Navigating Treacherous Waters, Part I

This is the first of a three-parter dealing with the current financial crisis. Part I deals with the causes and origins of the crisis. Part II addresses the issue of what, if anything, us lowly consumers should be doing with our money. Part III will focus on longer-term issues of investing and reforms.

Lehman Brothers is gone. Morgan Stanley may be bought by a Chinese concern. Merrill Lynch has been taken over. Bear Stearns — bought. AIG is the subject of a massive bailout. Freddie Mac and Fannie Mae are in conservatorship. IndyMac was shut down. Overseas, the crisis has taken its toll on Northern Rock and other banks (most recently the Halifax Bank of Scotland). Now it is clear that we are in the midst of a truly global economic crisis.

Over the last few weeks, I have been receiving increasing numbers of emails from people wondering about the financial problems in the U.S. markets. Questions I have heard range from “should I move my savings account away from X Bank?” to “which political party should I blame for this?”

First, some disclosure: I’m not an expert in financial matters, I am not a money manager and nothing in this series should ever be taken as definitive advice — find a good financial advisor and vet anything I say against their advice. These are just my random thoughts; my background is that of a corporate lawyer with some experience in the global markets, including collateralized debt obligations.

So, some Q&As. The Qs: (1) what the heck is going on? (2) Where did it start? (3) Where will it end?

(1) Here is what is going on: a global economic crisis that includes inflation (linked at least in part to high oil prices); a credit and lending crisis leading to the collapse of several large investment banks; sizeable unemployment; and to top it off, a stock market crash worldwide, largely the result of investor fear. Put them all together and you have a remarkable confluence of horrible financial results and the possibility of a global great depression. The NYTimes, the Financial Times and The Economist are great resources to get the layman’s view of what is going on. The NYT recurring Freakonomics series has a good article. Here is a fun powerpoint, which is a bit bitter but gets some of it right (language warning). Here’s a quote from a NYT blog, responding to a request to tell us in English what’s happening:

Banks used to make mortgages and hold them; so they only wanted to make good mortgages. With securitization, those who made the mortgages were different from those who held them, usually in the form of mortgage-backed securities that represented bundles of mortgages. Then, with house prices only going up, they started adding weak mortgages to the mix to increase return.

It worked well for a while so it grew and grew. Then the unthinkable happened: house prices started falling and people all over the world had a piece of the bad stuff.
–Bob McTeer

From Dwight M. Jaffee, of the Haas School of Business at the University of California, Berkeley:

Two points:

1) Mortgage lenders (and borrowers) did not anticipate that if the lending slowed down, then house prices would crash, creating an enormous wave of bankruptcies. You might think this was really stupid on their part, but remember that we had no such wave of national house price declines since 1935, which is to say for almost 75 years.

2) Liquidity. Investment banks, Fannie, and Freddie alike all borrowed short-term while investing long-term, assuming they could always roll over their maturing debt. They assumed the market would always be there to make a new loan, even if the interest rate might be higher. Turned out not to be true. In the week leading to its demise, Bear Stearns could not find anyone willing to lend it money. — Dwight M. Jaffee

(2) It started here, in the United States. Well, kind of.

On the inflationary side, oil and food prices rose dramatically in the last year, with oil going well above $100/barrel. Oil and food prices today tend to go hand-in-hand, as so much of the production and distribution of food globally is utterly reliant upon petroleum, whether to power farm machines, create artificial fertilizers or to ship your Costco strawberries in from Chile. The reasons for the rise in food prices are not settled, but massive drought in 2006-2007, increasing use of crops for biofuel, and changes in diet towards meat consumption are factors. Oil prices, meanwhile, have been steadily rising for decades due to inflation, ever-increasing demand, changes in state fuel subsidies and other reasons.

Regarding the subprime mortgage crisis, a couple of terms are useful if you want to sound intelligent in your cocktail hour discussions: “securitization” and “CDO” (or CMBS). Securitization refers to the process of taking something that is not a financial security (i.e., some asset that provides cash flow that is not inherently tradable like a share of stock is tradable) and turning it into a security by bunching it with a group of other similar assets and selling it to a special purpose company, which in turn then sells shares in itself (the wiki is pretty good on this). A CDO is a collateralized debt obligation, which is an unregulated sort of asset-backed security (CDOs are a frequently-blamed villain in this story). A CMBS is a commercial mortgage-backed security, or a bond related to one of these securitized products where the underlying asset is a group of mortgages of various qualities.

