Monday, September 29, 2008

Post No. 49: Finally, Someone Explains Something That We Can Understand

I was fortunate enough to receive a decent education at some decent educational institutions. I also took corporate, business, accounting, banking, finance, and various other management courses.

However, I must be honest. I do not understand even a quarter of what occurred over the past 20 – 30 years to lead to our current financial situation.

Although I am sure that most of us can point to some emotional, conceptual issues, be it outsourcing, illegal immigration, two foreign wars, decreased industrial output, and greed, I just really feel like I am in the minority in terms of understanding investment banks, hedge funds, selling short, bundling, derivatives, and such.

Just last week, I contacted two of my graduate school buddies, one with a specialty in banking, and the other in corporate securities, and I told them that I hoped that they were in the Senate Banking Committee sessions to keep them honest.


One of them, “The Bear” (no relation to the term to describe financial markets), forwarded the following article to us by John P. Hussman, Ph.D. of Hussman Funds, entitled You Can’t Rescue the Financial System If You Can’t Read a Balance Sheet, which was posted by Dr. Hussman earlier today. It provides food for thought.

September 29, 2008

You Can't Rescue the Financial System If You Can't Read a Balance Sheet
John P. Hussman, Ph.D.
All rights reserved and actively enforced.

This is a bad idea.

However the final legislation is written, the Troubled Assets Relief Program (TARP) being rushed through Congress will evidently be built around its single worst provision, which is that the Treasury will have authority to purchase distressed mortgage securities from U.S. financials.
As I noted last week in An Open Letter To Congress Regarding the Current Financial Crisis, the sequence of bankruptcies that we've observed among U.S. financials has been almost exactly in order of their gross leverage (the ratio of total assets to shareholder equity). The reason for that is:
1) as the assets of a financial company lose value, the losses reduce the asset side of the balance sheet, but also reduce shareholder equity on the liability side;

2) as the cushion of shareholder equity becomes thinner, customers begin to make withdrawals;

3) in order to satisfy customer withdrawals, the financial company is forced to liquidate assets at distressed prices, prompting a further reduction in shareholder equity;

4) go back to 1) and continue the vicious cycle until shareholder equity goes negative and the company becomes insolvent.

Let's return to the basic balance sheet of a typical financial company before the writedowns:
To read the remainder, click on: http://www.hussmanfunds.com/wmc/wmc080929.htm.

18 comments:

  1. I just wanted to say thank you for posting on my blog Politic Buzz! I was very interested in what you said. The money could be used much more wisely if they did hook up together and make a good stand at it then maybe we all will have a fighting chance. Thanks again for your insight! GWIZARD

    ReplyDelete
  2. Thanks, logistician, for your comment on my blog 'Narratives of Incompleteness'!
    Meanwhile, the financial storm rages- as a self-employed artist, previous recessions have not changed my life at all; will this one? Recently I was summoned by my bank to persuade me to have a credit card, etc. I patiently explained that i have a minimal life style as i don't earn very much and am unlikely to do so-I live 'within my means'. it was clear that the bank found this concept very baffling!

    ReplyDelete
  3. Thanks for your comments on my blog. I somehow was unable to publish it as I intended. I am having fun with photos these days!I like your blog--very informative.
    http://healthandhappiness2008.blogspot.com

    ReplyDelete
  4. Thanks for putting a very thoughtful, educating and interesting comment on my blog post about bailout. I sincerely appreciate it.

    I have visited your wonderful blog with the more informative contents. I am adding you to my blogger following list so I could uptodate on various legislative happenings and could understand it more better.

    Sincere Thanks,

    Phoenix2Life

    ReplyDelete
  5. Thank you, Nicola Lane. The effort on the part of your bank to solicit business in this fashion posed various attendant risks. In their effort to hook every imaginable customer, without an affirmative request by the potential customer him or herself, they took a risk. Sometimes it worked out, sometimes not. Thanks again.

    ReplyDelete
  6. Thanks again Amy for leaving a comment on my blog, and I am happy that you find it informative. When I examined your blog again in order to respond, I was once again delighted with the vibrant colors of the flowers in your shots. Great work.

    ReplyDelete
  7. Thanks Phoenix Blogger for leaving your comment on my blog, the compliments, and for adding my blog to your link list. I had previously done so upon finding your blog engaging. I like your thought process.

    ReplyDelete
  8. Thanks "Born with a Big Mouth" for visiting my blog and leaving a complimentary comment. I hope that you will visit often, as I plan to do with respect to your blog.

