. At least during the Great Depression, if your bank hadn’t gone under and you still had money, it retained its purchasing power.

    I also note that you are comparing the worst of the Great Depression to current conditions. We aren’t in 1932 now. We are in 1929, before the worst has hit. Most people aren’t saying that things are really bad now. I don’t think they are. But I think that what we can see down the road doesn’t look very promising.

    That said, I’m not acting out of fear. I don’t feel panicked. That’s because we are preparing.

  48. Kevin says:

    Nice summary, Trent. I see this whole situation as a correction, not financial Armageddon as so many in the press keep saying. The banks and institutions that made too many bad loans are now suffering or failing and the people that took the stupid loans can’t pay them back. There is some short term pain for most of us, but in the end the market is simply correcting things that shouldn’t have happened in the first place and were triggered by greed.

    Those of us that were responsbile – got a mortgage we could afford, pay their bills, live below our means – will be fine and like you said, could benefit from this. My investing and saving is on autopilot. My net worth is down, but I take solace in the fact that my dollar cost averaging is buying a few more shares each month than previously.

  49. CER says:

    In reply to comment #27, that is not how the unemployment rate is calculated. The number of those collecting unemployment insurance is tracked, and is reported at the same time as the unemployment rate, but they are not the same. The unemployment rate is collected via a survey conducted by the Bureau of Labor Statistics (with some aid from the Census Bureau, I believe).

  50. Kevin says:

    Sean – why is the bailout necessary? What specific goal is it to accomplish?

    So we can give those firms the credit they need to start making bad loans again? There is a reason credit is tight now – because it shouldn’t have been loose in the first place. Now everyone is suffering.

    Instead of buying all the bad loans and related securities from them, why not insure them instead? That way, IF they fail – and not all of them will – the firms will have protection. I don’t like writing a blank check, or a $700 billion dollar one, to firms that screwed up in the first place – many of which are run by Paulson’s buddies or which Paulson has ties to.

  51. bob says:

    The reason we need this bailout is because it is difficult for people with poor credit to get loans now.

    The reason that led up to this bailout is because it was too easy for people with poor credit to obtain credit.

    And the wheels go round and round.

  52. Kim says:

    It’s good to note that you stated yourself that you don’t really have a firm grasp on the economy. Guess what? Neither does the average american…and the average american is against the bailout. Everyone has been quite short sighted on this. All of the things you mentioned that make you feel like you don’t need to panic are actually the things we are trying to preserve. If the bailout doesn’t pass, guess what happens? Farmers suffer because farms RELY on revolving credit, right now unemployment may only be 6% but it will rise GUARANTEED as more people will be losing their jobs and small businesses will be unable to continue running or even open up, is it just a scare tactic? Or is it a repeat of history. It doesn’t take a genius to realize what happens to a society with no credit. Even the fiscally responsible will be affected. You have to wonder why a smart and respected man such as Buffett is all FOR the bailout.
    I think the biggest problem was that the government did a horrible job of explaining what exactly is happening. The general public distrusts our leaders so they are quick to jump to conclusions that they are just trying to screw with us.
    Noone says the bailout is a great thing, but it’s just something that needs to be done.

  53. Gordon says:

    Buffet invested the money in GE and GS preferred stock…which is closer to a bond. If those companies fold then the stock is paid before common stock. Basically he gave them a loan that has equity behind it.

  54. Kevin says:

    bob – you’re the hammer, you hit that nail right on the head. Nice work.

  55. Sean says:

    Kevin-

    Credit was way too loose. Now it’s way too tight. The goal of the bailout is to loosen it up to an appropriate level–loose enough that it’s actually possible to obtain loans, not so loose that we’ll see a repeat of the problem.

    It’s easy to say with hindsight that credit should have been tightened before it became a problem. But we didn’t. People are always more eager to prevent a recession than a boom. Now, however, it’s plain that credit needs loosening before it strangles us.

    Insurance doesn’t work when the problem is the capitalization of the banks. We take money away from them for insurance premiums, then give it right back to them when they fail? That just doesn’t make sense. It’s not a realistic idea, just a bone for some congresspeople to throw their constituents.

    As for writing a blank check, I don’t like it either. There’s something to be said for moral hazard. But we can’t let the banks drag us down with them.

  56. doc S says:

    Amazing post indeed Trent! I really think everyone should pass this one along to more and more people, if the FED got a hold and read this maybe it would knock some sense to them. Over on toughmoneylove.com he said it best that this economic situation shows us that the people in charge do not have sufficient knowledge of economics!!!!

  57. Jesse Wojdylo says:

    VERY good post in a troubling time. All Americans need to read this and think about it.

    http://jwojdylo.wordpress.com

  58. Kevin says:

    Sean –

    What’s your evidence that credit is too tight? I know someone who just got a mortgage that doesn’t have very good credit and had no money to put down – the buyer even paid some of the closing costs. I know it’s one example, but that doesn’t sound like tight credit to me.

    If you’re a good risk, you’ll get a loan. If not, then you won’t and probably shouldn’t anyway. I would prefer the banks be on the conservative side rather than the past decade where credit has been way too loose.

