-
Photos
Dr. Kalinda Rose Stevenson
Governments Are Buying Banks : Will They Ever Let Them Go?
If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!
In response to the global credit crisis, governments are buying ownership in banks. Often, we don’t recognize significant moments when they happen. We don’t see the events that change things forever. But the economic events of the last few days are a clear sign of enormous systemic changes that are underway around the world.
For weeks, we have heard about the proposed “$700 billion bailout” for banks passed by the United States Congress. On Monday, October 13, European governments topped that amount with a plan to invest $2.3 trillion into European banks.
European governments overcame their differences to put $2.3 trillion on the line Monday in guarantees and other emergency measures to save the banking system in their most unified response yet to the global financial crisis. “Europe puts $2.3 trillion on line for banks”
http://www.msnbc.msn.com/id/27137551/
Today, Tuesday, October 14, the United States government announced that it will buy shares in the largest banks.
The government put itself four-square into the country’s banking business Tuesday, resorting to what President Bush conceded was the unwelcome choice of massive government investments in the banking system in order to loosen paralyzed channels of credit.
The president said the decision to buy shares in the nation’s leading banks - a kind of federal intervention not seen since the Depression era - was “not intended to take over the free market but to preserve it.” “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
From a long term perspective, these actions to nationalize banks, both in the United States and Europe, raise several issues.
First, is this a temporary response to a global crisis or are we witnessing a fundamental change in the relationship between governments and banks?
In both Europe and the United States, governments are stressing that the actions are temporary.
The government said its stake in each of the banks is strictly temporary, but the subsequent transformation of the sector is on the massive scale of the postwar bank nationalizations in the 1940s and the privatization of the industry in 1980s. “Europe puts $2.3 trillion on line for banks” http://www.msnbc.msn.com/id/27137551/
Under the new multifaceted stabilization program described Tuesday, the government will initially buy stocks in major banks. When financial markets stabilize and recover, the banks are expected to buy the stock back from the government, Bush said in brief remarks from the White House Rose Garden. “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
However urgent the crisis, and however necessary this response, temporary solutions, made under crisis conditions, have a way of becoming permanent. Under crisis conditions, people and their leaders will agree to conditions that they would reject under non-crisis conditions.
Said Treasury Secretary Henry Paulson: “We regret having to take these actions. Today’s actions are not what we ever wanted to do - but today’s actions are what we must do to restore confidence to our financial system.” “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
History shows all too often that when governments receive temporary powers under crisis conditions, they are often not willing to surrender those powers when the time of crisis has passed. This plan does not make clear how the government will get out of the banking business after the time of crisis has passed.
It’s far from clear what the government’s exit strategy will be. The history of financial panics shows that they are rarely resolved in a single moment by a single measure. The loss of confidence that underlies the current panic took years to develop; it will be months at least before some measure of confidence is restored. “Massive bailout won’t work overnight” http://www.msnbc.msn.com/id/27181364/
Another notable issue is that the United States government will buy these bank shares with part of the $700 billion bailout fund that was supposed to buy up bad mortgage debt. In other words, however urgent and however necessary this action to buy bank shares, the government is already veering away from the stated purpose of the $700 billion bailout. This means that the bill that was passed with enormous conflict and drama is already being modified by actions without the approval of Congress.
The administration plans to spend $250 billion this year on the stock purchases and the president certified Tuesday that another $100 billion would be needed in connection with covering bad assets. That would leave $350 billion of the $700 billion program, presumably to be spent by the next president.
The action represents a remarkable turnaround for a rescue program that was already the largest bailout in U.S. history. As the plan sped through Congress, the administration said the money was needed to purchase bad mortgage-related assets that are weighing on the books of financial institutions, never mentioning direct stock purchases. “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
A final issue concerns Bob Hope’s observation:
“A bank is a place that will lend you money if you can prove that you don’t need it.”
The government is following a similar strategy. The banks that don’t need the money are the ones that will get the government’s money. The United States government is going to appropriate half of the money appropriated for the $700 billion bailout to buy shares in banks that are stable.
Nine major banks will participate initially, including all of the country’s largest institutions. The first bank to take advantage of the new program was Bank of New York Mellon which announced Tuesday that it would sell $3 billion in preferred shares to the Treasury.
Some of the nation’s largest banks had to be pressured by to participate by Paulson, who wanted healthy institutions that did not necessarily need capital from the government to go first as a way of removing any stigma that might be associated with banks getting bailouts. “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
These are perilous times and government leaders around the world are in full crisis mode. Each day brings more proposals, more challenges, and more fear, as leaders around the world make decisions that are intended to prevent a global economic collapse.
There is an old proverb—reputed to be an ancient Chinese curse—that says:
”May you live in interesting times.”
We are certainly living in interesting times. No one knows what the remade economic system will be like when this current time of crisis is over. What is clear is that banking will never be the same, whether the banks are owned by governments, held privately, or some combination of the two. We are witnessing the end of an era of economic growth fueled by uncontrolled debt owed to banks.
Dr. Kalinda Rose Stevenson
For more on how economic growth is fueled by debt created by banks, see Chapter 9 of No Money Limits For Real Estate Investors
No tags for this post.Related posts
When Banks Go Broke
The heart of the economic crisis right now is that the banks are unwilling to make loans. Even though governments are pouring money into the banking system, the banks are hanging onto the money.
