Is the bear already in the house?

August 10, 2007 9:35 AM

I have just spent the afternoon watching stocks around the world decline partially based on sub prime market fallout. My question is how can things be so great when the Fed is handing out stacks of cash to keep things stable (34 Billion USD and counting, not including the international bail out)?
posted by Funmonkey1 to work & money (25 comments total)

Things may not be great. But if people start thinking things are not great, it can result in a crash. So the world's central banks are doing what they can to instill investor confidence.
posted by acoutu at 9:38 AM on August 10, 2007

Did you mean things are so great in a sarcastic sense, or is there a market sector you're seeing that's doing well? Well, yeah, this is bad... we can all print an infinite amount of money but that will increase demand infinitely and force retailers and industry to jack up their prices infinitely, thus inflation. It always energizes the market at first, but has bad consequences later as purchasing power is reduced again. I have heard some alarmist mention we're on the verge of hyperinflation, though I don't understand the workings of how that would occur.
posted by zek at 9:46 AM on August 10, 2007

no sarcasm here. curious.
posted by Funmonkey1 at 9:55 AM on August 10, 2007

Inflation also works to devalue debt though, and there sure is a lot of that...
posted by zeoslap at 10:10 AM on August 10, 2007

It's fear of the unknown that is causing the drop in stocks. Yesterday a french bank came out and froze several of their mutual funds due to the whole subprime thing. The big problem with that wasn't so much the freezing (which is bad anyway), but the fact that two weeks ago they said that they had little exposure to the subprime market. So when they come out and say "umm... we're sorta screwed for a while", the market panics and moves down, since who knows what other banks are going to have similar problems.

Outside the financial industry, you are getting problems since who is going to be buying computers or cars, or any consumer good when they can't even pay for their house? Cheap money is only good as long as you don't have to pay too much of it back...
posted by cschneid at 10:19 AM on August 10, 2007

Funmonkey1! Glad to see you again.

I'll tell you what's great right now, even though there's a global liquidity problem and a lot of banks, mortgage lenders and credit derivative traders are going to go belly-up:

Unemployment is 4.6% and core CPI is only going up at about 3.6% annually. Those are great numbers, historically, and they have a lot of meaning regarding the health of the economy where the rubber meets the road.

There was a point in the 80's when inflation was 20% and unemployment was 11%, and that was ruinous for a lot of regular Joes like you and me. The current environment is going to be rough on homebuyers, homesellers, and others who benefit from a credit-rich environment, but there is a natural cycle in these markets. The Fed's manipulations (which were designed to avoid a total collapse and recession after the economic paralysis caused by 9/11) may look stupid to someone who's $400,000 underwater on a $300,000 home today; but there are a lot of folks who have jobs today who might not if the Fed hadn't eased rates starting in 2001-2002.

As for US stocks, major indices have gone up 15%-20% in the last 10 months. That's not a normal rate of change for them and they may correct from this. Only some of what you're seeing in the market is a direct result of the subprime problem, and I think I'd be much more careful than the guy who gets paid to write a weekly column on CNN Money to be so sure I knew exactly why stocks were doing what they do.
posted by ikkyu2 at 11:04 AM on August 10, 2007 [2 favorites has favorites]

(and can someone explain where exactly the Fed puts that money it is assisting things with? i realize it goes into the "economy", but what exactly? thanks, and apologies to FunMonkey for the side-question but I figured it was relevant)
posted by poppo at 11:33 AM on August 10, 2007

Have you seen bookie's analysis in the Cramer meltdown post?
posted by caddis at 11:55 AM on August 10, 2007

the Fed is handing out stacks of cash to keep things stable

It's not just the Fed in the US; the European Central Bank just pumped in 94 billion Euros yesterday. There's a growing liquidity crisis; everyone wants to keep their money close to their vest and not lend it around, either because they know they may need that money really soon (to cover their exposure) or because they don't trust the people they would otherwise lend it to. The Fed and ECB are trying to add more money to fight the "hold 'em" attitude.