    As for the insurance idea, why do the banks have to pay premiums, why not just have the government insure things IF something happens instead of buying everything bad right away?

  59. AnnJo says:

    Thank you, Trent, for showing our politicians how this crisis should be discussed, realistically and without theatrics or alarmism. Too bad they won’t listen, and they will persist, like Harry Reid and Chicken Little, in running around screeching that the sky is falling.

    Too bad also that the political lesson that should have been learned here won’t be. It’s easy to blame “deregulation” but forget that the need for heavy regulation is itself a sign that bad policies are at work – usually policies that try to repeal the basic laws of economics. After all, you don’t need constant careful course corrections if you steer well clear of the rocks to start with.

    Nobel Prize winning economist Gary Becker wrote an article in 1997 that pointed out that the 1987 stock crash (a 20% decline in financial wealth) represented the loss of only 2% of the nation’s total wealth and he calculated that a 25% drop in the 1997 market, which would have been huge in relation to the 1987 one, would represent only about 3% decline in total wealth. Helps put things in perspective.

    That being said, the government bailout process may succeed briefly (today it doesn’t look like it will even do that), but is undoubtedly going to do more harm than good in the long run. The increase in the FDIC insurance coverage, assuming the premiums paid by banks increased appropriately, would have been a more neutral intervention and might even have been enough by itself although probably not, but on top of the rest, it brings the price tag for this package well over a trillion by any realistic measure, because the FDIC is already underfunded to guard against bank failures, and will itself need to be bailed out soon enough.

    Your quote from FDR should serve as a reminder: Many of the policies he implemented to “help” actually prolonged the Depression and made it broader and deeper than it would have been otherwise, and people’s ideas now of what is an appropriate “safety net” are nowhere near as modest as they were then – witness your reader above who argues that people who foolishly bought far more house than they could really afford should be allowed to remain in them at the expense of the taxpayer.

    This is certainly a better time to invest in the market than two weeks ago, or two months ago. It’s also a really good time to rethink taking on more debt or increasing your costs of living – it’s not just banks and credit markets that can suffer from a lack of liquidity. In other words, it’s time to follow the sound advice Trent publishes every day.

  60. Sean says:

    Sorry, I should have been more clear. In this context, the “credit market” refers to inter-bank loans and loans to businesses. While ordinary people will also have a harder time getting loans (and yes, that includes people who are good risks), that’s not what will ultimately cause the most problems.

    A freeze in the credit market will likely lead to cash crunches within individual companies, inability to make payroll or pay existing loans, sell-offs of investment assets (i.e. property, plant, equipment), layoffs, lower revenues, and it all builds on itself and spirals downward. Is this inevitable? No, but it is likely.

    That’s what we want to avoid, and that’s the reason for all the doom-saying in Washinton, not Joe Schmoe going to the bank and being turned down for his fancy new car loan.

    He didn’t really need that car anyway. :P

  61. gr8whyte says:

    I cannot agree with bob’s comment #32 “The reason we need this bailout is because it is difficult for people with poor credit to get loans now.” suggesting that once the bailout is implemented, low-FICO people will again be able to get loans and spend like before. The real underlying reason is the lack of confidence in the financial markets.

    Businesses in good standing who previously could borrow money without difficulty are being denied loans. We’re in a recession so when revenue falls, businesses may have to borrow to meet payroll and bills and they’re finding it difficult to do so. This can only go on so long before they have to let employees go. Is it because the businesses are a bad risk? No, it’s because the banks (on average) are holding a lot of bad paper and they cannot lend out as much cash as before because the banks need the cash themselves to shore up their own books. What compounds the problem is there are no accounting rules in place to determine the value of the bad paper. One bank does it one way, another bank another way. If I’m holding bad paper, why would I want to lend out cash that I’m going to need myself especially when I don’t even know how much the bad paper I’m holding will be worth eventually? If I’m not holding bad paper, I might continue to lend to busineses/individuals with good credit ratings for a while but how long can I continue to do so when no other bank will lend me money should I need it, and how can I lend to other banks that’re holding bad paper when I don’t know what they’re worth and I might not get my money back at all?

    Low-FICO people will find it difficult to get loans now, after, and long after the G$700 bailout is implemented, if it’s indeed implemented. Don’t people understand the borrowing landscape has fundamentally changed?

  62. Amy Sisson says:

    Thank you for this post!

    I am with WaMu-now-Chase, and even though I knew it was likely to fail, I left my money there (where it still is), because I didn’t want to help make it fail. I haven’t had a single moment’s interruption using my ATM card, online banking, etc. And even if Chase had not stepped in, I knew that I would get my money with little to no delay.

    I AM a little concerned with how things are going — but I’m not changing my financial behavior.

  63. Sean says:

    gr8whyte- You explained it far better than I did. Thanks.

  64. Lurker Carl says:

    The borrowing landscape is reverting back to the way it used to be, before sub-prime loans were invented and banks entered the loan sharking business.