The rescue program originally was sold to Congress and the public as a plan to buy mortgage-related loans from financial institutions. The goal was to remove troubled assets from those institutions’ books and inspire them to restart more normal lending operations.
Congress passed the massive and hard-fought legislation, and Bush signed it. The government raised the amount of bank deposits it insured. Billions of dollars of reserves have gone into banking systems in the U.S. and other countries. Yet credit, the economy’s lifeblood, has remained virtually frozen. “IMF warns of global financial meltdown” http://www.msnbc.msn.com/id/27129830/
Why are the banks so unwilling to lend? The heart of the current economic crisis is that banks are going broke. This is very different from the Monopoly Game, which is the most popular board game in the world. In Monopoly, a bank cannot go broke. In Monopoly, if the bank runs out of money, the banker can make more money by the simple act of writing an amount on a piece of paper.
But the global economy is not Monopoly. Banks around the world are going broke and being bought up by other banks. Banks are also being bought by governments, in an effort to stabilize the economic system that cannot function without banks.
Banks are in the middle of the economic system because they control the flow of money between creditors and debtors. At the same time, banks are also creditors and debtors themselves.
The economic system includes several types of banks, including central banks, national banks, commercial banks, and thrifts. These different types of banks have charters to serve different functions within the economic system, but the essential point is that the flow of money is controlled by banks.
The critical point is that the current economic crisis is not a money crisis. It is a credit crisis. Banks are cutting or canceling credit limits for home equity lines of credit. Banks are reducing credit card limits. Banks are extremely reluctant to make real estate mortgages.
But there is more to the credit freeze than the effect on consumers. The real crisis is the credit freeze for the banks themselves. This is a brief introduction to borrowing within the banking system, from No Money Limits For Real Estate Investors.
In the United States, the Fed is the central bank, which controls the amount of money in the economic system. The Fed is a shadowy institution, formerly called the Federal Reserve. The Fed is a strange hybrid of private banks with federal authority, but not really under government control. It operates mostly out of sight, to keep the money flowing between the extremely rich, the financial markets, the banks, and the consumers, all the while responding to political pressures, both nationally and internationally, and demands by the extremely rich to increase their wealth even more. It holds its meetings in private, making decisions that affect the economic well-being of all of us.The Fed has the power to increase or decrease the amount of money available in the economic system. They can do this by raising and lowering interest rates.
……When the Fed wants to increase the money in the money supply, it lowers the interest rates the commercial banks pay for borrowing money. When it wants to decrease the amount of money, it raises interest rates the commercial banks must pay. When there is too much money, the Fed begins to increase interest rates. This shrinks the amount of money in the system, and the shrinkage continues down to the amount of money available for you to borrow for your mortgage.
….
Let’s say that the Fed pumps a billion dollars into the economy through the commercial banks. The commercial banks do what banks do. They loan out that money. By the time the commercial banks get through loaning the billion dollars, the commercial banks have created more money. Let’s say, five billion. And the commercial banks loan out the five billion to the “thrifts,” which are the savings banks, savings and loan banks, corporate banks, and credit unions. The thrifts take those five billion dollars and make loans, creating who knows how many more billion dollars. Chapter 9, “How Banks Use Debt To Create Money,” No Money Limits For Real Estate Investors.
The fact is, the banks don’t trust each other. Recent events have demonstrated how much the banking industry as a whole has thrown much of its traditional bankerly caution to the wind, not only providing credit that has mired millions of consumers in debt, but also plunged banks into massive debt.
For instance, Lehman Brothers failed because it carried a debt ratio of 35:1.
To keep profits growing, Lehman borrowed huge sums relative to its size. Its debts were about 35 times its capital, far higher than its peer group’s ratio. And it plunged heavily into real estate ventures that cratered.
Here’s how leverage works in reverse. When things go well, as they did until last year, Lehman is immensely profitable. If you borrow 35 times your capital and those investments rise only 1%, you’ve made 35% on your money. If, however, things move against you - as they did with Lehman - a 1% or 2% drop in the value of your assets puts your future in doubt. “How Financial Madness Overtook Wall Street”
http://www.time.com/time/business/article/0,8599,1842123-3,00.html
The banks that have failed have been debtors that could not repay their debts. This is why banks are so reluctant to make any loans. The credit squeeze is not primarily about you and me. It is about banks being unwilling to loan to other banks.
The actions being taken by governments around the world are an effort to stabilize the banks and induce the banks to start lending to other banks, as well as consumers.
The International Monetary Fund warned Saturday that debt-ridden banks were pushing the global financial system to the brink of meltdown and rich nations had so far failed to restore confidence. “IMF warns of global financial meltdown ” http://www.msnbc.msn.com/id/27129830/
The critical point is that the first priority of the IMF is to restore confidence in the banks about other banks.
Seized-up credit markets began to see the first small signs of easing Friday, but anxiety over the long-term prospects for recovery is keeping lenders mostly sidelined.
The overnight interbank lending rate, known as Libor, fell by half, suggesting that banks are becoming more willing to lend to each other in the very near term. The longer-term 3-month rate, however, continued to rise, hitting its highest level this year.
