Archive for the ‘Economics’ Category

How Your Tax Dollars are Spent

April 17, 2012

Accounting Degree Online has created an informative infographic about U.S. personal taxes.

Click “Read the rest…” to see the entire presentation. (more…)

The Seduction of America

September 6, 2009

From easy money in Wall Street banking to easy money in Main Street America real estate, the country has been seduced. We now live with the ensuing mess that was begat. I read a comment that talked about the free lunch syndrome, written by a certain “morph366” on a Seeking Alpha article by another author. I now know that commenter personally as Clive Corcoran, a London private equity manager. At the time this article was written, though, he was known to me only by his pseudonym, taken from the name of his personal blog site.

This article was originally published about five months ago, but I think that with what has unfolded since, it has even greater significance today. The structural problems in our economic theories, financial systems and our individual situations continue to be revealed. Read the entire article at Seeking Alpha.

More on the Historic Size of the Bank Crisis

August 26, 2009

The ratio of failed bank assets to GDP is much larger (seven-fold) than the Great Depression and has an even greater magnitude compared to the S&L crisis. This follow-up to the article below was discussed at

Banking Crisis Dwarfs the Great Depression

August 24, 2009

Even when adjusted for inflation and population growth, the 2008-09 banking crisis exceeds by far previous banking crises, including even the Great Depression. There were 10,000 bank failures in the Great Depression, but few of them had branches. Today, a medium sized bank usually has hundreds of branches and the two big failures, Washington Mutual and Wachovia Bank had more than 8,000 branches between them. Thus the number of actual bank locations affected in the current crisis, which is not over, is similar to the entire period of the Great Depression from 1929 to 1941.

When it comes to the amount of money involved, the current crisis has had bank failures 70 times those of the Great Depression. Even when the figures are adjusted for inflation and population growth, the current crisis is still much larger in dollar terms.

Read the entire analysis at The numbers are truly astounding.

Housing: Where Is The Bottom?

March 1, 2009

Note:  This is an update of an article by the same title published in early January.  Data and discussion of the previous article is not repeated here, unless specific updates are being made.  Some additional data is included in this article, including data from the National Association of Home Builders and regional housing market differences.

Thursday morning (February 26) a new U.S. Department of Commerce report found new home sales in January at a lower level than any time since they started keeping records in 1963 (New-Home Sales Tumble To Record Low; Prices Fall). The day before, the National Association of Realtors announced a 12-year low in sales of existing homes for January (January Existing Home Sales).

To continue reading this article click on Housing: Where Is the Bottom?

The Top Five Financial Issues for the Coming Decades

July 23, 2008

With all the turmoil in investment markets, I have found it useful to try to estimate major financial issues that will influence the American economy over the next few years and several decades.  This will summarize my current findings ranked in order of total dollar value.  All of these problems need to be resolved for the future viability of our way of life.  I think it is obvious that if the biggest problem is not solved, what we do with the other four will be of little consequence.

Issue #5:  The estimated asset write-downs resulting from the 2007-2008 credit crisis.  The International Monetary Fund has estimated this to be $1.1 trillion.  Less than half of this has been realized to date.  The time frame for this to be totally realized is one to three years.  The potential for this estimate to be too high is limited to a couple hundred billion at the most.  The potential for this estimate to be too low depends on whether or not we see an extended downward spiral in home prices and the associated worsening of credit markets.  Worst case scenario is probably another $1 to $1.5 trillion, corresponding to defaults on 20% to 30% of home mortgages.

Issue #4:  U.S. national debt of $4.4 Trillion.  This figure is obtained from the “Long-tern Financial Outlook”, U.S. Government Accountability Office, Jan. 2008.  Government estimates envision a balanced budget by 2013.  If you believe this, I would like to sell you a well known bridge over the East River.  However, I will use that to project the national debt to grow to $5.9 Trillion in the next five years.  The probability that this is too high an estimate is extremely low.  The probability that the national debt will be larger than $5.9 Trillion in 2013 is very high.  Furthermore, I am skeptical that a balanced budget will be achieved, not only in five years, but even in 10 years.  The risk is high that the national debt will continue to grow through deficit spending for many years to come.  I do not have a rational way to estimate an upper limit for the national debt in five years or beyond.

Issue #3:  The unfunded liabilty of the Social Security System is estimated to be $6.7 Trillion (Government Accountability Office, Jan. 2008).  This number could be higher with inflation above the report estimate – approximately 3%.  The time frame for this figure is several decades.

Issue #2:  The unfunded liability of Medicare is estimated by the Government Accountability Office to be $34.1 Trillion.  Again, higher inflation could raise this estimate.  The time frame is several decades.