    The Treasury is warming up the printing presses to crank out about one trillion dollars. The press tells us it is to bail out banks holding sub-prime home loans. I wanted to know what the estimated loss is for all those properties now owned by banks. So I dove into the Census Bureau records to find out the worst possible situation we may be facing with this mess. Congress is anxious to commit $850 BILLION of my tax dollars for this plan but my calculations say $700 BILLION unaccounted for. Congress is allocating SIX TIMES the amount of money necessary to cover the subprime mortgage loans, assuming each and every sub-prime loan defaults.

    I wanted to do the math just to rap my head around so many zeros and I rounded up to make the math easier. The US Census data from 2006 says the average value home value of all mortgaged owner-occupied properties is $208K, so I’ll use $210K for the average defaulted mortgage. I’ll assume the worst, everyone is mortgaged to the max. The average purchase for foreclosed homes from banks is approximately 75% of the mortgage owed. That leave about $60K unpaid to the banks per property. With a bail out of $850 BILLION and a $60 THOUSAND loss per property, my math says our Congress believes there are 14 MILLION properties in the system for foreclosure.

    US Census data from 2006 also tells us there are 52 million occupied houses owing a mortgage. But only 5% of all mortgage loans are considered subprime, that would be only 2.5 million properties with a $150 BILLION loss.

    Where is the remaining $600 BILLION going? Looks to me like a lot of pork is about to served.

  65. gr8whyte says:

    @ Lurker Carl : Don’t quite understand what you’re saying, here’s my take given your numbers. If Paulson bought 5% of 52 million mortgages at an average price of 75% of k$208 each, the amount needed would be 0.05*52e6*0.75*208e3=G$406. I hope Paulson doesn’t pay G$750 because that would exceed the face value of 0.05*52e6*208e3=G$541, doesn’t it?

  66. Becca says:

    At this point, it’s no longer an issue of sub-prime versus standard, stable mortgages. There are actually two distinct economic issues at play: one is an expected (but incredibly painful) economic correction. One is an incredibly dangerous spiral that the $700 bailout will attempt to address.

    1. Foreclosures are rising, even amongst those who were eminently qualified at the time they purchased their homes, so it’s disingenuous to now focus on sub-prime issues. Why? The economy is undergoing a necessary correction after recent free-spending years. This may be painfully necessary, but it’s affecting a lot of people who played by the rules and never went into poorly-planned debt. Had a job in construction? Gone, possibly along with your ability to pay your 30-year-fixed-but-upside-down-mortgage. And the stores where the former construction workers shopped (dry cleaners, restaurants, car dealerships, etc) are also going under. So the stores the drycleaners used to frequent are now going under too, and their owners are feeling mortgage payment pain. It’s a vicious, but probably necessary, correction.

    2. This slowly building recession is now instilling the fear Trent mentioned into the general economy. Folks are generally cutting back on non-necessary expenses and learning to live within their means. Which is great, but it means even fewer businesses are making it. So now, as we learn to now rely on credit cards and HELOCs for luxury purchases that were always out of our reach, it’s absolutely critical that the United States figure out how to produce something other than “consumer spending” to prop up the economy. And therein lies the problem, because…

    3. The bailout is less connected to the correction aspect of the economy than to the “produce something other than consumer spending” aspect of the economy. Since a) banks don’t know how much their holdings are actually worth, since they’re bound up in so many bad mortgages/possibly bad mortgages/mortgages-that-were-chopped-up-and-resold-as-risk-free-investment-packages. Therefore b) Banks aren’t going to make any loans right now – not to each other, not to small businesses, not to large businesses, not to state or municipal governments for infrastructure projects, and not to potential homeowners. Banks need to make sure they have enough capital on hand to keep themselves solvent, especially because they’re clueless as to what they actually HAVE on hand (worthless mortgages/mortgage-backed-securities, or long term profit potential?) Therefore c) businesses with genuinely good expansion prospects, with an eager-to-expanding customer base, CAN’T EXPAND. Businesses that need to purchase inventory a month out, CAN’T BUY (and therefore sell) new inventory. Municipalities that want to build a new bride, can’t get the upfront credit to build the bridge (or provide the construction jobs or help you drive to work in the morning.) Growth is stifled. Even large, proven-to-be-low-risk businesses can’t get the credit they need right now to perform or expand. And therefore, people lose jobs. Want to buy a house? Have amazing credit and a 20% down payment? Too bad, in this credit market. Banks are afraid to lend, and a community that would welcome your infusion of cash, commerce, and general community stability (because none of us want a foreclosed neighbor) are out of luck.

    This is affecting everyone, and we need to stem it now, by providing managed (not open-pocket-Paulson) bailout packages to the jerks who got us into this mess. It makes me sick, but it’s a truly necessary evil. The bailout will help banks and lending institutions accurately value what they have (since the federal government will, to some extent, take on the amorphous aspects of their balance sheets). It won’t fix the correction, but it can provide us with a way out of this mess by providing credit for new and growing businesses to develop. These new businesses will pick up the slack from all the now-failing “aspirational” consumer crap markets that kept the US economy moving these past 15 years.

