Hundred Power

I just can’t think about the Great Depression and today’s
“Credit Crisis” without thinking “Ponzi Scheme.” Ponzi’s
main success had a great “Wall Street Story” behind it.
He said he could buy international postal coupons abroad
and redeem them in the United States for a gross profit of 400%.
That was true. Ponzi said an investor could make
a 50% profit in 45 days. He repaid enough investors often
enough that his company eventually was bringing in $250,000
each day. However, no one analyzed that the overhead of
converting those low-value coupons produced losses, not profits.
The only “dividend” was a return of money paid with the NEW money
coming in. But, Ponzi was getting rich. The end came in 1920.
That’s one form of free enterprise. Truly free enterprise allows
this kind of “Bubble.”
(See the reference link below for the full Ponzi story.)

The 1920’s Stock Market Bubble

Next comes the Stock Market Credit Scheme in the 1920’s.
It is the root cause of the Great Depression. In some
segments of society, it was indeed the Roaring Twenties.
The stock market was rising. By the late twenties, one
esteemed economist said America had reached a permanent
level of prosperity. However, there was little regulation
of credit. Banks would lend money for stocks if the borrower
put up 5%. That is huge leverage. A person who had $100
could buy stock worth $2,000. HUGE LEVERAGE! A stock which
rose in value to $2,500 had made 500 percent for the
borrower who only put up $100. Well, just like Ponzi’s
investors, the word got around about a great way to get
rich. It was, “Borrow money. Buy stock.” We know that
the Mighty Mississippi River begins with trickles of
water in Minnesota. The growing amounts of money mushroomed.
As more borrowed money created more demand for stocks,
prices rose. The price of the stock could be sent to the
sky based on credit only. So far, so good.

That was the rosy picture. The flip side of leverage
(margin money) is that the investor above would lose
100% of his capital when the stock price went down 5%.
As above, a DROP of $500 meant the speculator (forget
the word investor) lost the $100 and still owed another
$400 to repay the bank. And, what if the speculator didn’t
repay the bank? The bank had to pay. Thus, the lucrative
bank loan business wiped out 20% of the banks. On the
way down, the bank as well as the borrower had to liquidate
everything they could get their hands on.

We know the rest of the story of this Bubble: meltdown
and misery. Will Rogers was a savvy financial manager in
addition to being a great humorist. Rogers said he was more
concerned about the return of his money than the return on
his money.

More Crises and Bubbles

Fast forward to the 1980’s. Remember the Savings and Loan
Crisis? Why? The bankers screwed up the managment of credit.
How about the Dot-Com Bubble? Well, that wasn’t credit.
That stands apart as simply a detachment from the belief
that internet companies needed to actually make money.
It is closer to the Tulip Craze and the South Sea Bubble.
In sum, they sound like a manic greedy rush of many without
getting a boost from the credit industry.

I recall reading many books about finance and economics
following the Stock Market Crash of 1987. I concluded that
the cause of the Great Depression was “LEVERAGE.” I wanted
to imagine what pitfall(s) lay in the future that could
ever lead to such a “Category 5 Economic Hurricane”. The only
condition I saw was the leverage in residential housing.
I believed that a conventional mortgage with 20% down was
a vulnerability that resembled buying stocks with 5% down.
After all, in 1987 regulations required stock buyers to have
at least 50% down, i.e. margin. And, houses are bought and sold
in a market. I did not forecast that such a disaster would
really happen. However, if and when all other economic activity
took a big nosedive at the same time, housing would then be
the sector that would bring to America the “perfect storm” of collapse.

Today’s Housing Bubble

Well, here’s the cause: Leverage. This is exactly the
parallel story of the Stock Market Bubble. In 1998 or so,
I read a feature article about a West Coast mortgage broker
who said, “If you can fog a mirror, I can get you a loan.”