Mortgages by their nature are not very portable products. They are contracts between two parties, irrevocably tied to the collateral (such as your house). The gist is that someone figured out how to get around that importability, and how to trade on that mortgage. The only problem is that to do this, you need a lot of mortgages — and the more you want to do this (and make loads of money doing it), the more willing you need to be to include in your securitization bundle some mortgages of dubious quality. You effectively separate the loan from what gave the loan value and moral hazard, i.e., the quality of the collateral and the reliability of the debtor. As bloggernacle denizen Mathew has noted, “this is the functional equivalent of the separation of ownership and control in business.”

So at the top of the chain (at say, Lehman) you have investment banks who see easy money in CDOs, which are untested securities — but they’re backed by mortgages on real property, which means they’re not ultimately not worthless, and everyone knows that real property is the top of the food chain when it comes to collateral. These securitized products and CDOs are unlike their traditional assets or securities, but they shoehorn them into their existing financial models because the prospect of not selling them is intolerable. Nobody is able to vouch for the veracity of the models–but everyone can see that the models don’t exactly fit the asset classes they were now dealing with. The ratings agencies are either silent as to the value of these packages, or their ratings are spurious at best. Risk factors are included in each prospectus, making it clear that each investor could theoretically lose his or her shirt — but nobody seems to care.

At the bottom of the chain, you have local property mortgage lenders (like say, Countrywide), who get paid for each mortgage they make. Property values are skyrocketing in previous deserted wasteland areas, and any fool can see that you can make a fortune in real estate — after all, markets go up and down, but real estate has been a great overall bet for decades. So people with no down payments, no prospects for payment, no history of lending or clue of what they are doing are nonetheless handed low-interest loans (or ARMS or other balloon-payment products), which bear obligations that they cannot fully understand.

It is in nobody’s interest to verify the quality of the loan.

With the benefit of hindsight, a crash seems inevitable. Couple that with a declining dollar, extremely low GDP, the highest unemployment in five years and global inflation, and we are faced with an unprecedented challenge.

(3) Where will it end? None seem to know. A Harvard economist I heard last night predicted several years of depression before fundamental economic indicators began to turn around. Others are predicting fallout from the current crisis that will last seven to nine years. Best-case scenarios are still showing serious economic troubles in the U.S. until at least 2010. This much is clear — the golden days are over, and Joe Investor needs to be ready for a long tough haul for years to come. It is as Joseph saw:

And, behold, seven other kine came up after them, poor and very ill favoured and leanfleshed, such as I never saw in all the land of Egypt for badness: and the lean and the ill favoured kine did eat up the first seven fat kine.


  1. Joseph and President Hinckley. Even if he didn’t “see” this event, he definitely warned us that it would be coming and asked us to prepare….

  2. Jim, yes he did.

  3. My husband blogs about a lot of this financial stuff here.

  4. Nice write-up, Steve.

  5. A few months ago, This American Life did a very listen-to-able story on the causes of the credit situation that we are now in. It’s a good supplement to an already informative article.

  6. Thanks for the link Jessawhy. I’d be curious to hear his thoughts on this.

  7. Clint, I love that episode. It’s extremely valuable.

  8. Thanks for the explanation, Steve. I’ve been hearing lots about this from my peers, but I’m quite clueless about most of it. So, if I understand you correctly, there has been a trend to trade things that aren’t secure, and, presumably, not regulated by the usual bodies? Of course, the pioneers in this have probably made millions, even if they’re losing money now, right?

    It would help me if you could give an example (other than mortgages) of something that would fall into the category of securitization. (I’ll go look at the wiki article next to see if that helps.) Come to think of it, we’re getting loans from a couple of investors using alarm accounts as collateral (essentially.) These are basically financial contracts between us and customers, so perhaps it’s something like that.

  9. FHL, auto loans, student loans and credit cards are the most common other forms.

    And no, these things are still regulated — all securities are regulated. The problem is that there is a separation between the securities themselves and what gives them value, i.e. the quality of the underlying loan. The ratings agencies who rate the securities gave cursory inspection to the loans and nobody really was checking to see how many of these packages included bogus loans. Yes, the pioneers made millions.