And the LIBOR (London Interbank Offered Rate -- which is the interest rate at which banks loan money to each other just for overnight time periods) is now at its highest point since 2001. The reason the rate is so high is that banks are all really suspicious of each other and who's really affected by the mortgage mess but not fessing up, so they're reluctant to lend out their money to their peers, even just for overnight. So a higher LIBOR means a higher rate of return for those banks that do lend out overnight -- it's an incentive for banks to keep things liquid and keep the money moving around.

Yesterday a french bank came out and froze several of their mutual funds due to the whole subprime thing.

Just to be clear, those two now-closed funds were, technically speaking, money market accounts. Which is so much more ominous than if they had been, say, hedge funds or mutual funds.

can someone explain where exactly the Fed puts that money it is assisting things with? i realize it goes into the "economy", but what exactly?

As I understand it, the Fed stepped up and said they would agree to buy a bunch of AAA (highly rated) MBS's (mortgage backed securities -- the things that are causing all the problems because no one wants 'em at any price) for a limited time only. It's actually a loan, I think, not really free money. It's a poke in the butt to get things moving again. Only the Fed has poked three times in one day today, and that's almost unheard of. The comments on this post over at the "Calculated Risk" blog give better details.

Finally, note that a bunch of the hedge funds are going to be in deep doo-doo on August 15th, when they need to make their quarterly statements. At which point, a lot of people invested in them may stampede for the exits -- or try anyway. There are rumors that a lot of very big hedge funds are in trouble right now and are trying to unwind their positions (i.e. sell stuff to make cash) so that they won't have to halt redemptions (i.e. say "sorry, no money back guarantee for you") next week.
posted by Asparagirl at 12:08 PM on August 10, 2007

From Aaron Krowne, the guy who brought us the Mortgage Lender Implode-O-Meter (now up to 116 companies imploded!) and who also bought Casey Serin's old domain name, there's now the Hedge Fund Implode-O-Meter! Something to keep an eye on in the next few weeks...
posted by Asparagirl at 12:15 PM on August 10, 2007

Unemployment is 4.6%

This number ignores those who have exhausted their unemployment benefits, those who've given up on the system altogether as well as those who are underemployed with no benefits correct? That was a new twist on the unemployment numbers instituted by Karl Rove. Also back in the 80's when someone was "employed" it was more likely a job that had benefits and could support a family as opposed to stocking shelves in Walmart part-time while searching in vain for a real job. I would trust Pravda before I trusted any numbers released by the ministry of truth that is the Bush administration.
posted by any major dude at 12:16 PM on August 10, 2007 [1 favorite has favorites]

This number ignores those who have exhausted their unemployment benefits, those who've given up on the system altogether as well as those who are underemployed with no benefits correct?

Not entirely. The standard unemployment number is survey-based, not based on unemployment benefits. A nice person asks you if you're working. If you say yes, you're employed. If you're not working, they ask you whether you were looking for work. If you weren't working but were looking for work, you're unemployed.

So you're correct in thinking that it doesn't count the underemployed and that it doesn't count people who have lost hope and aren't even looking for work anymore.

But you're wrong in thinking that it's somehow tied to unemployment benefits or claims. The number of new unemployment claims does get reported, but that's a different thing from the unemployment rate.

That was a new twist on the unemployment numbers instituted by Karl Rove.

AFAIK, the unemployment rate has always been calculated in more or less the same manner. If there's been recent fiddling, it's been small fiddling around the edges. The BLS unemployment rates have always excluded people not in the labor force (= not working and not looking for work).
posted by ROU_Xenophobe at 12:52 PM on August 10, 2007

Any Major Dude is right; today's "unemployment" figures are not really comparable to those of the past, because they do not share the same meaning of "employment." They are further disguised by the fact that people who can only marginally support themselves via Walmart-style "employment" often have credit debt that would have been impossible to attain just a few years ago. I think too many people are looking at past indicators and finding justifications which aren't supported by common sense and other factors. (For instance, a ridiculously weak dollar has helped support the state of the economy to an extent not measured by other indicators.)