  67. Lurker Carl says:

    Assuming all sub-prime loans end in foreclosure Paulson should only be purchasing the loss realized on each defaulted loan. That estimated loss will be 0.05*52e6*0.25*208e3=$135.2 billion if every sub-prime defaults. The lenders will received the remaining 75%, $406 billion, when they resell those properties. Even the banks estimate 2% of the sub-prime mortgages will default, I’m estimating all will default.

    So, why does the Senate think he needs $850 billion?

  68. Rick says:

    Some commenters have continued to state that unless this bailout happens, low FICO people won’t be able to obtain loans. I’m sorry, but low FICO people don’t NEED to obtain loans. Whatever happened to the good old-fashioned principles of living within your means? Instead of buying a huge 3000 sq ft house, just get a small 900 sq ft house, or rent an apartment. Instead of buying a new $35K luxury car every 2 years, why don’t you just buy a used $5000 every 4 or 5 years, and make it last. Instead of going out to eat every night, learn to cook your own food for much cheaper. Come on. Live within your means. Not everybody is rich, so don’t live like you are rich.

    Now, the comments regarding business I can sort of understand. I would still suggest businesses save and have a rainy day fund. But I can definitely understand that they might have to take cost cutting measures and lay off many of their employees. And I have a sneaking suspicion that the management cutting costs will not be among the first to leave.

    Still, I don’t support this bailout, because I just don’t see enough in the bill to discourage or “punish” the bad behavior we’ve seen the past few years.

  69. Betts says:

    Well, we’re over on the other side of the creek in Australia and frankly most ‘thinking’ people over here are scared stiff that the bail-out WON’T go ahead.

    Am very happy to be proven wrong. Houses selling for $10? Families living in cars in parking lots? How much worse does it have to get?

    I know people over here who have already up anchors and pulled their money out of banks, who have moved all their Super to easy to get cash.

    We are nervous for YOU and for us.

    Betts

  70. Collision says:

    Certainly now is a cheap time to buy stocks and noone should pull money out of banks, and we aren’t starting another Great Depression, but gr8whyte and others have it correct, this credit crisis will come home to roost on all of us eventually if nothing is done because ALL businesses run on credit, even if it is nothing more than the standard net-30 or net-60 that lets goods be delivered and sold before suppliers have to be paid.

    Right now it may just be Caterpiller and Ford Motor Company getting hammered because their credit is suddenly more expensive, but soon enough it will be your employer cutting costs, your credit card with the interest hiked, all the goods you want to buy having credit charges passed on in higher costs to you.

    It’s gone well beyond keeping people in houses they can’t afford. With the way the world works now you can’t punish Wall Street without punishing yourself, and those guys can afford it better than you can.

  71. Lorax says:

    I’m afraid I don’t completely agree with Trent on this one.

    While no one should panic and put cash under the mattress, they should be concerned about liquidity. I’d spread my emergency cash in two local FDIC or NCUA backed banks. I’d up the cash to one year living expenses if you have a family.

    You don’t want to lose your job and not have access to cash. That would be the perfect personal financial storm.

    I hope that I’m wrong.

    (In the meantime, for those with cash and a long time horizon, stocks might actually be at a fair P/E now – unless the E part goes down in the next quarter.)

  72. Mule Skinner says:

    How about we put Warren Buffet in charge after Paulson’s term is up (15 weeks!)? We tell him (a) Solve it (b) Make some money for the government while you’re at it.

  73. Lorax says:

    > Some commenters have continued to state that
    > unless this bailout happens, low FICO people won’t be
    > able to obtain loans.

    I don’t believe they’ll be able to get loans even if the bailout gets passed. There’s too much Alt-A, SIVs, CDOs, and CDSes on the books of banks. Houses aren’t going up.

    As others said, the days of low/no downpayment loans are just about over.

  74. Big B says:

    With all due respect, I think people should be very concerned about this economy. The bailout may calm some things down, but it only serves to prolong the pain that will come later. You can’t fix a credit and inflation problem by pumping in more credit and inflation. It’s like giving a crack addict one more fix. Eventually he’ll have to stop and go through withdrawals. The deeper the addiction, the worse the withdrawal.

    This is the case with our banking and monetary system as well. The Federal Reserve and Treasury will turn the spigot on full blast, and make this whole thing worse in the process. One day soon the bill comes due, and it will no longer be just a mild recession.

    Trent, I love this website and you have excellent personal financial advise. However, when it comes to more global economic issues, I have a video I would like to recommend:

    Money, Banking, and the Federal Reserve (45 minutes): http://www.youtube.com/watch?v=iYZM58dulPE

    It explains why this kind of thing is happening, and why we can expect more of the same if we don’t fix our monetary system.

  75. Lorax says:

    > Warren Buffett has invested $3 billion in
    > General Electric stock and $5 billion in Goldman Sachs stock

    But did you see the terms he got?!! These aren’t ordinary shares. For GE, he’s well protected against losses and gets 10% annual returns.

    And it’s not like he bought them on the open market. These shares were “poof” created out of thin air, diluting existing GE shares by 6%.

    Not good for the shareholders, but at least GE stays solvent.