  10. FHL,
    David Bowie famously securitized the royalties from his back catalog (or at least part of it). Look up “Bowie Bonds.” While not exactly the same, it’s kind of the same theory: he had an asset that could generate a revenue stream, and people could buy the rights to a portion of the revenue stream.

    The CMOs are way more clever, though: the think was, you can make an untrustworthy asset trustworthy by bundling it with thousands more. Even if one or two people fail to make their mortgage payments, the other (say) 2,998 will do it, and so these things will pay off, at least at the safe tranches. Turns out, though, that the risk was mispriced and the various actors saw upside potential without the downside, freeing them to take bigger risks than they would have rationally chosen.

    Great write-up, Steve.

  11. Good summary, Steve. I am shoehorning it into what I have been listening to on NPR and reading in various other media.

    An observation about investor fear. I have heard a couple of times over the last few years the fact that so many more regular citizens now own stocks or mutual funds through 401K or IRA plans shows the strength of the market system. I suspect that as most of these funds probably include many of these more speculative securities (AIG has been very popular in mutual funds, I understand). I think our sense of ownership is part of the problem, and then you hand us normal rubes the game controller and online control of these assets. That seems to me like a prescription for disaster.

    My wife and I were talking about what steps to take last night regarding our retirement savings plans, and the best that I could come up with is “Don’t do anything!”

    Most of us really don’t have the time or resources to really understand what is going on in the markets, so we tend to overreact due to ignorance and fear. One of my married sons took his account out of WAMU, even though we assured him that the deposits were insured to $100K, and he certainly didn’t have that much there, plus the WAMU banking system, outside of home mortgages, is very sound and profitable. Couldn’t dissuade him.

    My father-in-law is now in his 80’s, and has on two occasions now lost on paper through his investments more than he made working for a living during his entire life. However, he is diversified into several mutual funds, and a few other stocks, and in each case, has seen his investments return to their previous values because he ALMOST NEVER TRADES. And the market comes back.

    I’m also just a casual observer, but his experience speaks volumes to me. Maybe most of us shouldn’t even try to control things. Time is a better ally than a tip about what somebody made money on yesterday.

  12. Steve Evans says:

    Kevinf, tomorrow I’ll write up what people ought to be doing right now. Your married son might not have been wrong.

  13. Steve, I was only frightened before. Now, you’ve got me terrified. That, plus the nagging fear that today’s positive market performance represents the proverbial “dead cat bounce”.

  14. “nobody’s interest to verify the quality of the loan”

    Why? I would think it would be in the interest of whoever is putting up the money, whether it be a local bank or some more distant entity buying a bundled security. There are certainly ways that you could verify the quality of the bundled security, by simply taking a sample of the loans and looking closely at them.

    The mystery to me is why they so many people didn’t do that. Perhaps they were fooled by the rating agencies and the modelers. I’m sure there were lots of other investors who stayed away from the securities for these very reasons.

  15. The ratings agencies are either silent as to the value of these packages, or their ratings are spurious at best.

    Not to give anyone else a free pass–because none of the major player in this market deserve it–but I actually think the rating agencies are where this market truly broke down. The “independent” raters on these bond deals were supposed to provide everyone with all the diligence they needed to feel good about the investment, and it appears that they were as venal as the rest.

    Of course, everyone should have done their own diligence, but if I’m ML or Bear, and I get a Lend Lease to give me a stellar rating, I’m not going to waste as much time kicking the REIT’s tires.

    It reminds me a lot of the relationship Arthur Anderson (allegedly) had with Enron: those tasked with telling it like it was ended up being co-conspirators for the sake of profit.

  16. Steve Evans says:

    ed, the reason that nobody cared to verify the individual loan is because each security represented a whole host of various loans. Because the risk of each loan in the bundle defaulting was so low, the threat of the overall security not producing a healthy return was deemed insignificant. However, the time and expense to hunt down and verify each loan is enormous. Therefore nobody bothered — it was simply not worth the effort.

    Here’s another good summary of how these CDOs work and why it’s not such a mystery as to why they were unverified.

  17. Did you read what I wrote? You don’t have to look at “each loan.” You look at a random sample.

  18. Steve Evans says:

    Ed, people did do exactly what you are talking about, and it didn’t make a difference until the housing bubble started to burst. Random sampling was commonplace.

    p.s. “did you read what I wrote?” geeez man.