Now we were back in the 1920’s. No longer did a buyer have
to come up with 20%, or even 5% (margin) to buy a house.
The lenders went along with it. The financial industry
created the “Credit Default Swap” (CDS) to tell investors
that weak mortgages had been insured. The industry did not
explain that they were unregulated. As such, the so-called
insurers kept selling their “insurance” taking on leverage
of 20 times, 30 times, 60 times their reserves to ever cover
any losses anyway. So the bankers closed their eyes and lent
money. Does that remind you of the bankers of the 1920’s?
And the sellers of the Swaps made a ton of money while it
lasted. Does that remind you of Charlie Ponzi’s Scheme?
Thus, the perfect marriage of stupidity and swindle created
this perfect storm. It has been in place and making money for
years. They just lasted longer than Ponzi’s enterprise.

What’s Going To Change?

The conventional wisdom these days is: “The definition of
insanity is making the same mistake over and over and
expecting a different result.” Both major political groups
have overseen the entire system for decades. Albert
Einstein said that it takes a brilliant person to solve a problem,
but real genius to prevent the problem.

I really don’t see any national political leadership that addresses the long-term solution to prevent another bubble. In other words, the inmates are still in charge of the asylum.

– Byron.

Reference Links:

Charles Ponzi:  http://en.wikipedia.org/wiki/Ponzi

A new Rasmussen poll digs into the depth of dissatisfaction with the national elected politicians. The polls in general reveal the disapproval level registered by the American people. It’s very, very low. However, this poll shows the anger of a party voter even against his/her OWN party. This link gives you the details.

59% Would Vote to Replace Entire Congress

Did you note this finding: “Only half (49%) believe that the current Congress is better than individuals selected at random from the phone book.”

The bailout has just added anger on top of disgust.
Imagine! Imagine! America just might get a really fresh start
on election day. We could hardly do worse, could we?

The U.S. Senate passed a variation of the Paulson Bailout
Scheme. Yes, the Kritters in the Kongress will come up
with some version of it. Again, no new ideas will
penetrate the minds of those living the lifestyles of
the rich and powerful members of the U.S. Kongress.

Is the problem a credit crunch caused by too many
Americans buying homes at prices too high? Losses
in real estate values? Cheap credit at artificially
bargain interest rates? All of that is symptomatic.
Too high or too low compared to WHAT? What are the
root causes of so much misery and instability?

MONEY 101

Lesson 1:  This is simple. Why can’t people can’t pay
their bills? When they can’t do that, they’re poor.
Poor people are poor because they don’t have enough money.

Lesson 2: How do people get money for their bills and
mortgages? (This is Money 101.) They go to work and get paid
a wage. So, what will mess up your life or their lives?

Lesson 3:  Well, if you lose a job to an immigrant, you
have lost your ability to pay your bills. If you’re looking
for a job, but an immigrant (legal or illegal) gets the job,
you’re out of income. How are you going to pay the rent or
the mortgage?

Lesson 4: If your company is in a shaky industry (or has
shaky management), a downturn may cost you your job.
No job; no income; no money for all your bills.

Lesson 5: If you get sick and can’t work, you lose your
job and your income. How are you going to pay your rent
or mortgage? Oh, maybe you have medical insurance.
That may pay doctors and hospitals, but it doesn’t pay
the rent or the mortgage, does it? Got cancer? You get
to decide to pay the insurance for treatment, or pay
for the treatment itself, or pay the mortgage.

Forty-seven million Americans don’t even have bad
medical insurance. They have none. Half the bankruptcies
in the country involve illness. 27,000 people die each
year because they have no money for medical treatment.
(Dead people don’t have to file for bankruptcy.)

Lesson 6: If you spend all your savings on your kid’s
education, that means you have no cushion. You’re a great,
unselfish parent. However, any negative event makes
you unable to pay your bills. You’re poor.

Lesson 7: Oh, one more thing. Bad things happen to nice
people. How about those credit cards to see you over the
tough spots? How long does it take to run out of
credit when the credit pushers charge 20%, 25%, or 29%
rapidly compounding interest? (Used to be only the Mafia
charged that.) Albert Einstein said, “The most powerful
force in the universe is compound interest.”

Lesson 8: The cost of energy (and everything else) goes
up because you are dependent on foreign products. America’s
leaders, thirty years ago, told you that the goal was
to become independent of imported oil. Our dependence
is now at an all time high.

Lesson 9: You have to pay more for everything for
a couple of reasons. First, the government is spending
more money than it has. It’s close to broke. It is
also on “credit crack.” Second, America has been buying
way more from foreigners than it sells to foreigners.
The result? The dollar has been going down the toilet
for years. Your prices are going up . . . and up . . .
and up. Where’s our American leadership?