  76. A.M. says:

    [...As Trent over at The Simple Dollar said, the only thing we have to fear is fear itself. While I agree with Trent...]

    The credit market is collapsing and help is needed. A pork-filled bill is better than no bill at this point. Banks need to be able to lend confidently!

    I just wrote a post about this tonight:

    http://stayingafloattoday.blogspot.com/2008/10/economic-crisis-to-be-avoided.html

  77. mkb says:

    Trent, I’m so relieved to hear that you maxed out your Roth – I was feeling like a crazy person for having done so! (My money went to the Vanguard STAR fund…)

    As a (relatively) young person – my retirement date is even further away than yours is – I feel like buying in a down market is a good plan, as long as my stocks are diversified. And that that’s true even if the market keeps falling.

  78. nic says:

    well written.
    Optimistically fruitful & uplifting.

    Also:

    Totally unrealistic.

    This is a classic case of taking positive lining sold on a mass media front’s page.

    If anything, read the comments above. Many people dropped important details (such as Lorax) that prove we’re standing in pig shit and trying to call it a rose bush.

    See here for a little insight:

    http://www.youtube.com/watch?v=Uha0DY3O0ng

    For more:

    http://www.youtube.com/watch?v=ji_G0MqAqq8&feature=related

  79. gr8whyte says:

    @ Lurker Carl : Thanks for the clarification. I haven’t read the bailout proposal but had assumed that Paulson intends to buy foreclosed mortgages in whole (the G$406 amount) to get them completely off banks’ books at distressed prices. In the way you describe, the banks would only receive 25% to lend out and have to keep 75% as non-performing loans on their books until the housing market revives. By buying them outright, the banks take a loss on the deal (depending on how much equity has been paid by the previous homeowner) but gets most of its capital back to lend out again, and their books are clean. This punishes the banks somewhat for their poor lending practices without totally destroying them and injects a decent amount of money back into the system. The real question is whether the banks will play along and accept a loss. They may simply have to to survive. Buffet believes taxpayers will profit from the deal in the long run as long as we don’t pay more than what the bad paper’s presently worth. I think the large amount was to intended to buy the bad paper off foreign banks as well. We should; we created the mess, we should clean it up.

  80. I am not sure if we only have to fear fear… what about all those unregulated derivatives floating around…On Myinvestorsplace.com one of the members spoke about 62 trillion dollars of these floating around.. this is scary stuff… no one knows what to do… everyone has a simple opinion… but in all sincerity…our members are scared… what do you suggest… what do you suggest for us personally…and what are the suggestions for the country…

  81. Matt says:

    I was expecting to read these comments bashing Trent’s post. It’s good to see a lot of Trent’s readers have common-sense as well.
    I would just like to add the following:
    The majority of homeowners losing their home bought a home they couldn’t afford, but the adjustable short-term rate they got allowed them to afford it, just barely. 5-7 years ago, it was reasonable to assume that, at the end of the ARM, you could just refinance, since CLEARLY your house appreciates, right? Well, the Clinton administration gave a ton of loans out to unqualified people, and they started foreclosing or filing bankruptcy. This started the wheel turning. As more houses foreclosed, house prices began to stagnate, and then fall. Before they knew it, the people with ARMs that were ready to refinance were rejected by banks because they were upside-down. These people eventually joined the “Oh, screw it!” crowd, swallowed their pride and took the only way out — foreclosure and bankruptcy.
    Whether it was Clinton’s fault or not, in that banks were FORCED or WILLINGLY gave these loans out, isn’t the problem anymore. But it would certainly help if the government would take any homeowner that wanted to refinance, buy the loan (or insure it) from the bank, and –REGARDLESS of how upside-down they are–refinance them at the going rate… maybe even a lower-than-market rate if necessary.
    I, to a very small degree, felt what they must’ve been feeling. I put 20% down on my house, owned it for 2 years with $0 on my equity line, and then I got a letter in the mail saying my equity line was shut down. If banks are willing to do this to people with perfect credit and absolutely no risk, I can certainly sympathize with people who weren’t in as great a situation as I’m in.

    Long rant, sorry :) I just think we should refinance all the foreclosures at a fixed rate like 5%, and get done with this housing mess. Such a simple fix, and it would actually CREATE equity, not try to pour money into the equity hole that’s happening now.

  82. SK says:

    FYI, when the Indymac bank failed, there were more than 10,000 depositors who had more than 100k in it, and most of them lost the money above 100k. So we cant necessarily say that no money has been lost. Whether it was stupid of them to have more than FDIC insured limit, I am sure they had their own reasons…

  83. Kevin says:

    gr8whyte – bob in #32 was being facetious – read the whole comment over again – he was not advocating loose credit now.

  84. Outstanding post, Trent. Your brevity and clarification of favorable situations during the drama of the financial sector crisis comforts all of us. You are gifted in taking muddied, convoluted situations and have them make sense to us, your readers. Excellent summary.

    I wish the guys down at the newspaper wrote as clear as you.

  85. Kevin says:

    For all of you advocating the bailout so that companies can borrow money to meet payroll and other “normal expenses” – isn’t that the problem behind all of this mess?