  19. OK, then the problem wasn’t that they didn’t know what kind of loans were in the bundle…the problem was that they had unrealistic expectations about how such loans would perform. The problem wasn’t the bundling, it was the expectations.

  20. In the 90s, the government required lenders to make loans to borrowers that couldn’t qualify under normal underwriting credit standards of prior years. Many inflated (bloated) loans were made to prospective buyers of homes with little or no down. It was a feel good action with severe unintended consequences. But that’s what the government does more often than not–sticking its nose into business matters with no idea other han wanting to make it so easy.

    Rating agencies are also at fault. Maybe we should now say they were asleep. And then there was the naked greed of investment and some commercial bankers. It all added up to the perfect storm. I didn’t mention Fannie Mae and Freddie Mac. Their officials cooked the bookes and walked away with millions in bonuses. They paid minimal fines but should have gone to the pen and should still be there.

  21. Ed, by and large that’s correct. The ratings agencies would look at the payment histories/backgrounds associated with the loans and give the CDO a ranking (AAA, etc.) based on the mixture of the various bundles. So you could have an expectation based on the ratings. One of the problems is that when the housing bubble burst, even the AAA rated ones started having rates of default far, far above historical returns. The expectations were high, but not unrealistic based on historical returns.

    The point is that a few years ago, we all had expectations about the economy that were (in hindsight) unrealistic.

  22. Thanks for taking the time to write this up, Steve. You’ve helped me understand the situation a lot better. Up to now I’ve had to rely on Brother Beck to teach me about our economy. :)

  23. Lawrence, your comment shows a lot of anger towards the traditional punching bags of government, ratings agencies, officials and bankers. No doubt they played a role. But I don’t think it so easy to blame others for this crisis. A general culture of consumerism, greed and overextending ourselves is to blame. Let’s not lay the greed at the feet of investment and commercial bankers — we all sought to profit from cheap credit and seemingly endless climbs in the housing market.

    In any event, I definitely do not think that we can blame government intervention for the current crisis.

  24. OK, Steve, then maybe we agree. I got the impression from your post that you object to the bundling of mortgages per se. I think bundling is still in principle a good idea that has lowered lending costs for families, and should continue.

    Also, I do suspect that there actually WAS some failure of investors to look under the hood at these mortgages; certainly the ratings agencies failed to do so. The recent mortgage vintages tended to become delinquent very quickly, which probably indicates fraud or just complete incompetence by the originators.

    I do think things like the credit derivatives market have exacerbated the problem…those probably need to be regulated. It’s now far too easy for a firm to take positions that make it “too big to fail.”

  25. ed, sure — securitization is a brilliant idea, and it worked really well (and can continue to work well, with safeguards).

    I am not sure that lowered lending costs for families is such a good thing, however. People quickly get in over their heads. Raising the bar for capital might help prevent some of the more knuckleheaded prospective investors, by forcing them to spend their paychecks on Colt 45 and Red Man instead of on a mortgage they cannot afford and which ultimately you and I will have to bear.

  26. Token Average Member says:

    We saw this on a smaller scale in California in the late 80s and 90s. It is just such a shame that so many people thought they could afford those mortgages some day, some way, if they just held on. The individuals who have lost their homes are the ones I feel sorry for. As Robert Heinlein wrote: TANSTAAFL!

  27. Thomas Parkin says:


    The elitism of your #25 is a little shocking. Next time you’re down here slumming in Puyallup, we should hook up so I can introduce you to some genuine salt of the earth types. One thing sure to result from the knuckleheadedness of the not so Colt 45 inclined is that there will soon be many more salt of the earth types to enjoy. You might be one of them (us).



  28. Steve Evans says:

    TP I was there last weekend, and I can tell you there’s more to being salt of the earth than malt liquor and chew!

    There’s also guns, for instance.

  29. re: 27
    He can’t help it, Thomas. Steve is Canadian.

  30. As tough as this is for many people it may turn out to be just the thing to wake America up from our spiritual slumber (including church members). Prosperity is a powerful spiritual opiate (Helaman 12).