When banks show a willingness to lend to each other, it makes it easier for consumers and business to obtain loans. The financial crisis that caused Wall Street to buckle has spread around the globe, pushing panicky investors to sell stocks and sit on their capital.
“There is still an awful lot of fear driving this market and a preference to hoard cash rather than lend it out because you don’t know if you will get it back,” said Kim Rupert, fixed income analyst at Action Economics. “Credit freeze sees small cracks”
http://money.cnn.com/2008/10/10/markets/bondcenter/credit_markets/index.htm?postversion=2008101017
What we have seen so far is that the ”rescue” efforts by governments have involved pouring massive amounts of money into a banking system that is hoarding the money, from lack of confidence in the banking system itself.
Finance leaders from the world’s top economies, the Group of Seven, pledged Friday night to take steps to keep leading institutions afloat, unfreeze credit, ensure banks have enough capital to kick start lending and safeguard depositors’ funds and restart the secondary markets for mortgages and other securitized assets. “Global response” http://money.cnn.com/2008/10/11/news/economy/bush_group_of_seven/index.htm?postversion=2008101114
This credit crisis is by no means resolved, but already we see the direction that resolution will take—more government ownership of banks.
Bush did not mention any specific action that prompted his call. But Ireland recently moved to guarantee all bank deposits, triggering similar actions in Germany and other countries concerned that nervous depositors would move their bank accounts to Ireland.
The president barely referenced a significant new step from his administration - partial nationalization of some banks. After days of speculation this move was coming, Treasury Secretary Henry Paulson announced late Friday night that the government would buy part ownership in an array of American banks. “IMF warns of global financial meltdown” http://www.msnbc.msn.com/id/27129830/
So, at this point, it seems that the “bailout” or “rescue” plan, intended to buy mortgages, will be used to buy the banks themselves.
Dr. Kalinda Rose Stevenson
Find out more about the essential role of banks in the creation of money in No Money Limits For Real Estate Investors: Discover The Money-Making Secret In The Real Estate Game That Transforms Your Money Struggles Into Financial Abundance.
Award Winner of National Best Books 2007 Awards
Business: Real Estate Category
And Finalist in Business: Personal Finance Category
Related posts
The Credit Crisis Of 2008: Fear and Panic When The Banks Stop Lending Money
The world is in economic crisis. So far, nothing has stopped the crisis from spreading. It started with subprime mortgages, and has grown into a hydra-headed monster that is creating fear around the world as banks cut off credit.
“With global stock markets continuing their sickening plunge and the credit system all but shut down, efforts by the Federal Reserve, Treasury and global leaders have been overwhelmed by global panic.
The wide-ranging, unprecedented actions to cure the illness may yet prove effective. But until the fever breaks, fear has the upper hand.”
John Schoen, “Fear trumps efforts to solve crisis” http://www.msnbc.msn.com/id/27119159/
In the time of crisis everyone wants to know why. Why did this happen? Who caused it? Was it greed on Wall Street? Lack of regulation that let investment banks get away with shoddy lending practices? Too much regulation that forced banks to lend money to deadbeats? You will hear many explanations, along with many accusations. But the most basic reason has to do with lack of trust in the value of money. This is why every effort to fix the problem increases fear.
When trust in money dies, economic systems go broke, fortunes are destroyed, retirement portfolios are decimated, stock markets fall, and even banks go broke.
What happens when people are afraid that they will not get the full value of their money? They tend to hoard money. People who lost money when banks collapsed in the Great Depression hid their money under their mattresses.
In a very real sense, the banks are also hiding their money under mattresses. This is the real cause of the economic crisis. We don’t have a lack of money. We have a lack of credit. Credit and debt are two sides of the same coin. The banks won’t loan money on credit, which has dried up the amount of money available to borrow.
The following is an excerpt from my book, No Money Limits For Real Estate Investors, in which I use the Monopoly Game as a way to talk about the nature of money.
Now imagine what would happen if every one suddenly became debt free. The entire economic system would collapse. The lifeblood of the economy is borrowed money. Governments depend on borrowed money. Businesses depend on borrowed money. Consumers depend on borrowed money. And with borrowed money, investors can create more money. Debt is the mechanism that has allowed substantial numbers of real estate investors to make fortunes in the real estate market, especially in recent years.
Monopoly teaches a fundamental misunderstanding of the role of debt in our economic system. The Monopoly winner and the Bank continue to take money out of circulation, until there is not enough left for the game to continue.
If the handful of extremely rich people did what the Monopoly winner does, which is to gather almost all of the money in circulation and hang onto it, the result would be the collapse of our economic system.
Chapter 9, No Money Limits For Real Estate Investors
The bankers are unwilling to loan money because they don’t trust that they will be paid back. Considering that the banks have lost billions of dollars, the lack of trust is justified. The banks have made so many bad loans—extended credit to buyers who could not repay the loans-that the banks are awash with bad debts. Some of the largest banks have even collapsed because they had so much bad debt.
So what was the remedy that was supposed to resolve the credit crisis? The $700 bailout for the banks. The expectation behind the bailout was that the government would relieve the banks of the staggering burden of bad debts so that that the banks would have enough trust to start to offer credit again. But so far, the banks are still unwilling to offer credit. Instead, the banks are tightening credit lines and reducing credit limits.