Issue #1:  The cost of imported oil.  Many sources have estimated the 2008 cost for imported oil to be approximately $800 Billion at an average price of $120 to $130 per barrel.  The estimate for the hidden cost of oil – added military expense, environmental expense, health care expense, infrastructure degradation, etc – was approximately $825 Billion per year in 2006.  See the following website for details on the hidden cost:                                                               . 

If we assume the 2006 hidden costs and the estimated 2008 purchase cost to be applicable for the next 30 years, the cost of importing oil over that time frame is approximately $48.7 Trillion.  The likelihood that this too high an estimate is extremely small.  To lower the cost not only does the price of oil have to stay at or below current levels, the amount of oil we import must stay at or below current levels and there must be no inflation for 30 years.  With that scenario, the present value of a cash flow of $1.6 Trillion per year is $45 Trillion at a discount rate of 5%.

It is much more likely that the annual cost for imported oil will rise from the $1.6 Trillion per year.  If the cost rises by 10% per year (probably too small a figure), the present value of the cash flows over 30 years is approximately $58 Trillion.  The cost of continuing current energy policy is somewhere between $45 Trillion (an unrealistic lower bound) and something larger than $58 Trillion.  Half of this money is paid to entities outside of our economy and can only return to us by purchase of our assets.  A lot of the hidden cost remains within our economy, but none contributes to higher productivity.  The hidden costs are basically maintenance expenses.

Can a Margin Call Instantaneously Double the National Debt?

July 11, 2008

Rumors abound that the U.S. government will, one way or another, step in to guarantee the debt held by Fannie Mae (FNM) and Freddie Mac (FRE), the mortgage underwriters for the country.  Why has this possibility arisen?  These mortgage corporations hold $3 trillion in mortgage paper.  This has been written with a leverage of 100+ to 1.  In otherwords, these corporations have put up about $30 million (stock holders equity) and borrowed about $2.97 trillion within the U.S. financial system (which includes international lenders) to buy the mortgage obligations.

This situation has resulted in what is comparable to a margin call.  When an investor buys stocks on margin, he puts up part of the purchase price and borrows the rest.  U.S. security laws have a margin requirement, a limit on the percentage of stock value that can be borrowed.  If the stock purchased on margin falls far enough below the purchase price, the percentage of stock value financed by the margin loan can rise above the maximum value permitted by law.  When this happens, the investor receives a margin call.  He must then immediately provide more cash or the position will be liquidated by the broker/dealer.

The situation with FRE and FNM is similar in concept to the margin call, but is different the details.  The conceptual similarity is that these corporations have bought mortgages, effectively, on margin.  Investors around the world have provided the money for the margin, which totals approximately $2.97 trillion.  Many of these mortgages have been written with loans at 80% to 100% of the purchase price.  Currently, the market value of some of these mortgaged properties have fallen as much as 20% or even more.  Thus some of these mortgages are “under water”, i.e. the balance owed by the homeowner is more than the current market value.  This produces a situation where the balance sheets for FRE and FNM should show negative net worth.  In other words, these corporations should be bankrupt.  Technically, they can not be proven bankrupt because there is no transparent market for the mortgages they own. The market value can only be estimated.  It should be obvious, however, that the value of each mortgage can not be more than the market value of the underlying property.  I compare the current situation to a margin call because it is possible that the market value of mortgaged homes has fallen by more than $30 billion (1%) plus the aggregated down payments.  Therefore the $2.97 trillion in borrowed money is probably backed by negative equity.  In other words, to adequately secure the debt, more capital must be raised or the debt must be sold to repay the lenders.  I refer to this as the FNM/FRE margin call.

What can happen now?   One possiblity is nothing.  This would be disaster for the reeling U.S. financial system.  It would effectively cause a collapse because no one would have the confidence to lend to a system that ignores its obligation to honor its debt.  This will not be allowed to happen.

Another possibility is that FNM and FRE would be provided access to the Fed discount window.  In other words, these corporations could obtain capital by putting up their mortgage paper to secure loans by the Fed.  This would solve the problem if the bottom is close in housing prices.  However, if housing prices were to continue to fall, this action would be like a bandaid on a severed limb.  A total decline in house prices of 30% to 40% could require as much as $900 billion to $1.2 trillion in Fed financing.  This is in excess of the money in circulation under the Fed.  In order to provide liquidity, the Fed would need to have the Treasury issue more debt in order to obtain the necessary money to keep the Fed window open.  Thus, the national debt would be increased.  There would be some offsetting assets (value of mortgaged properties).  The major problem, however, is capital, not liquidity.  Therefore, this use of the Fed discount window would be outside the stated purpose of the facility. 