    Our enemies think we are easy pickings, the great satan. The Book of Mormon teaches otherwise. America, the Lord’s promised land has embraced decadence for a season, but I think He has many more blessings in store before the “consumption decreed” is declared.

  31. Steve Evans says:

    Jared, you’ll forgive me if I believe that the Book of Mormon does not necessarily teach otherwise at all.

  32. “It’s not surprising that the people of Puyallup get bitter, that they cling to guns, and funnel cake, and hog judgings…”

  33. Thomas Parkin says:


    I heard that you were local, and I wished I’d known before hand. The fairgrounds is just the other side of the boundaries of my ward. (For now. If this year keeps up much longer we may be living in a chicken coop, Lord knows where.) The only man with an aversion to guns is one that hasn’t been out shooting with me, brutha.


    “just the thing to wake America up from our spiritual slumber ”

    It certainly has got my attention.


    Anything that has given us Rush, Arcade Fire and Corner Gas can’t be all bad.

    I recall my mom talking about some former apostle who had a vision of Cache Valley filled with thousands of tents of refugees. Wonder if anyone has a reference for that. Pray ye the Lord that your flight be not in the winter, neither on the Sabbath day, neither take ye to Logan.


  34. Steve Evans says:

    TP, I’ll go on a shoot with you whenever you like. Sounds great.

    If you could combine Rush, Arcade Fire and Corner Gas, you’d have pretty much the best entertainment in the world, ever.

  35. Steve, I see two powerful messages for the gentiles in the pages of the Book of Mormon:

    1. Those scripture that warn destruction, and

    2. Thosee scripture that tell how the Lord delivers.

    Alma 19:27, Alma 45:1, Alma 60:20, Mormon 3:3.

    However, the time does come when wickedness among those who were once enlightened becomes great enough then the Lord withdraws from them. Mormon 3:14-16.

    I believe the Lord will bless America in the future, just as He has blessed her in the past. He does this because of the righteous.

    …nevertheless for the righteous’ sake, yea, because of the prayers of the righteous, they were spared
    Alma 62:40

    Wherefore, he will preserve the righteous by his power, even if it so be that the fulness of his wrath must come, and the righteous be preserved, even unto the destruction of their enemies by fire. Wherefore, the righteous need not fear; for thus saith the prophet, they shall be saved, even if it so be as by fire. 1 Nephi 22:17

    Wherefore, for this cause, that my covenants may be fulfilled which I have made unto the children of men, that I will do unto them while they are in the flesh, I must needs destroy the secret works of darkness, and of murders, and of abominations. 2 Nephi 10:15

  36. re-#34: I don’t know, Steve. Reading your comment, suddenly my head was filled with the imaginary sound of Getty Lee’s voice singing: “workin’ for the church while your family dies…”. It wasn’t pretty.

    Looking forward to tomorrow’s post…

  37. Steve Evans says:

    mpb, it’s always good to read my comments with Getty Lee’s voice. Awesome.

    Jared, I have no doubt that the Lord will deliver the righteousness, certainly from spiritual bondage. But I do not agree with the conclusions you are drawing re: America based on the scriptures you cite.

  38. jonahtrainer says:

    At least strike at the root people.

    The fundamental cause of this financial crisis is an immoral monetary system in violation of the Judeo-Christian, Biblical, Quran, Book of Mormon and US Constitutional principles.

    The Federal Reserve and use of Federal Reserve Notes as Legal Tender violates Article 1 Section 8 Clause 5 and Article 1 Section 10 Clause 1. Joseph Smith taught that it was ‘much safer’ to go upon the ‘hard money’ system and doing so was ‘absolutely necessary’ (Scriptural Teachings of the Prophet Joseph Smith pg. 314, 1993).

    For the first time in decades, during the Republican Presidential Primary elections America had the opportunity to vote for a candidate that would re-enthrone such principles and openly espoused and raised the ‘sound money’ issue but instead the voice of the America people chose not to embrace the candidate (Mosiah 29:27; Hel. 13:33).

    History is replete with examples of currency collapses which are a regular occurrence (Rome, England in 1694, America in 1776, France in 1793, Weimar Germany in 1923, Argentina in 2002 and currently Zimbabwe, etc.). There are a couple non-authoritative citations of prophecy from Church history predicting the impending ‘storm’ President Hinckley may have alluded to. For example,

    “Question: What do you mean by that?
    Answer: A civil war more bloody and cruel than the rebellion. It will be the smashing up of this nation, about which time the second great work has to be done, a work like Joseph did, and the translation of the sealed plates and peace all over.”