The result is that credit is not flowing freely. Everyone who depends on borrowed money is being squeezed. When credit stops flowing, the money supply shrinks. The cascading effect puts the entire global economy at risk because the whole house of cards depends upon borrowed money.
As the system of credit dries up, the more fear is created, and the more banks and other institutions will treat credit as something to hide under the mattress.
“Right now it’s a measure of trust between the banks,” said James Reed, a money manager at the UMB Scout Stock Fund. “It’s continuing to move up, and that shows less and less trust in the system. That’s what you have to restore, is trust. That’s when you know you have a bottom, and that’s when the (credit) markets finally loosen up a little bit. ”
With so little trust among bankers, the Treasury may ultimately have to move to guarantee all lending between banks. That would help reduce the risk of lending again and help unfreeze the system. John Schoen, “Fear trumps efforts to solve crisis” http://www.msnbc.msn.com/id/27119159/
Every effort to restore the economy is primarily an effort to restore trust in a system that has violated trust. This is the challenge and this is the opportunity. The challenge is to recognize that there is no shortage of money. Money is created by trust and destroyed by lack of trust. We have a shortage of trust that results in a shortage of money.
In 1933, during the economic crisis of the Great Depression, Franklin Delano Roosevelt began his inaugural address with these words about fear.
I am certain that my fellow Americans expect that on my induction into the Presidency I will address them with a candor and a decision which the present situation of our people impel. This is preeminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing conditions in our country today. This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself-nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. In every dark hour of our national life a leadership of frankness and vigor has met with that understanding and support of the people themselves which is essential to victory. I am convinced that you will again give that support to leadership in these critical days. “Only Thing We Have to Fear Is Fear Itself”: FDR’s First Inaugural Address. http://historymatters.gmu.edu/d/5057/
I’ll end by the way I began, by repeating the words of John Schoen.
The wide-ranging, unprecedented actions to cure the illness may yet prove effective. But until the fever breaks, fear has the upper hand.
John Schoen, “Fear trumps efforts to solve crisis” http://www.msnbc.msn.com/id/27119159/
Dr. Kalinda Rose Stevenson
Discover the true nature of money as a belief in value in
Award Winner, National Best Books 2007 Awards
Business: Real Estate Category
And Finalist Business: Personal Finance Category
No tags for this post.Related posts
Does A $700 Billion Bailout For Banks Prevent Foreclosures For Homeowners?
The top item in the news in the last week has been the financial crisis facing the banks. Yesterday, Washington Mutual was seized by the FDIC. This is the largest bank failure in United States history. WaMu was then sold to JP Morgan Chase, to further consolidate the banking industry into a handful of giant banks.
“As the debate over a $700 billion bank bailout rages on in Washington, one of the nation’s largest banks - Washington Mutual Inc. - has collapsed under the weight of its enormous bad bets on the mortgage market.”
“The Federal Deposit Insurance Corp. seized WaMu on Thursday, and then sold the thrift’s banking assets to JPMorgan Chase & Co. for $1.9 billion.”
“Seattle-based WaMu, which was founded in 1889, is the largest bank to fail by far in the country’s history. Its $307 billion in assets eclipse the $40 billion of Continental Illinois National Bank, which failed in 1984, and the $32 billion of IndyMac, which the government seized in July.” Government seizes WaMu
Meanwhile, the debate continues in Washington about a $700 billion bailout for the banking industry to buy up bad mortgages. One of the issues at debate is whether homeowners who are facing foreclosure because of bad mortgages will receive any part of the $700 billion.
In an outstanding article, “It’s The Empty Houses, Stupid,” Bob Sullivan asks the question why the government bailout is focusing on the banks that hold the bad mortgages and not the homeowners who cannot pay the bad mortgages.
“In case anyone has forgotten the core of the current economic crisis, here’s a reminder: empty homes, both present and future. Empty homes are behind all the supposedly worthless mortgage-backed securities that no one wants to buy on Wall Street. Fear of the coming avalanche of empty homes — what the Center for Responsible Lending calls the “tsunami of foreclosures” — has made Wall Street’s mortgage-related paper nearly worthless.”
“It seems that filling those empty homes by dealing with foreclosures and stoking demand to buy homes should be the first order of business. So why — as we discuss the most dramatic government intervention in nearly a century — is there only passing mention of all these vacancies?” It’s the empty houses, stupid
Sullivan makes the point that there are two interlinked crises. The liquidity crisis affecting the banks and the housing crisis affecting homeowners. At this point, it seems as if the bailout will benefit the banks, but homeowners are on their own. He cites bankruptcy experts and consumer advocates who make the case that the simplest and fairest solution would be to amend bankruptcy law, to allow bankruptcy judges authority to modify mortgages, as they can modify payments for other types of loans.
“‘This was kind of a game of chicken and I’m afraid it looks like the consumer advocates in Congress are the ones who blinked,’ said Adam J. Levitin, a bankruptcy expert at the Georgetown University Law Center.”
“Details of the not-quite-completed-bailout-plan are still emerging, but by all accounts it will not include the most obvious and direct tool to stem the empty house problem: adjustments to bankruptcy law that would allow judges to modify the mortgages of at-risk homeowners.” It’s the empty houses, stupid
But as the current negotiations stand, there is no provision for homeowners facing foreclosure to receive any direct help from the massive government bailout for the big banks.
