Bailout, the $700 billion dilemma and world markets

[kgun]

Last week was a remarkable week for an economist. Short selling of stock were halted and financial markets are effectively frozen and losses of big financial institutions are socialized. We witnessed how Lehman Brothers was filing for bankruptcy and finally bought by Barclays.


This is not surpricing for economists that have followed these sites

1. Crosscurrents August 2008
2. Elliott Wave International: Expert Market Forecasting using the Elliott Wave Principle

since 1999.

Links:
Morning Brief: The $700 billion dilemma | FP Passport

BusinessWorld Online: Corporate Watch By Amelia H.C. Ylagan: "Banca rotta"

AFP: End of era as Goldman, Morgan Stanley agree overhaul

elliott wave - Google News

[ctabuk]

I think the concept has backfired and the stock exchange is heading further downwards

[kgun]

At least the persons behind the two links mentioned above (1. and 2.) will agree with you as far as I know.

Fareed Zakaria has written an interesting book "The Post-American World" and make some interesting interviews.

I watched this interesting yesterday where the video may be included later.

Facts: http://www.interbrand.com/best_globa...px?langid=1000

My own opinion.

1. This is not a characteristic of a market bottom.
2. Governments can postpone and hopefully soften the developement but it is difficult to control the social mood.
3. When everybody hates the market and there is silence, you may be close to a bottom.

[ctabuk]

The rotters left CTABUK off the list

We feel that the real crash will be in October.

[cw1865]

Essentially from what I have been reading the government is going to set up the equivalent of the Resolution Trust Corporation which existed during the S&L crisis. This entity will buy up bad debt, which, from what I have read is mortgage debt gone sour.

In any event I just find this amazing because mortgages are fairly well secured. First they're secured by the debtor (who has apparently defaulted), then they are secured by the land/property (which apparently has declined in value), and, at least in the case of sub prime loans where the debtor put up less than 20%, the loan is further secured by PMI which is essentially mortgage insurance that the debtor pays to the lender for the benefit of the lender. (What were all of these people paying PMI for to begin with?); essentially between foreclosure and the insurance company, that just isn't enough, they need the government bailout too.

It seems that the markets have become prone to bubbles; whether its stocks, housing, commodities....

I opine that the root of the problem is wanton speculation.

To reign in speculation, I suggest increasing the short-term capital gains tax. As many of you know, if you hold an asset for less than a year, its essentially taxed like income. If you hold it for longer than a year it gets taxed as a long term capital gain (which is a much lower rate). Housing is an exception because you must hold it for two years and you get an exemption on your primary residence of up to $500K for a couple and $250K for a single individual.

Notwithstanding, the rules could be changed to lengthen the time to qualify for long term capital gains and/or the rate on short term capital gains can be increased.

I suppose the 'they're too big to fail' argument works, but this bailout seems to be becoming a habit....

[cw1865]

Oh, and by the way, when the government says $700 billion, multiply by three, they don't know how to estimate costs. Guaranteed, five years from now it'll come in at over $2 trillion.

[kgun]

To reign in speculation, I suggest increasing the short-term capital gains tax. As many of you know, if you hold an asset for less than a year, its essentially taxed like income. If you hold it for longer than a year it gets taxed as a long term capital gain (which is a much lower rate). Housing is an exception because you must hold it for two years and you get an exemption on your primary residence of up to $500K for a couple and $250K for a single individual.

IMO a good proposal.

1. A new story under the headline "the end of the titans" Goldman Sachs and Morgan Stanley are being transformed from investment banks to traditional banks regulated by the Federal Reserve System. This reminds me of the Norwegian Banking crises where some went bust and others were take over by the Government for a periode.
2. Sometimes, in extraordinary situations, markets must be tamed.
3. In my opinion prioritizing are important. Since losses are socialized a sort of insurance system are imposed on the part of the population that can stand it via the tax bill.
4. It should be possible to make a temporary Financial institution backed by this social insurance system - the tax bill - that buys the bad loans in the housing sector so ordinary people can keep their homes.
5. Individual plans must be made so that it is possible to pay the periodic annituities until the sitution (that still may last for years) gets better.
6. That was done after the war here in Norway. Den Norske Husbank was invented for social house building. Loans were granted on an individual basis based on needs.
7. Now a similar bank / financial institution can be invented so people can keep their homes.
8. Message, don't only socialize company losses, but losses for the average citizen as well.
9. I have seen that some short selling has been halted. May be a tax should also be imposed on such transactions as long as it is needed.
10. So prioriticing correctly is important. No nation has so many Nobel Prize winners as the USA, so you should have the availble brain power to get out of the crisis. Political ability or will is another story. What happens in your country will have transmission effect to the rest of the world. The worlds monetary system is tightly integrated.

[cw1865]

Yes, they filed to become holding companies so that they can take deposits from people.

The person they need to put in charge of this fiasco is obvious to me. Governor Jon Corzine (my state, NJ).

He's been spending his term touring NJ trying to convince voters that the tolls need to increase on the NJ Turnpike and Garden State Parkway. Frankly, governor of a state is a job beneath his talents.

He's a former co-chairman of Goldman Sachs.

His business credentials should appeal to Republicans, his party affiliation to the Democrats.