    (Source: Interview by Dr. Poulson with David Whitmer, Deseret News, Friday, August 16, 1878)

    “My brother, Noah Packard, says that he heard the Prophet Joseph say that the next great (U.S. civil) war after the war of the rebellion (the Civil War of the 1860’s between the North and the South) would commence in a little town now called Chicago but at that time it would have grown to be a very large city. And another brother told me that the Prophet said that the ***cause*** of the next great trouble of the United States would be the ***depreciation of the currency of the United States.*** I believe I have given you all the facts in as short and concise manner as possible.” (Source: A. Milton Musser papers, LDS Church Archives, letter from Nephi Packard to A. Milton Musser, July 24, 1896.)

    What is happening is the collapse of a worldwide immoral fiat monetary system. This is unprecedented and therefore there is no history for how it will turn out. Hopefully everyone has followed the advice of the prophets and is prepared (D&C 38:27-30). As Pres. Monson has said, “When the time for performance has come the time for preparation has passed.” For more analysis on the secular reasons for the current turmoil visit [URL edited at caprice of evil admin].

  39. Steve Evans says:

    LOL, jonahtrainer. Thanks for playing.

  40. re: 33 I was being facetious with the Canadian comment; personally, I’d trade our system for theirs in a second. We can mock our neighbors to the north all we want, but they’re laughing all the way to their well-funded pensions.

    Man, what a great thread. (Threadjack Alert!) It just occurred to me that perhaps it’s for the best that Sarah Palin isn’t LDS. Imagine the fun she’d have as President with a scripture like 1 Nephi 22:17 at her disposal. Instead of Drill, Baby, Drill it would be Burn, Baby, Burn.

  41. Please spare us the nutjob gold standard speeches. If you haven’t figured it out by now, let me enlighten you: the gold standard is long dead and not coming back. The end.

  42. Well done, Steve.

    Looking forward to tomorrow. Oh, WaMu!

  43. My question is, given the above, why has the dollar been on such a rally since July?

  44. jonahtrainer’s comment is at least entertaining.

    jared’s borders on scary

  45. “My question is, given the above, why has the dollar been on such a rally since July?”

    Mostly because the price of oil has declined during that time.

  46. Peter — oil baby.

  47. Mostly because the price of oil has declined during that time.

    I have noted the strong correlation, but what is it about weak oil that makes the dollar look good? As Steve writes, it will likely take years for the fundamentals to turn around.

  48. John,

    I just saw your reply. Again, the correlation is clear–but what’s the connection?

  49. Excellent write-up Steve — although a little pessimistic, especially considering the rally on the markets.

    Despite the rally, I think that the wide swings we have seen lately in the markets portend continued turbulence and the uncertainty could definitely stretch out to 2010 or beyond as the market takes a new shape after the tumultuous events of the last year, so the timing of your post is appropriate and the substance very informative.

  50. Gerald Smith says:

    Good blog, however I think you are missing some key elements. First, the economic status of the USA. We have trillions of dollars of both federal and consumer debt. We are close to becoming rated as junk for borrowing money internationally.

    Our Congress and Presidents do not know how to stay out of debt. The numbers have been hidden, so we do not see all of the national debt anymore. The $500B estimate for 2008 does not include debt for the Iraq War nor for bailing out banks and insurance companies.

    Social Security and Medicare are on the brink of collapsing, because we’ve mismanaged them and the money going into those funds.

    Several leading economists have now predicted we are coming into a Depression, because our economy is no longer stable.

    This actually began years ago, with unnecessary deficits. It was made worse by the feds trying to soften previous recessions by throwing money into new markets. When the tech market died in 1999 (due to Microsoft being declared an illegal monopoly by the feds, and it rattled Wall Street), money was being lost hand over foot. The fed “saved” the economy by pumping money into housing and deregulating everything.

    Sadly, no one learned from the S&L junk bonds, or the worthless Internet tech companies that were worth far more than they could ever earn in a lifetime, so when they crashed, they came down hard. We are not just feeling the pain from one crash, but a variety of crashes that we’ve pushed off down the road. This is just the straw that broke the camel’s back.