The simplest way to prevent the coming avalanche of additional empty homes — and thereby make those asset-backed-securities have some real value — is to prevent people from getting kicked out. It’s stunning that $700 billion is about to change hands with no direct plan for keeping them in their homes. It’s the empty houses, stupid
Dr. Kalinda Rose Stevenson
Find out how the current mortgage crisis is a direct result of a banking system that allows banks to make money out of thin air in No Money Limits For Real Estate Investors at www.NoMoneyLimits.com.
No tags for this post.Related posts
Using Leverage To Create Weapons Of Financial Mass Destruction
Leverage creates wealth. This has been the promise behind the real estate boom. Now that the boom has gone bust, what is the role of leverage in the current financial crisis?
Greed is blamed for much of the economic crisis currently facing us. But blaming greed misses the real point. Greed needs a mechanism—a tool—to put greed to work. This tool has been touted as the magic money-making tool. What is the tool? It is leverage.
Underneath all of the complicated terms, such as “derivatives,” “leveraged buyouts,” “financial instruments,” the fundamental tool that has led us to this point of crisis is misused leverage.
What is leverage anyway? Leverage is the result of the action of a lever. When properly positioned, a lever allows you to move something you could not move with your own strength.
“A simple machine consisting of a rigid bar pivoted on a fixed point and used to transmit force, as in raising or moving a weight at one end by pushing down on the other.” “Lever” http://www.answers.com/topic/lever
In finance, leverage is primarily the use of borrowed money to buy what you could not afford to buy with your own money.
The real estate boom has been fueled by leverage. This has been the great selling point for real estate investing. You can use leverage to buy real estate with little or none of your own money. In other words, you finance your real estate purchases with debt.
Leverage is the tool that rewards greed. With leverage—whatever form that leverage takes—you can buy more than you would be able to buy using your own money.
Leverage is a tool that can and does create profit. The real estate boom is a testimony to the effectiveness of leverage as a wealth creating tool.
“People used to build wealth through building equity in their homes. Today, people prefer to speculate on the price of their house by using historically high levels of leverage.” Richard Bernstein
So why are we in the current financial crisis? Underneath the crisis is a shared belief that values will keep going up. Robert Schiller makes this point in his book, Subprime Solution.
“In Shiller’s view, the biggest dangers in financial markets come from unanimity. In Subprime Solution, he argues that what united the missteps by the Federal Reserve, mortgage brokers, Wall Street bankers and home buyers that together brought on the current financial mess was a shared belief that house prices never go down.” “Crash Master” http://www.time.com/time/magazine/article/0,9171,1838756,00.html
This is the true irrational belief behind the financial mess. In reality, real estate prices are subject to cycles, and ups-and-downs. The old adage states: What goes up must come down. Nothing continues on a continual upward path indefinitely.
Yet, from the greatest investment banks on Wall Street, to novice real estate investors, many of us operated with the belief that real estate values would continue to go up, and that leveraging borrowed money was the smart way to make money fast.
As a result of this shared belief, many real estate investors and the bankers who financed their transactions, never saw the downside of using leverage as a tool to create wealth.
Think again of using a lever to move something. Leverage is inherently risky. Think of changing your tire. As long as your car is resting on four tires, it is stable. As soon as you lift up your car with a jack, you have created a potential danger. A car on a tire jack is no longer stable. The car can slip off the jack, and you can get hurt.
This is the downside of leverage. When you use leverage, you create a potentially dangerous object that can slip off the bar. Leverage lets you go higher than you could on your own, but it also means that you can come crashing down faster and lower than you would without the lever.
“In finance, leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified and/or enhanced. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity.” “Leverage” http://en.wikipedia.org/wiki/Leverage_(finance)
The fundamental reason that the big investment banks have failed is because they threw caution out of the window and relied on ever-increasing amounts of risky leverage. in simple terms, they used large amounts of borrowed money.
“Lehman’s fall shows the downside of using borrowed money. Even though Lehman has a 158-year-old name, it’s actually a 14-year-old company that was spun off by American Express in 1994. AmEx had gobbled it up 10 years earlier, and it wasn’t in prime shape when AmEx spat it out. To compensate for its relatively small size and skinny capital base, Lehman took risks that proved too large. To keep profits growing, Lehman borrowed huge sums relative to its size. Its debts were about 35 times its capital, far higher than its peer group’s ratio. And it plunged heavily into real estate ventures that cratered.”
“Here’s how leverage works in reverse. When things go well, as they did until last year, Lehman is immensely profitable. If you borrow 35 times your capital and those investments rise only 1%, you’ve made 35% on your money. If, however, things move against you - as they did with Lehman - a 1% or 2% drop in the value of your assets puts your future in doubt” in “How Financial Madness Overtook Wall Street” http://www.time.com/time/business/article/0,8599,1842123,00.html
The current economic mess is tremendously complicated, but the basic mechanism behind the crisis is leverage created by arcane financial instruments that few of us have any hope of understanding. The particular form of the leverage ranges from subprime mortgages, to derivatives with fancy names, such as “collateralized debt obligations” (CDOs) or “credit-default swaps” (CDSs)
In 2003, Warren Buffet called these derivatives “weapons of financial mass destruction.”