To give a personal example, I've got a friend who's never been late with a credit card payment and has always paid what he owed in full. The most he ever charged in a month is $4000. But his combined credit (card) limit is well over $120,000! He's shown restraint, but many haven't, and the situation wherein this is commonly possible is historically new and obviously alters things a bit in itself.
posted by Dee Xtrovert at 12:54 PM on August 10, 2007

This number ignores those who have exhausted their unemployment benefits, those who've given up on the system altogether as well as those who are underemployed with no benefits correct?

That's something that rarely comes up in discussions in the economy, yet seems rather crucial.

The "funny" thing is that they could decrease the unemployment rate by just cutting benefits.
posted by bshort at 1:01 PM on August 10, 2007

Finally, note that a bunch of the hedge funds are going to be in deep doo-doo on August 15th, when they need to make their quarterly statements. At which point, a lot of people invested in them may stampede for the exits

Are you sure about that? I think that 8/15 is the day that redemption requests have to be in for 9/30 disbursements.

I might be wrong.
posted by Kwantsar at 1:31 PM on August 10, 2007

On 8/15 several of them make their quarterly statements to their customers *and* their customers' redemption requests need to be in, which then get paid out by the funds (or not) on 9/30. (Although some funds only do redemptions once a year, and some charge a fee for it too.)

So we're both right and both awesome. :-)
posted by Asparagirl at 4:27 PM on August 10, 2007

It is very likely that the US (maybe even the world) is on the eve of a very big recession. The idea since 90ies is that you can solve any macroeconomic problem if you just print enough money an increase the M3 money supply without limit.
Or to put it with Mr. Greenspan:"Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit. They can discount loans and other assets of banks or other private depository institutions, thereby converting potentially illiquid private assets into riskless claims on the government in the form of deposits at the central bank. That all of these claims on government are readily accepted reflects the fact that a government cannot become insolvent with respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such claims without limit. To be sure, if a central bank produces too many, inflation will inexorably rise as will interest rates, and economic activity will inevitably be constrained by the misallocation of resources induced by inflation. If it produces too few, the economy’s expansion also will presumably be constrained by a shortage of the necessary lubricant for transactions. Authorities must struggle continuously to find the proper balance."

But don't listen to me. Probably I am just telling nonsense. Just got rejected from the Boston Consulting Group. The guy who interviewed me had not heard on the 8/25/07 of the Subprime mortgage problems and looked at me in disbelief when I told him that I expect a declining stock market (that just declined that very day). They told me that I have not enough business knowledge and should read the business part of the newspaper more often...
posted by yoyo_nyc at 5:09 PM on August 10, 2007

Inflation also works to devalue debt though, and there sure is a lot of that...

Define inflation... ;-)
posted by yoyo_nyc at 5:11 PM on August 10, 2007

Wow, yoyo_nyc, that's nuts.

But I guess you can take comfort in the fact that when you talk to your kids and grandkids some day about What It Was Like when you were young ("tell us again about the Bad Panic of 2007-2009, Papa Yoyo!") you can pull out that terrific anecdote, and you and the kids can all laugh together about it. And you'll even have this old AskMeFi thread lying around in an Internet archive somewhere to prove to them you didn't make it up or back-date your foresight!

Screw BCG, I hear Bain is a better place to work anyway.
posted by Asparagirl at 5:33 PM on August 10, 2007

This post reminds me of one of the greatest economics articles I have ever read, by Paul Krugman, a Princeton economics professor. He has been writing for the NYTimes recently, with a politicized slant, but this early article on slate is much more tilted toward an explanatory style than polemic, and did a lot for me in helping me understand some of the issues in monetary policy.