    Fiscal responsibility is needed on Wall Street, Pennsylvania Avenue and Main street. But it will require a Depression for everyone to awaken and get smart.

  51. But it will require a Depression for everyone to awaken and get smart.

    Like, every generation? ‘Cause there was a Great one not that long ago.

  52. molly bennion says:

    Peter #48, The correlation is not 1 to 1 because other factors (interest rates relative to those of Europe, debt, trade deficits, etc for the dollar and supply disruptions, declining oil reserves, demand, war, speculation for oil) are at play but the argument is basically that since oil is priced in US dollars, when the oil producer can buy less with the dollars he is paid, he will charge more for the oil to make up the difference. Simplistically, a dollar is worth what I can buy with it.

  53. Please spare us the nutjob gold standard speeches.

    Well, I, for one, want to make clear that none of you shall crucify mankind upon a cross of gold.

  54. I highly recommend the “fun powerpoint” that Steve linked to in his post (and I echo his languge warning). It’s the best cartoon explanation of the subprime mess that I have seen. There are a couple different versions floating around the internet.

  55. Michael Lewis, not a finance guy, provided a funny, harsh take on the subprime mess a year ago (don’t have to worry about language):

  56. Molly,

    Thanks for your answer. I guess what I’m wondering about is this: does a decline in the price of oil cause investors with deep pockets to buy dollars instead? If so, why dollars? Why not euros or pounds?
    Or does a rising dollar cause the price of oil to go down? Like you wrote, if an oil producer can buy more with his dollar he will charge less. If this is the case, then oil would not seem to explain the dollar rally.

  57. Good work, Steve. I especially liked your reference to Joseph in Egypt. I personally could write a very thick book about seven skinny cows and seven fat cows.

    Through all of this, I think it is important to retain perspective. If you can tolerate a mixed metaphor, now is the time we need to keep our powder dry and our eyes on the ball. Our grandparents, who knew what a real depression looks like, would probably laugh at us as we tremble, watching the Dow shed an entire 7% of its value. By contrast, on Black Monday in October 1987, the Dow lost 22% of its value in one day. That was less than 20 yaers ago, and the world didn’t end.

    Yesterday’s edition of USA Today reported that the total amount the government will in the to bail out banks, guarantee bad mortgages, and shore up the financial markets will be around 900 billion dollars. That sounds like a big pile of money, and it is, but again, some perspective is useful. It is less than 3% of the annual GDP. We spend 9 billion per year on the school lunch program. Are we the kind of people who can be made to fear the prospect of funding a hundred school lunch programs? If so, then I guess we are getting what we deserve.

    This, too, shall pass.

  58. CE,

    That powerpoint pretty much summed the whole thing up.

    The housing bubble was of course obvious. So was the fact that when you originate loans and there is limited ability to repay and you do not do your “due diligence” you then get lots of defaults.

    “Its in nobody’s interest to verify the quality of the loan”

    That pretty much sums up the entire issue.

  59. So we are in the camp of the housing bubble was so obvious. But should we buy now? Frankly, we have our picking here in SF area because we waited, but should we continue to wait?
    I admit, we have two bids out on houses, and are thinking of rescinding our offers.

    Also, I’ve been wondering–there are several abandoned houses around my town. They have foreclosed (I know they foreclosed for sure–I’ve been following them closely), but they aren’t listing. My concern is that because they were bundled into securities it might not be known who really owns them now (who has the mortgage).
    I suspect someday they will find out, and it is probably a failed company-and the houses will go up for auction at a public auction or sold as listings for dirt cheap–maybe in a year or so. Anyone with and educated guess?

  60. Mark,

    So the rally in the markets yesterday and today is more of a “fat cow bounce” than a “skinny cow bounce?” My dead cat is pretty well used up.

  61. molly bennion says:

    Peter, Yesterday and today are interesting on this issue. Yesterday oil rose and the dollar fell. Today oil is rising and the dollar has been rising. (Though we now know both could fall before I hit the send button.) It’s the other factors. Those monied interests you speak of may be happy our deficit and trade deficit are falling (and thus the recent rise in the dollar), but they need stability in the banking system, a good yield relative to other currencies (note Europe is on the brink of recession too) and a favorable growth rate in our economy. Yesterday those were less certain.