The reason that all of these leveraging tools worked so well for so long was because property values were going up. But when property values started to go down, these leveraging tools turned into the weapons of financial mass destruction that Buffet foresaw.
Dr. Kalinda Rose Stevenson
Do you know how banks make money out of thin air? Find out in No Money Limits For Real Estate Investors. And be sure to sign up for your Free “52 Heart Of Money Insights” at NoMoneyLimits.com.
No tags for this post.Related posts
Greenspan’s Folly: Why Lack of Regulation By The Federal Reserve Is The Root Cause Of The Current Financial Mess
John McCain claims that Wall Street greed is responsible for the current financial mess behind the bank failures and the subprime mortgage debacle. Michael Hirsh has written a significant article that places the blame squarely on the refusal of the Federal Reserve under Alan Greenspan to use its regulatory authority.
“Who is mostly to blame for the biggest upheaval on Wall Street since the Great Crash? The disaster appears to have many fathers. “In a way, it’s the perfect crime: Who do you go after?” asks Jim Rokakis, the treasurer of Cuyahoga County in Ohio, one of a slew of state-level officials who saw the mess coming years ago but were ignored by the Feds. “If you arrest the mortgage brokers, how can you in good conscience not arrest the officers of the mortgage banks and the rating agencies?” Rokakis wonders. Ultimately, a big share of the blame lies with Wall Street CEOs who encouraged all this bad lending by packaging it into ever more complex securities, and then invested in it themselves by the billions. Indeed, the myth surrounding the subprime fallout is that no single player along the pipeline could have prevented what happened, including the giant investment banks that loaded their balance sheets with this dreck only to have it drag them into oblivion. “Everyone’s to blame, and no one’s to blame,” says financial expert Joseph Mason of Drexel University, summing up a common view of academia and in Washington.
I don’t buy it. Especially the idea that somehow the blame lies mainly with Wall Street’s greed, as John McCain reiterated the other day, saying we have to “fix” it. How do you fix greed? And let’s face it, left to its own devices, Wall Street has always operated on pure adrenalized greed, which is why financial manias and bubbles come and go and always will.”
“This mess is mostly a titanic failure of regulation. And the largest share of blame goes back to one man: Alan Greenspan. People mainly fault the former Fed chief, who once enjoyed a near-saintly reputation because of his reputed “feel” for market conditions, for ushering in an era of easy credit that accelerated the mortgage mania. But the much bigger problem was Greenspan’s Ayn Randian passion for regulatory minimalism.” Read the rest of “Greenspan’s Folly” here.
Dr. Kalinda Rose Stevenson
Discover how Federal Reserve interest rates determine how much money banks have available to fund your business and real estate projects in No Money Limits For Real Estate Investors. Visit NoMoneyLimits.com for your Free ”52 Heart of Money Insights.”
No tags for this post.
Related posts
Why The Federal Reserve Is Keeping Its Fingers Crossed Under The Streetlight
On Tuesday, August 5, the Federal Reserve voted to keep the interest rate for banks unchanged. Although I am by no means an expert on the economy and the role of the Federal Reserve, the actions of the Federal Reserve often remind me of that old cartoon about the conversation between Bob and Joe under the streetlamp. Bob sees Joe looking at the sidewalk under the streetlamp and asks:
Bob: “What are you looking for?”
Joe: “My keys.”
Bob: “Did you lose them here?”
Joe: “No, I dropped them over there.”
Bob: “Why are you looking for them here, when you dropped them over there?
Joe: “There’s no light over there.”
The goal of the Fed is to control the money supply to prevent both inflation and recession. It’s easy to think of the Federal Reserve as a giant puppet master in Washington, able to pull the strings of the economy when it goes off track. As powerful as it is, the Federal Reserve is really a one-trick pony, with one major tool. It can raise or lower the interest rates that it charges banks for money.
“The Federal Reserve, confronted with the perils of a slumping economy and rising inflation, has decided for a second straight meeting to leave interest rates unchanged.
“The Fed announced Tuesday that it was keeping its target for the federal funds rate, the interest that banks charge each other on overnight loans, at 2 percent.
“Wall Street seem pleased with the decision. Share prices had been higher most of the day after oil dropped to around $118 a barrel. They gained a little more speed when the announcement came in as expected and the central bank didn’t tip its hand on when it might begin raising rates again. Federal Reserve
The Fed’s problem is that its main policy tool–setting interest rates for the banks–can only address one problem at a time.
To get back to Bob and Joe, the real problem is “over there, but the Fed can’t fix that problem, so it stands under the streetlamp, looking for a solution in the wrong place.
The two big threats facing the economy right now are inflation and recession. What can the Fed do when inflation is not the result of interest rates but the cost of oil? What can the Fed do when recession is not the result of interest rates but a result of the housing, mortgage, and credit crises?
“Federal Reserve Chairman Ben Bernanke and his colleagues are being forced to navigate treacherous waters, trying to keep the economy from plunging into a deep recession while worrying about keeping interest rates so low that they could trigger a dangerous inflation spiral.
“The Fed is really locked in right now. They can’t go forward or backward,” said Sung Won Sohn, an economics professor at the Smith School of Business at California State University Channel Islands. Stuck In Quagmire
What effect does the Fed’s decision to hold the banks’ prime lending rate at 2 percent have on inflation when the primary cause of inflation is oil prices?