Another possibility is the abolishment of FNM and FRE with the assets and liability assumed by the U.S. government.  Instantaneously the national debt would be increased from the current value (approximately $3 trillion) to a new level of approximately $6 trillion.  Unless our economy collapses, this increase in national debt is offset by approximately the same value in assets, the mortgaged properties.  The problem is that, absent the huge mortgage financing vehicle represented by FNM and FRE, home mortgage financing would be reduced to a very low level.  Absent the ability to obtain mortgages, buyers would not be able to buy homes.  The housing market would dry up and home values could easily fall precipitously.  In that event, the national debt would be permanently increased by the loss in home values.  Therefore, if this option is pursued it would be necessary for the government to operate the mortgage underwriting business that FNM and FRE have operated in order to hold down the potential escalation of the national debt.

Inaction is not a possible solution.  Some form of action will be taken by the government.  The best result will have a mortgage market continue in the future.  The best result will not be fractured if housing values drop another 20%.  Preserving equity for FNM and FRE stockholders should not be a primary objective of the government action.  It is most likely that government action will be to offer some form quarantee to FNM and FRE issued debt and to keep these corporate agencies operating, probably with more regulatory oversight.

The Fed Rides to the Rescue – Or Does It?

May 25, 2008

The Federal Reserve arranged rescue of Bear Stearns in March has been widely credited as having stabilized financial markets.  Stocks, especially financials, have performed very well since.  The ensuing celebration  has largely viewed these events as the Fed’s gift to the economy, and investors in particular.  Caution:  there is an old saying “Do not look a gift horse in the mouth.”  The meaning is that if someone is willing to gift you a horse there might be something wrong with it, such as a lack of teeth.  If that is the case the horse is doomed to starvation.

Let’s examine the Fed’s “gift horse”.  The Bear Stern rescue was accomplished by the Fed changing the way it serves the financial system.  One major change is that it opened the discount window for short term lending to investment banks.  Previously the window was available only to traditional (commercial) banks, although the expansion of many of these banks into the investment arena had blurred the distinction between commercial and investment banking.  For example, Bank of America, Wachovia and other super-regional banks have moved into some investment banking areas in the past several years.  Now, however, investment corporations such as JP Morgan and Goldman Sachs can arrange short term financing directly by the Fed.  This was not possible before March.

Another major change with the “gift horse” is the way the Fed allows the discount window to used.  Traditionally, the securities traded through the window were U.S. Treasuries.  These were the collateral used to secure the Fed loans to the banks.  Now the Fed is accepting collateralized debt obligations (CDOs), including mortgage backed securities, in exchange for U.S. Treasuries.  In other words, the toxic waste of the mortgage crisis is now being taken off the books of the investment banks and put on the books of the Federal Reserve.

Securities held by the Fed is what backs the value of the $818 billion of U.S. currency estimated to be in circulation.   Because approximately 20% of the securities backing the value of this $818 billion is now comprised of CDOs of unknown value, the future value of the dollar is at risk.  Of course, the value of the dollar is already down because of huge federal deficits and trade deficits.  The debasing of the securitization of the dollar just adds another layer of burden weighing down the value.

The dollar is a fiat currency.  This means it is a currency not backed by any hard physical assets, such as gold.  The dollar has been the reserve currency of the world for several decades.  However, since the end of the gold standard in 1972, the only backing of the dollar is “the full faith and credit of the U.S government”.  The agent of the U.S. government for maintaining faith and credit is the Federal Reserve Bank.  The securities held by the Fed are becoming increasingly suspect.  For a few months in the spring of 2008 the Fed has “rescued” a floundering U.S. financial system.  What will the consequences of this rescue be in the coming months and years?  It is unsettling that in the history of the world there has not been a previous fiat currency that has survived.  All historical fiat currencies have eventually collapsed to worthlessness.  It is true that some fiat currencies have survived for a long time.  An example is the currency of the Roman Empire, which survived for hundreds of years.  In more recent times, fiat survival has been much shorter.

The possible salvation for this gloomy scenario is that the CDOs will prove to have value and will be returned to the books of the investment banks.  In this case the securities held by the Fed will be restored to U.S. Treasuries.  After all, Fed loans are temporary and short-term.  The problem is that the value of the mortaged backed securities will not be worked out in the short term.  The work out of variable mortgage resets will not be substantially completed for 2-3 years.  The decline in the housing market (house values) may not be 50% complete.  The lower house values fall, the higher the mortage default rate.  So the question mark in the title will not be resolved for several years.  Ask again in 2011. 

Can Bush Save the Dollar?

March 13, 2008
By Prof. Menzie Chin, University of Wisconsin
Author Bio and PiedmontHudson notes are at the end of this very interesting article which shows just how deep a hole the dollar is in.
Figure 1: Log real trade weighted value of dollar against a broad basket of currencies (blue) and against major currencies (red). (more…)