  62. Steve Evans says:

    I do not think we can draw any conclusions from yesterday and today’s markets, other than initial reactions of relief in response to the unprecedented interventions by the Fed, SEC and other entities. We are definitely in a depression — the difference is that in the 1930s we had no such infrastructure in place.

    mmiles, your questions will be answered in today’s post.

  63. Thanks, keep them coming, Oh wise ones.

  64. molly bennion says:

    Steve, I don’t see how we can define this as a depression. Hasn’t been long enough or evidenced a sufficient drop in real GDP. What are your criteria?

  65. Molly, I think the GDP numbers were a little cooked, frankly. If you take inflation into account the numbers have been negative for some time. The National Bureau of Economic Research’s recession indicators peaked last September.

  66. Frank McIntyre says:


    I think you’ve written a decent summary. I really liked the freakonomics piece. Do you remember the name of the Harvard economist you mention above?

    Also, what is this about negative real GDP growth? Are you sure? Because a quick google search gave me this from the BEA less than a month ago:

    Real gross domestic product — the output of goods and services produced by labor and property
    located in the United States — increased at an annual rate of 3.3 percent in the second quarter of 2008,
    (that is, from the first quarter to the second quarter), according to preliminary estimates released by the
    Bureau of Economic Analysis. In the first quarter, real GDP increased 0.9 percent.

    Has some new info come out since then?

    Regardless, even if we were in a recession we’re nowhere close to the kind of collapse we had in the 30s.

  67. Steve Evans says:

    Frank, thanks — I am glad to have not written an indecent summary. I don’t remember the name of the economist — I was in the car and didn’t catch his name. It could have been Feldstein.

    Totally agree that we are in a different world than we were in the 30s, both in terms of raw numbers — and in terms of infrastructure in place to handle crisis, which is what I see as really key. In terms of actual recession/real GDP, I am going off what I’ve been reading, say here and here.

  68. About a year ago I was working at a state bee research lab in Florida, and for some reason they have a hard time finding PhDs who like to play with beehives… so there you are with a bunch of redneck southern beekeepers who never finished college.

    Says one, “You know, my other Redneck Beekeeper Who Never Finished College buddy was telling me one day, ‘All these people I know are buying houses that look way bigger than they can afford, but they keep saying it’s ok because they’ve got a special mortgage figured out.’ And I keep telling him, ‘But Jim-Bob! WTF makes you think you can go from a single-wide to a three-bedroom? So look, all these special mortgages are changing terms in five years, right? You watch, man, in five years it’s gonna get reeeaal ugly.”

    So fast-forward six years, and last night we were up at a friend’s house in the ritzy part of town last night playing Count the For-Sale Signs. We’re still in grad school and student housing, and thus well out of the loop when it comes to buying into neighborhoods and the like- and it seems like everybody’s first instinct to think it’s “people who couldn’t afford any house, period, but got sweet-talked by the bank” who have a lot of these bad mortgages. And there’s certainly a lot of that going on.

    But wow- Dave’s redneck beekeeper friend saw it coming from five years away, and these well-educated, high-class people in the nice school district didn’t have a clue. It’s a pretty special thing when that happens.

  69. Jimmy W. Adair says:

    someof the things we are seeing is being fulfilled by prophets saying that the times of gentiles is being done right before our eyes. Our nation is being managed by money because it drives them to point of where they were willing to cheat us out of millions even billions. This may not be about finances but the prophets has told us as long as I remember that we need to stay out of debt. A good example is that the average person has about 8 credit cards, two mortgages, two car payments and a line of credit with that. When that person loses his or her job then the taxpayer ends up with the bill. This is what is happening today now because the American public has not paid off their debt like the prophet has foretold. This is just the starting point of things where the times of the gentiles will begin I believe will take effect. You realize that money has an affect on people because some are willing to lie and cheat or kill to get ahead of others?

  70. Steve:

    You left out the Fed’s easy money policy as a key precipitant of the current crisis. Without that easy money the likes of Bear Sterns, Lehman, et al would not have levered up to the tune of 30-1. Note how the traditional banks that maintained a government mandated ratio of around 10-1 have largely survived to feast on the carcasses of the highly leveraged investment banks and the traditional banks that relied too much on CA, AZ, NV, and FL real estate.