Since this obviously will take a bipartisan effort, and both Republicans and Democrats have indicated support for the bailout; the man to spearhead the effort, ie. the bailout 'czar', should be Corzine.

[cw1865]

Sometimes, in extraordinary situations, markets must be tamed.

I tend to agree, the purpose of free markets is to find that 'optimal' market equilibrium price. If prices are fueled by speculative bubbles; it sends incorrect price information to economic decision makers (ie. we don't know if we're coming or going!). Oil's rise to $147, then down to $92 really illustrated this point. There shouldn't be sudden 50% price swings when supply is relatively stable.

In my opinion prioritizing are important. Since losses are socialized a sort of insurance system are imposed on the part of the population that can stand it via the tax bill.

That is correct, it will come from the 'general fund' meaning that we will all pay in accordance with our contribution to the overall tax bill. What bothers me is that these costs have already been socialized with the 'PMI' (albeit private insurance). To a certain extent its almost as if the general tax fund is being used as a massive 'last resort' re-insurance company.

It should be possible to make a temporary Financial institution backed by this social insurance system - the tax bill - that buys the bad loans in the housing sector so ordinary people can keep their homes.

This is what they are going to do. They will set up the equivalent of the Resolution Trust Co.

Individual plans must be made so that it is possible to pay the periodic annituities until the sitution (that still may last for years) gets better.

I'm not sure what you mean here. Any asset that is continuing to pay isn't going to be sold since by definition, its not 'bad debt' - if the bank owns some sort of annuity that isn't paying, they will sell it lock, stock and barrel to the federal institution.

That was done after the war here in Norway. Den Norske Husbank was invented for social house building. Loans were granted on an individual basis based on needs.

They have similar programs here. If you look at the focus of HUD (Housing and Urban Development), they will guarantee certain loans made for the construction of low to moderate income housing.

Now a similar bank / financial institution can be invented so people can keep their homes.

The best they're going to do is to convert ARM mortgages into conventional mortgages. If the individual still cannot pay the mortgage, they will probably (at best) permit a 'short sale' meaning, essentially they will let the house get sold below the actual mortgage amount and let the homeowner walk away.

Message, don't only socialize company losses, but losses for the average citizen as well.

The funny thing here is that this is actually the realm of the various state governments. Its not under state control. Different states will do different things. At one point in time, California did not permit what are called 'deficiency judgments' - what this means is simply. Let's say you have a house for 500K, you also borrow 500K to buy it. The house declines to 400K in value (you still owe 100K). Now you lose your job and can't pay; the bank forecloses. You lose your home and technically you would still owe 100K on the mortgage. In certain jurisdictions, this isn't permitted and the cost of 'deficiency' judgments is spread automatically across the market since it ostensibly costs more (in intangible risk) to issue mortgages to homeowners.

PMI is also supposed to secure the loan. Although its private insurance, it doesn't make it any less collective in nature.

I have seen that some short selling has been halted. May be a tax should also be imposed on such transactions as long as it is needed.

If you want to make a bet, go to a casino. You should not be betting for negative outcomes. Essentially be short selling your betting that the price of a certain stock will decrease. This is ludicrous. Your choice of a stock should be based on the underlying fundamentals. If you don't think the companies' fundamentals justify its price, you simply shouldn't buy it.

So prioriticing correctly is important. No nation has so many Nobel Prize winners as the USA, so you should have the availble brain power to get out of the crisis.

I understand your point, the person will need to be intelligent of course (my choice would be Corzine), but really there is going to need to be some sort of institutional addjustment and the person will need the ability to manage an institutional solution capable of forming consensus not only with Congress, but also the financial community. At the end of the day its going to be difficult to find an equitable solution that balances the needs of the financial community, the affected homeowners, and the taxpayers.

Political ability or will is another story. What happens in your country will have transmission effect to the rest of the world. The worlds monetary system is tightly integrated.

The political will will be there, from what I have read, the Democrats are in (critical of the situation of course, but apparently understanding that its necessary)

[kgun]

I'm not sure what you mean here. Any asset that is continuing to pay isn't going to be sold since by definition, its not 'bad debt' - if the bank owns some sort of annuity that isn't paying, they will sell it lock, stock and barrel to the federal institution.

May be the Norwegian word "annuitet"=interest + part-payment, is different from the American / English word annuity.

At least there is:

• Annuity (US financial products - Wikipedia, the free encyclopedia)
• Annuity (European financial arrangements - Wikipedia, the free encyclopedia)

an US and an European meaning of the word.

Individual plans must be made so that it is possible to pay the periodic annituities until the sitution (that still may last for years) gets better.

Aside from obvious spelling errors, I simply mean:

1. The representative house owner (individual) should get an arrangement so it is possible to pay the monthly or quarterly interest + part-payment on the house loan. Part-payments may even be set to zero for a longer or shorter periode.
2. A private profit maximizing financial institution will increase the interest rate for bad loans. That may be one root of the problem in the short run.
3. As economists we know that in case of externalties (e.g. like extraordinary market situations and periods of financial fragility) there may be a large difference between the social and the private optimum. For that reason, a governmental institution could set a lower price of loans (that is interest rate) than a private institution would take.