Consider what happened in the 1970s, when oil prices shot through the roof and the Federal Reserve raised interest rates. The result was “stagflation,” an era of both inflation and stagnant growth in the economy.
But the most important element in the war against inflation was the Federal Reserve Board, which clamped down hard on the money supply beginning in 1979. By refusing to supply all the money an inflation-ravaged economy wanted, the Fed caused interest rates to rise. As a result, consumer spending and business borrowing slowed abruptly. The economy soon fell into a deep recession. Stagflation in the 1970s
Once again, we have rising inflation, triggered mostly by oil prices, and either the imminent threat or reality of recession as a result of the housing, credit, and mortgage debacles. What is the Federal Reserve doing in response?
“Responding to a severe credit crisis, the Fed last September launched an aggressive effort to cut interest rates. It reduced the funds rate seven times, lowering it from 5.25 percent, where it had been for more than a year, down to 2 percent in April.
“At the Fed’s last meeting on June 24-25, Fed officials passed up the chance to cut rates again. Instead, they signaled growing concerns about inflation pressures that have been made worse this year by surging oil prices, which hit a record high at $147.27 per barrel on July 11. Stuck%20In%20Quagmire %20
“>Stuck In Quagmire
The decision on August 5, 2008 to keep the prime lending rate unchanged is not so much smart strategy as recognition that the Federal Reserve can’t do much to prevent inflation or control recession.
So, will the Fed’s decision help the economy? Wall Street responded favorably, but it is important to note that Wall Street was already responding favorably because oil prices have fallen.
“The oil market also helped soothe some of Wall Street’s worries - crude fell as low as $118 a barrel before settling at $119.17, down $2.24 on the New York Mercantile Exchange. Oil has now fallen $28 from its July 11 high of $147.27 on widening expectations that the slumping U.S. economy will keep curbing consumer demand for gasoline and other petroleum products. Stocks close sharply higher after Fed decision.” Federal Reserve Holds Key Rate
Taken as a whole, the economy is affected by many forces. Many of these forces are far beyond the control of elected officials and the actions of any agency, such as the Federal Reserve. Although the actions of the Federal Reserve are powerful, they are not all-powerful. And so, the Fed makes its decisions under the streetlamp, and keeps its fingers crossed that keeping interest rates for banks unchanged for now will buy time for other economic forces to work.
By Dr. Kalinda Rose Stevenson
Discover how Federal Reserve interest rates determine how much money banks have available to fund your business and real estate projects in No Money Limits For Real Estate Investors. Visit NoMoneyLimits.com for your Free ”52 Heart of Money Insights.”
No tags for this post.
Related posts
Beware The “STOLI” Insurance Scam That Offers You Big Money For Nothing.
Stranger-Owned Life Insurance (STOLI) is offered to older people, with the promise of a big money payout, with no cost and no risk. Even if you are too young to be approached about such polices, it’s a fair bet that your parents or grandparents could be targeted, if they haven’t been already. It is in everyone’s interest to understand how this insurance scam works.
“Stranger-Owned Life Insurance (”STOLI”) is a rapidly spreading virus that is infecting both individuals and charities. The end result is likely to be a lose-lose-lose situation for the public, the insureds, their families, and the insurance and estate planning communities. In fact, everyone is likely to lose–except the promoter-marketers and third-party investors they assemble to finance what is clearly an end-run around centuries old insurable interest laws.” (Stranger-Owned Life Insurance)
This one hits close to home because my husband and I were told about this insurance plan, and even met with someone who promotes it. It sounds like a great deal. You “buy” an insurance policy, but you don’t pay anything for it.
This is how it was explained to us. A bank will buy an insurance policy on your life. The bank pays the premium. You pay nothing. After a period of time–the exact time was very vague–the bank would pay you a part of the value of the policy. So, if you “buy” a fifteen million dollar policy, at some period of time, you would collect a lump sum of money. The numbers were vague too, but we heard something about a million dollars on a fifteen million dollar policy after two years.
It sounded too good to be true at the time. Guess what. It is too good to be true.
After doing just a few minutes of research on Google, we found that the State of New York Banking Department has stated clearly what insurance polices banks can buy. And guess what, banks cannot buy insurance polices for people in whom they have no insurance interest. They can buy insurance for employees or officers of the bank or people who have outstanding loans with the bank. They cannot buy insurance on strangers. Bank Owned Life Insurance (”BOLI”)
This is the first big lie of the scam.
So who would actually buy an insurance policy on a stranger’s life? These are investors, who are deliberately misleading older people to believe in something for nothing. They know what they are doing, and have documents set up to capitalize on loopholes in insurance law, so that everything looks perfectly legal, but is designed to circumvent well-established insurable interest laws.
“Major life insurance organizations, including the American Council of Life Insurers (ACLI), the Association for Advanced Life Underwriting (AALU) and the National Association of Insurance and Financial Advisors (NAIFA) plan to crack down on companies that pay elderly people to buy life insurance with the intention of selling the policies to investment groups, reports the Insurance News Network. And they’re calling for changes in state regulation to help curb the practice.”