    ReplyDelete
  9. However, I must be honest. I do not understand even a quarter of what occurred over the past 20 – 30 years to lead to our current financial situation.

    What happened was we were sold a bill of goods with "supply side" economics, the idea that cutting taxes on the rich and deregulating commerce would bring prosperity to everyone, a rising tide floats all boats. But what actually happened was the gap between the haves and the have nots greatly increased, the rich became obscenely wealthy while real income for the middle and lower classes stagnated or declined. Even the prosperity of the Clinton years went more to the wealthy than to everyone else. Stephanie Coontz's ""What We Really Miss About the 1950s" demonstrates what we've lost.

    The bailout currently being debated in Congress represents more of the same flawed thinking. At it's heart, the idea is little different from supply side economics, bail out the wealthy and they'll fix everything for the rest of us. The real solution to this financial crises would be, in part, to provide support to the middle class, the ones losing their homes, in the form of mortgage assistance and the refinancing of their loans, in other words, a bottom up bail out rather than top down.

    ReplyDelete
  10. Hi Reg,
    This is greatly informative and your absolutely right about few of us understanding the history and origin of how we got to point of being in the largest budget and
    trade deficits in recorded history. But what’s really important for all to understand clearly is- now that Congress has approved an unprecedented $700 billion rescue plan, where will the money come from?

    It’s going to be an inflationary debt charged to us.

    Vikki

    ReplyDelete
  11. IMO this bailout rates as one of the poorest decisions of our government in the last 30 years. Of course, going to Iraq twice is also down there.

    I am livid that congressmen/women had to be and were allowed to be purchased.

    They have convinced me:
    1.) to vote third party if available
    2.) to vote against the encumbant if not

    I do not hold to either party because both are part of the killing of my America.

    Watch in January and they will probably all get raises, without a citizen vote.

    ReplyDelete
  12. Thanks for commenting Vikki/Red Chair. You inquired as to the source of the $700B. On Satruday, when you first commented, I would have had some ideas. Today, with the downturn of the market, the figures in on consumer confidence and lack of spending, and the contraction of credit affecting the ability of more employers to make payroll, I must say that I honestly don't know. Our citizens are shell-shocked, and we our economy depends on spending.

    But, hope springs eternal. In the same way that $4.00 plus gasoline has finally prompted us to take some REAL action to become energy independent, we may have reached a tipping point with respect to some other issues. Getting back to basic research in the sciences; discontining the exportation of our technology; taking control of our borders; and perhaps a return to manufacturing in America. Sometimes tragedy has a positive effect on society. The Great Chicago Fire, which prompted a significant rebuilding of the city, turned out to be a good thing in the long term. It's time for us to rebuild while we still have the time, chance, and resources. Thanks again.

    ReplyDelete
  13. Thanks "The Cup is Half Full" for your comment regarding the Congressional response to our financial crisis. I vaguely recall, from my distant college days, the history of third parties in America and populist movements. Something tells me that a real, powerful, viable party might be capable of creation this time. I can only hope that its platform be limited to 3 or 4 issues. Once we get beyond that, dissension will reign and the glue will dissolve, because of too many conflicting goals. Wish us luck. Thanks again.

    ReplyDelete
  14. Thanks "The Cup is Half Full" for your comment regarding the Congressional response to our financial crisis. I vaguely recall, from my distant college days, the history of third parties in America and populist movements. Something tells me that a real, powerful, viable party might be capable of creation this time. I can only hope that its platform be limited to 3 or 4 issues. Once we get beyond that, dissension will reign and the glue will dissolve, because of too many conflicting goals. Wish us luck. Thanks again.

    ReplyDelete
  15. Thanks "Born with a Big Mouth" for visiting my blog and leaving a complimentary comment. I hope that you will visit often, as I plan to do with respect to your blog.

    ReplyDelete
  16. Thanks, logistician, for your comment on my blog 'Narratives of Incompleteness'!
    Meanwhile, the financial storm rages- as a self-employed artist, previous recessions have not changed my life at all; will this one? Recently I was summoned by my bank to persuade me to have a credit card, etc. I patiently explained that i have a minimal life style as i don't earn very much and am unlikely to do so-I live 'within my means'. it was clear that the bank found this concept very baffling!

    ReplyDelete
  17. I just wanted to say thank you for posting on my blog Politic Buzz! I was very interested in what you said. The money could be used much more wisely if they did hook up together and make a good stand at it then maybe we all will have a fighting chance. Thanks again for your insight! GWIZARD

    ReplyDelete

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