Lesson 10: To a korporate lobbyist, a good government
program gives the benefits to their own special group,
while a different group pays the bill. Can you see
who is getting bailed out? Are you going to pay for it?

POP QUIZ: Explain what would be a long-term plan for America
to improve the lives of Americans.

GOOD ANSWERS: a) Investing in America by building a great
system of highways, railroads, and transportation.
b) Implementing national health insurance.
c) Controlling the excesses of Korporate Amerika.
d) Ending the waste of a trillion dollars on foreign wars.
e) Balancing the federal budget.
f) Stopping the destruction of American jobs.
g) Voting against elected officials now in office.

In short, the average person needs a Fair Deal.

The House of Representatives defeated the Paulson-slanted
bailout bill. Two of three Republicans and forty percent
of Democrats voted “NO!” Surprising. Very surprising.
The reasons for it were supplied by voters and citizens.
Reps were reporting that the calls and emails overwhelmed
them. The opposition of us the people was running 100-1.
What a thrill to hear that people cared, expressed
themselves, and won! That’s the way the system is supposed
to work. Absolutely thrilling.

That number of $750 BILLION was too much to ignore, it seems.
And, the benefits were seen as going to Wall Street with
the bill of $5,000 per worker being paid by the average person.
There’s the source of the outrage. Enough is enough.

But . . . back to the democracy of it. The best known
uprising in America is the Boston Tea Party. Five thousand
people, a third of Boston, turned out to protest the
Tea Tax that night. Then the actual attack on the ships
with the tea was carried out by less than a hundred people
who chopped open 342 chests and dumped them in the water.
The huzzah was “Boston harbor a tea-pot tonight!”

Historian Paul Gilje found 150 riots between 1765 and 1769.
And it continued apace till the Revolution started. The
country was animated by anger and rebellion. Collectors
of the Stamp Tax were forced from office, sometimes tarred
and feathered. Governors had their homes destroyed and burned.

Before Ethan Allen and the Green Mountain Boys were soldiers
of the Revolution, they were a resistance movement threatening
the powerful and the rich. In North Carolina, Raphael
says the Regulators “intimidated their enemies, disrupted
the courts, and freed their leaders from jails.”

The history is full of incidents. Colonial America was
a top-down society and economy run by those put in power
by the King of England. The colonists had no vote except
the threat and exercise of violence. We modern Americans
have a vote. The threat and exercise of the vote is
a replacement for violence, in one sense. But it has
to be exercised. Agree or disagree with the so-called
bailout plan, the people spoke and got their way.
It’s thrilling.

Reference Source:

“A People’s History of the American Revolution” by Ray Raphael.

This bailout policy is simply wrong as Paulson proposed
it. In a rush to judgment, the Congress is trying to
tweak it. It’s pretty well too late to stop it even if
the elected officials were reading this. However, there
may be some value in writing this as an exercise. Your
comments would also be valuable.

The Big Picture:

90% of mortgages are currently being paid on time and in full.

Only 3% of mortgages are in foreclosure. Yes, that is high.
The bailout dollars requested are about $5,000 for each
person in the American workforce; the bailout has to be
paid for by borrowed money. If there absolutely must
be emergency action to “save the financial system,” then
there are safer, less costly alternatives. Here they are.

Provide NEW capital to fund NEW quality mortgages:
This allows lenders to do business as usual.
Rule: The borrower must have twenty percent down.
Rule: The lender has to hold the mortgage.
Rule: The borrower may not take out a second mortgage.
Rule: The borrower may not use built-up equity for
a second mortgage nor a line of credit.
Rule: The mortgage must have a fixed rate of interest.

Provide NEW capital to buy OLD mortgages:
Rule: The mortgage is current.
Rule: The mortgage was issued 5 or more years ago.

Establish a “Foreclosure Holiday”:
Rule: The homeowner in foreclosure gets a 3-month grace period.

A “Foreclosure Holiday” works like the Roosevelt “Bank Holiday”
in the Great Depression,  The purpose was to stop a
“run” on banks.  Less well-known was the “Insurance
Holiday.” No one could cash in an insurance policy
for six months. Thus, the idea of a “Foreclosure Holiday”
is an available option.