    Those companies are likely in trouble anyway – lending them more money when they can’t meet current obligations through normal operations isn’t going to solve the issue, just make it worse.

  86. Sally says:

    So how do you feel about the bailout (or rescue or whatever.) It sounds bad when we give hundreds of millions of dollars to save giant investment firms, but the economy doesn’t exist in a vacuum. I worry about the long term ripple effects. Five years from now, will I be able to get a home loan or a small business loan? We’ve passed the bailout now, but if they didn’t, would we have been screwed in the long run?

  87. gr8whyte says:

    @ Kevin (comment #52): bob’s first sentence in his comment #32 by itself can be interpreted to be facetious but not so when taken together with his second and third. Bob was simply saying that cheap credit was the cause that led to this bailout and not that it was a good thing to do so I’m baffled by your “he was not advocating loose credit now.”

  88. gr8whyte says:

    @ Kevin (comment #54)

    Re. “For all of you advocating the bailout so that companies can borrow money to meet payroll and other “normal expenses” – isn’t that the problem behind all of this mess?”, I don’t think so. The present problem is people are walking away from their mortgages and giving their homes back to the banks. Sure, businesses took advantage of cheap credit as well but I don’t think they’re walking away from their loans (don’t think their rates reset upwards like subprime mortages). And I’m not “advocating” the bailout; I’m merely stating my choice for it and leaving it up to individuals to decide for themselves.

    Re. “Those companies are likely in trouble anyway – lending them more money when they can’t meet current obligations through normal operations isn’t going to solve the issue, just make it worse.”, it’s considered normal for businesses to have a line of credit from a bank and these LOCs are being frozen just like HELOCs. A LOC is simply a tool that’s used routinely by businesses to ease short-term fluctuations in cash flow. Use of a LOC does not indicate a business is in financial trouble; it’s routine business practice. And when businesses are lucky enough to land a big contract, they will likely need financing to buy materials and hire additional employees for the project.

  89. Jim says:

    Good post Trent. The press is getting sensationalistic about this and people are over reacting.

  90. Jim says:

    Lurker Carl, You say that only 5% of loans are sub prime, but its actually 14%.

    This fed page has a graphic showing the % of loans that are prime, fha, va or subprime
    http://www.clevelandfed.org/research/trends/2007/0407/07ecoact_040307.cfm

    This page breaks it down in #’s:
    http://www.mbaa.org/NewsandMedia/PressCenter/50974.htm
    “This quarter’s NDS results cover over 43.5 million loans (33.3 million prime loans, 6 million subprime loans and 4 million government loans).”

    So with 6 million subprime loans at average value of $200k then thats $1.2 trillion in subprime loans.

    Paulson wasn’t proposing to just hand $700B over to banks. The idea was that the govt. would buy the loans. The $700B would be used to purchase the loans and then the government would own the loan. I believe they also intended to use the money for other things like loans to companies. In either case the government would have assets from the purchases. If a home foreclosed then the government would get the proceeds from the sale. Or if a company took a loan then the government would get collateral in the company. The government would also have gotten a cash flow from interest payments. The government would have effectively been acting as a big bag with $700B deep pockets to buy loans and make loans. There would be losses but it wouldnt’ be near 100% and the govt. would not have simply been writing no strings attached checks.

    Jim

  91. Jim says:

    @Kristine, #25, you say:
    “One thing regarding the unemployment figures- under Reagan they were changed to not include people who have been out of work longer than unemployment insurance lasts. So the jobless who have slipped into poverty are not included- they are considered- “no longer looking for work”-regardless of circumstance. The real unemployment figure is suspected to be in the double digits.”

    I’ve seen this theory floated around before. The so called ‘shadow governemnt statistics’ claim this kind of thing.

    Buy the theory is wrong. The idea that there are somehow a large # of unemployed people not being counted isn’t backed by any data.

    If this idea held true then the % of people who do not participate in the work force would have seen an abrupt jump at some point and it would be gradually increasing over time. Right? Its not.

    The civilian labor force participation rate increased from 64% in 1980 to 66% in 1990. If some accounting was changed in Reagans era to drop people out of the system of employed / unemployed then the % of people working would have decreased not increased. Since Reagaon the % participation rate has bounced around the 66-67% range.

    Jim

  92. Kevin says:

    gr8whyte –

    Re: bob’s comment @ 12:33 on 10/2 –
    “The reason we need this bailout is because it is difficult for people with poor credit to get loans now.

    The reason that led up to this bailout is because it was too easy for people with poor credit to obtain credit.

    And the wheels go round and round.”

    The way I read that – he is against the bailout because as he indicated with his comment “wheels go round and round” – the bailout would cause loose credit again which would call for another bailout, completing the cycle a 2nd time. Maybe I’m missing something?

    Re: your comment at 11:39am today –
    Your first point – how many mortgage are actually being “walked away from”? I’ve heard 5% to 7% are non-performing, so the number isn’t even that high. That’s not worth $700 billion dollars. And you’re wrong about business’ line of credit not being variable rates. Most of my clients’ rates are variable – based on prime and adjust monthly.