The issue he tackles by analogy is the "liquidity trap", or what happens when there isn't enough money in circulation in the context of the far-eastern economic depression in the mid 90's.

Baby-sitting the economy
posted by Maxwell_Smart at 6:19 PM on August 10, 2007

The issue he tackles by analogy is the "liquidity trap", or what happens when there isn't enough money in circulation in the context of the far-eastern economic depression in the mid 90's.

Krugman has predicted nine of the last zero liquidity traps (really). It's his hobbyhorse.
posted by Kwantsar at 12:35 PM on August 11, 2007

Is the bear already in the house? Washington Post columnist Steven Pearlstein thinks the bear is already in your bedroom. Here is his interesting analysis of the situation. Bottom line: things don't look good.
posted by redarmycomrade at 1:38 PM on August 11, 2007

Kwantsar,

The article seems to me to do a decent job of explaining te conventional wisdom behind the question of what leads a central bank to increase or decrease the money supply. No predictions are made, and the article was written nearly a decade ago, so it is not commentary on the present state of the economy.

Your joke about Krugman is just about the oldest one in the book, but point taken that experts in economics are quite often mistaken, and that what actually happens deviates from "what should happen according to theory" more so for economics than for most other scientific disciplines.

Do you have a particular point of criticism on the article? I'd be interested in hearing it, as from your other posts, you seem to have a far deeper background than I do here.
posted by Maxwell_Smart at 3:43 PM on August 11, 2007

Well, Krugman's bona fides are stellar, of course. And no one is going to win an argument by attacking his mental horsepower.

Furthermore, the baby-sitting co-op case is now taught in (probably) every reputable business school. So those lessons, in and of themselves, aren't really controversial.

That being said, the Japan situation isn't seen by all credible economists the way that it's seen by Krugman. Here's one way to look at the issue, vis-a-vis Japan.

My joke about Krugman is that he's more or less claimed that the US was teetering on a verge of a liquidity trap of its own for a very long time. It really is his hobbyhorse.

WRT today, many people in the business (rightists and leftists both) have suspected that the narrowing spreads of the past half-decade (where people demanded smaller and smaller returns from risky loans) would not end well. To be fair, CLOs and CDOs have probably extended this period of low risk premia.

The funny thing is, though, that there's this giant drive to place blame, and I think it's a bit pointless, because no one has clean hands in this mess:

The Fed's has practiced an easy money policy for far too long.
Appraisers and mortgage brokers are self-interested crooks who bent rules and greased palms.
Credit agencies didn't model many of these comples products as well as they should have.
Investors who bought this toxic waste largely never read all the documentation.
Investment banks extended ridiculous amounts of leverage to support their transaction and structuring revenue streams.
Real Estate speculators are, broadly speaking, the sleaziest people in the entire chain.
Washington has managed Fannie and Freddie just terribly, so that no one really knows whether their paper really carries a guarantee.
Homeowners (for some reason) insistred on doing anything possible to put themselves in their dream homes, eschewing savings, even health insurance premiums, just to get into their dream home.

Mix this all together and we have bonds (CDOs, CLOs, CMOs) out there, that no one can really seem to price. Buyers will pay 50, sellers want 90, and there's a bunch of sand in the gears.

This too will pass, but I doubt that we'll learn the right lessons.
posted by Kwantsar at 12:59 PM on August 12, 2007

(please forgive the grammar mistakes). And for the record, I think that the agencies are maligned a bit unfairly in this whole mess. The people who manage portfolios-- even if they are no more than median students of above-average MBA programmes-- had a duty to know what it is that they were buying. The blowup of this paper was even more obvious ex ante than the popping of the internet bubble. It's probably hard to understand without a rudimentary finance education, but the evolution of the CDO-squared should have rung quite a few alarms.
posted by Kwantsar at 1:05 PM on August 12, 2007