“These types of life insurance transactions, called stranger-oriented life insurance, or STOLI, has in the past been a way for policyholders to receive payment for life insurance policies they no longer need. The problem, notes a recent press release from the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), comes when financial companies seek out people who are insurable but have short life expectancies and who agree ahead of time to sell their policies for a fee.” (STOLI Alert)
So, even if the practice has not yet been outlawed directly in your state, it will be soon enough.
“The Ohio General Assembly has approved legislation designed to deter stranger-originated life insurance (STOLI) transactions in Ohio. Governor Strickland signed the bill on June 11, 2008 and it will take effect September 11, 2008. House Bill 404 strengthens Ohio’s existing Viatical Settlements Law, and establishes new restrictions intended to prevent STOLI.”
…“Ohio will become the twelfth state to adopt an anti-STOLI law. In Ohio and across the county, litigation continues regarding alleged STOLI transactions.” (Stoli Overview)
What about the two year time period? The reason for two years is that after two years, insurance companies cannot rescind policies for fraud.
The promoter who talked to us even suggested that this could be a good second business. He suggested that my husband get an insurance license to sell these policies, to–as he put it–”keep it under the radar.” That kind of language is also a clue that something fishy is going on.
There is also the “Tony Soprano factor” at work. Think about. Do you really want an investor to have a beneficial interest in your life? The sooner you die, the sooner the investor collects.
And what about the return you would get on such a policy. Would you really get a million dollars on a fifteen million dollar policy after two years? By the time the dust settles, you might end up with 5-6% of the value of the policy, provided the insurance company doesn’t rescind the policy. The real beneficiaries are the promoters and investors who set up these plans.
What is the lesson here? If something sounds too good to be true, it needs to be thoroughly invested. Even though the promise of lots of money with no cost and no risk is very tempting, something for nothing usually comes with a high price.
Dr. Kalinda Rose Stevenson
Author of “No Money Limits For Real Estate Investors”
National Best Books 2007 Awards
Winner
Business: Real Estate Category
No tags for this post.
Related posts
Do You Know How To Protect Your Money If Your Bank Fails?
By Kalinda Rose Stevenson
Banks some times fail, and when they do, depositors sometimes lose their money. However, there are failsafe ways to make sure that you do not lose any of your money if your bank fails.
The first step is to know that the Federal Deposit Insurance Corporation sets a $100,000 upper limit for any single insured account. (The upper limit is $250,000 for an IRA.) This is the federal agency that insures bank deposits. If the bank fails, the FDIC will reimburse your money.
The second step is to make sure that you keep your money in an insured account. Not all bank accounts are insured by the FDIC.
The third step is to spread your money into different accounts, preferably at different banks to keep your accounts below the $100,000 upper limit.
For more about how to protect your bank deposits, see “How Safe Are Banks?” By John W. Schoen
No tags for this post.Related posts
What’s Wrong With This Picture?
Turn on the news, and all you see is disaster. Floods, earthquakes, tornados, typhoons.
Meanwhile, prices at the supermarket are going through the roof.
And gas prices go up, up, up while the equity in your house goes down, down, down.
That assumes you still have a house after the bottom fell out of the real estate market from the subprime mortgage debacle and millions of homeowners have already lost their homes to foreclosure.
All of this is happening while politicians argue over who has the best strategy to restore hope and confidence to a population that is in a bad mood.
The Associated Press published an article today that claims:
“The can-do, bootstrap approach embedded in the American psyche is under assault. Eroding it is a dour powerlessness that is chipping away at the country’s sturdy conviction that destiny can be commanded with sheer courage and perseverance.” (Read the whole article at http://www.msnbc.msn.com/id/25311529/
So what do you do when times are tough and almost everyone you meet is in a bad mood?
Do you wait for the other shoe to drop? Are you really powerless to take control of your own freedom?
The solution is the same one that successful entrepreneurs have followed in good times and bad.
You follow the formula called “The Freedom Equation.”
This is a simple three-step formula that saved a real estate investor from financial ruin and made him a multimillionaire.
The formula is laid out in The Freedom Equation: A Proven Process For True Success.
The 3-Day Bonus Sale
Since “The Freedom Equation” is a three-step formula, I am offering the “3-Day Bonus Sale.”
In case you are thinking that you would love to invest, but you don’t have the money to do it, the solution is simple. Find a like-minded partner, and share your resources of time, money, energy, and talents.
How do you do that? The answer is laid out in Partner For Profits: Discover Why Partnerships with Like-Minded Real Estate Investors Can Give You More Deals, More Wealth, and More Fun Than Doing It Alone.
As a special bonus for taking quick action despite the gloom and doom, I am offering the 3-Day Bonus Sale which includes both The Freedom Equation and Partner For Profits.
Partner For Profits sells for $27. It’s FREE for the next three days when you buy The Freedom Equation at the regular price of $37.
The “3-Day Bonus Sale” ends at 8:00 P.M. (PDT) on Wednesday June 25, 2008.
Act now. Don’t believe that you are powerless to take charge of your own financial freedom.
Buy “The Freedom Equation” with FREE “Partner For Profits” Now
Go to The 3-Day Bonus Sale
Kalinda Rose Stevenson, PhD.
And don’t forget to sign up for your FREE “52 Heart Of Money Insights” at http://www.NoMoneyLimits.com
No tags for this post.Related posts
-
Syndicate