    Your second point – I understand using a LOC to smooth things out is somewhat common. Continued use of the LOC being a sign of poor business practice. I haven’t heard any of my clients complaining about their lines being frozen, so I wonder if this really is a legit problem.

  93. Bill in NC says:

    Few people reading this post have been through a 1981-style recession (10% unemployment), much less a 1973-style recession (go check stock market performance back then)

    It is important to remember the last 25 years have seen only VERY mild and VERY short recessions.

    Don’t expect this one to be as cheap and easy.

  94. Sean says:

    Kevin-

    Not a legit problem? Check out this article: http://news.yahoo.com/s/nm/20081003/us_nm/us_california_loan_5

  95. gr8whyte says:

    @ Kevin

    I interpret bob’s comment differently — the first 2 sentences are true, the third’s pure cynicism, and bob’s made no statement on whether he’s for or against the bailout. You can read bob’s-against-the-bailout into it but I prefer not to for it could have been written by one who’s neutral or don’t care on the bailout. Would have been simpler had bob stated clearly whether he’s for or against it but perhaps he can chime in now?

    Re. “how many mortgage are actually being “walked away from”? I’ve heard 5% to 7% are non-performing, so the number isn’t even that high. That’s not worth $700 billion dollars.”, I don’t know how many mortgages are being walked away from but is the exact number relevant? Lurker Carl did an back-of-the-envelop estimate and his number of mortgages resulted in a bailout $ amount with the right order of magnitude. I’ve no idea if all foreclosed or will-be-foreclosed properties are worth G$700 but the current number has been sufficient to cause severe financial difficulties for banks here and around the world (failures, bailouts, mergers). As I understand it, the G$700 is an authorized ceiling much like the credit limit on a credit card so if it won’t cost G$700 then the Secretary won’t be spending the whole G$700. If it turns out to be more, additional authorization will be needed from Congress, if the Secretary chooses to do so.

    Re. “And you’re wrong about business’ line of credit not being variable rates.”, I fully understand LOC rates fluctuate — they go up *and* down with fluctuations in interest rates, perhaps tied to some metric like LIBOR — but they don’t reset in the same sense as teasers rates on subprime mortgages do. “Reset” in my statement was intended to mean a sudden jump from teaser to market rate peculiar to subprime mortgages, while LOC rates fluctuate from one market rate to the next market rate all the time, but you’d interpreted it to mean that I didn’t know that LOC rates fluctuate.

    Re. “Continued use of the LOC being a sign of poor business practice.”, I’d use a LOC if I were trying to juggle several contracts simultaneously simply to make my life a whole lot easier. True, one can get into financial difficulty if the LOC’s used irresponsibly but the mere existence of a LOC should not indict a business owner as exhibiting poor business judgement. If customers refuse to do business with me because I’ve a LOC, then so be it. Irrational, but so be it. In my personal life, I use a CC for almost everything and pay if off in full every month just for the convenience (and it’s interest-free of course).

  96. gr8whyte says:

    @ Kevin: My reply to your comment #60 appears to have vanished into the ether.

  97. Bravo, bravo. By far the best article/post/advice/thoughts I’ve read on the topic. I applaud that you appealed to your readers’ sense of reason. Emotional financial planning is destructive financial planning. I’m actually in the middle of writing an article on why cashing in stocks is outrageously horrible; I’ll definitely link to this resource.

    Thanks again. :)

  98. Lurker Carl says:

    I fear we are witnessing the end of capitolism as we know it in the USA. The Secretary of the Treasury has been given incredible power (money) by Congress, without review or control or retribution by anyone. The road ahead is going to be long, rough and the ditches filled with financial wreckage.

  99. Sean says:

    That’s odd, my posts have been disappearing.

  100. Kristine says:

    Food for thought:

    In some Christian faiths, as well as the Muslim faith, it is forbidden to profit from a loan. A loan is only allowed to be a generous act, help from one person to another. Making money from another’s less fortunate situation is considered vulgar, and unacceptable. Ungodly, and also bad for the recipient.

    If loans were only given by the government, interest free, based on work experience, and only for education or health matters (the assumption being is better for all to have an educated and healthy populace), then the entire society would be forced to live within their means. So radical! Everybody would not have everything, and hardwork would produce the most reward, not saavy paper-pushing and marketing.

    Families would live together longer, and people wold not feel as isolated, either. Natural support networks would arise.

    You know who is completly unaffected by this whole crisis? The Amish. They must be scratching their heads at our self-created crisis.

  101. Good stuff to remember when everybody’s freaking out! The only thing that makes me a little mad about all this is the fact that I started investing about a year and a half ago, right BEFORE everything started falling apart. Kinda wished I’d waited. :-)

  102. The Charters Of Dreams says:

    I think this is exactly right — FEAR really is our greatest enemy.

    And, there’s still time to influence the government to make the best possible use of that $700 billion. It’ll take awhile for the plan to be implemented, and we need to push our representatives to bring in as many outside experts as possible to modify that plan.

    Why should we do this? Because the bailout, as is, could make the recession worse.

