Tuesday, October 14, 2008

Big Numbers

Anybody following the financial crisis unfolding would be shell shocked by the huge numbers being thrown around. A $100billion here or a $700billion there or maybe a couple of trillion.

The feeble mind begs to understand where the government is going to come by with this money. From what it understands, the feeble mind knows that:
There is a budget deficit
There is a trade deficit

A budget deficit means that tax revenues are not enough to fund current government spending.

A trade deficit means that imports are way more than export. While a trade deficit might result in currency valuation issues, it is inherently a private figure - that is it is comprised of the import and export totals for private company activity. It is not public money.

So with a budget deficit, spending the trillion dollars means
borrowing some more - by selling more treasuries and other bonds
printing more money eventually paying back the money through that most steady stream of government revenues – taxes.

I suppose in the scheme of things, greater minds can wrap themselves around these huge numbers and the miracle of the American economy can resurge and pay itself out of debt. One hopes that the preceding statement is true.

To a certain extent, tracing the current crisis, one gets the feeling that many people managed to dig themselves out of the tech bubble by creating a real-estate bubble. And people thought that there might be another bubble around the corner to salvage a real-estate bust. Unfortunately no build up immediately followed real-estate to take over where it left off. But given the huge amounts of liquidity being pumped in, which is not to say that there is not another bubble in the making?

As the economy gets more financial services oriented, companies will try harder to make money without really offering a tangible product. The current crisis is just a manifestation of that. What boggles the mind however is the number of people asleep at the wheel.

Companies start issuing sub-standard debt instruments.

Companies get away with giving the highest ratings to these instruments.

Companies insure this debt, but they label this insurance as credit default swaps so that they
don't fall under the insurance industries regulatory purview. Ironically some of the largest insurance companies offer these swaps.

Companies actively trade in the sub-standard debt instruments and swap without really understanding the mathematical models that define them - sort of reminds me when I started trading stocks and literally chose them on a whim (not that I am doing much better now).

To fuel this destructive model, more money is made available to mortgage brokers who happily sell mortgages to Joe Schmoe public. Joe Schmoe public conveniently ignores any nagging worries on affordability. And Joe Schmoe's mortgage gets lumped into a sub-prime Collaterized Debt Obligation which gets gets a great "AAA" rating and gets "insured" with a credit default swap and gets sold to a mutual fund. Joe Schmoe buys the mutual fund since it has a spectacular return for some inexplicable reason which he does not bother to understand or reason out. So in a way Joe Schmoe finacially cannibalizes himself.

Everybody is happy until it all breaks apart. Joe Schmoe can’t pay his mortgage. The Credit Default Swap cannot pay the “insurance” because –since it was outside insurance regulations- it did not have the capital to “insure”. Banks go psycho and stop lending. And the economy which has become dependent on financial services comes to a standstill.

And the Government HAS to step in.

And we pay "no" new taxes through our nose while the creative types devise another plan for another ponzi scheme wrapped around an algorithm.

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