Mortgage Administration:
Rule: When a mortgage is issued, establish
that only one company may handle the
payments for the life of the loan.
That could be the lender issuing the loan
or a licensed company agreed upon by both parties.

Explain Federal Deposit Insurance:

Conduct a national media campaign to educate the
public. The message should be:
1) Your bank deposits, in an FDIC bank, are insured
up to $100,000.
2) Put any money over that amount in a different bank.
3) The interest on your $100,000 CD is NOT insured.
The insured amount is $100,000, and not a penny more.

It’s hard to believe how many people lose money in
banks like IndyMac because their deposits exceed $100,000.
Second, there is turmoil as many small depositors withdraw
their money even though it is wholly insured by the
full faith and credit of the U.S. government.

Fatten up the FDIC reserves:

The banks pay a premium for federal deposit insurance.
Those FDIC reserves have been depleted. It’s time to
raise the premiums. Meantime, one bailout action could
be for the Congress to pump up the FDIC assets.
All the money will be repaid with the higher premiums.

Let the markets invest NEW capital:

One of the complaints is that there is not enough
money available. There are only two sources of money.
DEBT and EQUITY. Any bank or other company needing to borrow
money would be expected to offer a higher interest rate.
Second, new equity capital can be raised by selling stock.
The market will work when the price is right.

EXAMPLE #1: Goldman Sachs made a deal with Warren Buffett.
The company agreed to pay a 10% dividend on Buffett’s
$5 Billion of preferred stock. Buffett’s investment
is completely NEW money. Why did it happen? That
10% rate of return made it happen. Then, Goldman raised
another $5 billion in a separate stock offering.

EXAMPLE #2: JPMorgan Chase bought Bear, Stearns
a few months ago. This week they bought Washington
Mutual. The investor with the money took over.
Why? The price looked right.

Create a “National Mortgage Exchange”:

Let the financial institutions sell their “toxic
mortgages.” They are not worthless. If the value
of a foreclosed house is down, that’s just a reality.
The house itself is not worthless. The holder of
the mortgage owns the property, right? If the price
is right, there will be a buyer who will pay the
owner real money. Thus, the selling financial company
gets its money and can return to business as usual.
The government can establish some rules and promote
such a market, or even create an exchange, like
a stock or commodity exchange.

FINAL SOLUTION: Let the voters decide.

The American people and their elected representatives
are being asked to take monumental actions overnight.
This crisis did not arise overnight. What is wrong
with a “system” that gets this out of whack?
Where have our national elected officials been?
Do you think they deserve to be re-elected?

This writer thinks it’s time for sweeping changes.

/rb/

Treasury Secretary Paulson proposes that you and I pony up a few hundred BILLION dollars . . . maybe even a TRILLION dollars to achieve some unexplained goal with unexplained consequences.  So I’m not sure that Paulson even has a pig in his poke, with or without lipstick on it.

Oh, he says it’s to save our financial system. What does that mean specifically? Well, he also says he wants to buy up bad mortgage paper so lenders can free up capital to make more loans.  Krugman calls it “Cash for Trash.” Next, Paulson wants this authority and money in a few days. This credit crisis has been developing for years. Where were our leaders for the past few years? What were they doing? Let’s take a month or so to see what’s really in Paulson’s Poke. Let’s put different and better and cheaper ideas up for discussion.

Paulson led the bond-trading firm of Goldman Sachs. Debt is his specialty, i.e. his “hammer.” Remember, “When the only tool you have is a hammer, everything begins to look like a nail.”

Here are the best columns I read.

Related Links:

)    Paulson Bailout Plan a Historic Swindle
By William Greider

September 19, 2008
http://www.thenation.com/doc/20081006/greider

)    Fair Game — Your Money at Work, Fixing Others’ Mistakes
By GRETCHEN MORGENSON

September 20, 2008
http://www.nytimes.com/2008/09/21/business/21gret.html?_r=1&scp=2&sq=morgenson&st=cse&oref=slogin

)    John McCain: Crisis Enabler
By Mark Sumner

September 21, 2008
http://www.thenation.com/doc/20081006/sumner/1