    This is from the Breakingview.com site:

    Misallocation of capital:

    “Treasury secretary Hank Paulson’s plan uses money borrowed by the US government to buy value-impaired debt left over from the credit bubble. In a period of freely available credit, that might not matter. Good investments would get funded and, since additional money is available, some bad investments would, too. Diverting some money into unproductive uses should affect mainly those bad investments, with only modestly negative economic effects.

    When money is tight, however, as it is likely to be for some time, withdrawing $700bn from the funding pool to support failed, past investments has a more serious effect on the economy, because capital flows are restricted by market illiquidity and investor trepidation. If that reduces asset prices, it exposes more loans to losses. If it prevents good investments by crowding them out of any chance of getting funding, it reduces economic activity. Either way, it makes the economy less efficient.

    Herbert Hoover’s Reconstruction Finance Corporation of 1931-32, which made loans to politically connected companies, didn’t do much to alleviate the Great Depression. An equivalent amount of welfare handed out through the “Veterans’ Bonus”, which Hoover opposed, might have boosted consumption and stabilised the economy more quickly.

    Japan’s 1990s infrastructure spending spree also diverted capital from more productive uses, helping to cause consumption to stagnate and the downturn to extend for 13 years. Paulson’s plan differs from both these examples in some ways, but is similar in that it may divert capital from its most productive uses. The danger is that the rescue plan could have similar consequences.”

    To read more about consquence of the Paulson plan, see The Paulson Plan: Triumph of Cynicism & Why it’ll make things Worse.

    ~ Best,
    The Charters Of Dreams

  103. kitty says:

    I think Brent, Kevin, Kristine and others lack understanding the role credit plays in running of ANY business. Kristine, a simple example. Do you want keep earning a percentage on your bank account? I’d imagine so. What do you think a bank should do with your money, put it in a vault at 0% than pay you 4%? How can it do it without losing money? The only reason bank pays you interest it because it can invest your money into, for example, loans that bring it more than 4% it pays you. So by earning interest on your deposits in a bank, you are indeed profiting from loans.

    The reason we need these bailout is that BUSINESSES can get loans they need to pay your salaries, among other things. That banks can get short-term loans from other banks so when people withdraw more money that banks have available (rather than invested), the banks can pay their depositors. There have been runs on banks as people with over 100K were withdrawing at roughly the same time, as people with under 100K who don’t quite trust FDIC were withdrawing “just in case”. Normally when this happens bank take low interest loans from other banks, than repay from their revenue. Now the banks are afraid to loan to one another. Then there are transportation companies that need to pay employees before something is delivered, but get paid after the delivery is done. Or a construction company that has to pay employees first, then gets most of the money after the building is paid.

    I think the reason you call this bailout ridiculous is that you don’t understand to what extend credit is used in day-to-day operation of all companies. Even, maybe even especially, the large corporations. No business can afford to keep piles of cash doing nothing just lying in a vault or in multiple under-100K checking accounts. The money is normally invested. Since expenses often don’t coincide with the time a business gets money from its customers, the short-term loans is used.

    How do we know there is a lending crisis? There are number of indicators. The interbank loan rates which is normally at 2% is now at 4%. The Libor rate is almost at 5% (normally it’s a little over 2%). There are other indicators that show that even at these rates, loans are hard to get. If your employer isn’t able to get loans too, you may just lose your job.

    As to “this is not as bad as Great Depression”. NOT YET. This is the purpose of the bailout – to avoid the depression. We may still get recession, but maybe the bailout will make it short and less painful for all of us.

  104. George says:

    Lots of posts have disappeared from this thread.

  105. Trent Trent says:

    A ton of the comments on this thread went into moderation due to length and potential incendiary comments. I believe all non-flame comments are now approved.

  106. George says:

    Sorry, Trent, but none of my “inflammatory” posts have appeared.

  107. Sara R says:

    Quote from Krugman today:

    “The only thing we have to fear is fear itself. Fear and negative equity … The two things we have to fear are fear itself and negative equity, and the depleted capital of financial institutions … Amongst the things we have to fear are fear itself, negative equity, and the depleted capital of financial institutions.”

  108. danie d says:

    here’s my take, and i fully admit it may be born of fear:

    society is different now than in the 30’s. sure, unemployment is lower. but how many of the jobs held now either didn’t exist then and/or are expendable now? once you take away your service industry, your spa workers, your hair stylists — all those professions that have been created in the times of luxury — you’ll see unemployment surge. the fact is — people don’t need those types of businesses. when consumers cut back, waiters will lose their jobs. people who work in stores will have their hours cut back. people will dye their own hair. things that are not necessary for survival will go and the people who provided those services will be out of jobs.

    warren buffet can buy because he has already has money. i think people living check to check have a right to be scared. if they’re not self employed, or contracted, or farmers, they can be out on the street in less than a month. they don’t have to pull money out of the bank — they can spend it all just living in the day to day.

  109. Bryan says:

    Unemployment is MUCH higher than we’re told.

    http://www.shadowstats.com/alternate_data

  110. Jesse W. says:

    great post! keep up the good work!

    Jesse W.
    http://www.subprimeblogger.com

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