72 Comments

1. Dave:

Darn you L3! How dare you debunk my conspiracy theory of the prior thread—probably without even reading same.

Like the Englishman who was hit with a baseball bat said: “That’s not cricket!”.

Can’t really argue with your thesis. Those second mortage/ home equity stats look scary.
And do NOT forget how much has been run up on plastic in the belief that another cashout refi would solve all problems.

We are hitting deflationary times, no doubt about it and that is the fundamentals of the drop in petroleum prices.

H-O-W-E-V-E-R: I still estimate that some folks helped things along in order to limit/curtail cash flow to the likes of Putin,Chavez, and Actmeanywhackjob. If so,
Icertainly applaud them.

Besides that, going from $.47 a gallon for 91 octane to $1.95 is of great benefit to my finances.

But do keep your eye on the Permian Basin and what happens there. Might look over at the nearby Golden Triangle and what happens to
refineries there as well.

Like I said before, the Texas Oil Bidness may be in for Oak Leaf Cluster on Purple Heart.

Great job of analyzing and illustrating you did. Keep it up.

Dec 16, 2008 - 10:57 pm 2. Dave:

I certainly applaud them

$4.47 a gallon.

Dec 16, 2008 - 10:59 pm 3. vanderleun:

“Phantom equity” = “Real debt.”

Dec 16, 2008 - 11:06 pm 4. Joshua:

Another, simpler theory I’ve heard involving China is that the oil spike was due in large part to demand stemming from the PRC’s massive construction efforts in Beijing in advance of the Olympics. Once the Olympics ended, of course…

Dec 16, 2008 - 11:34 pm 5. Lifeofthemind:

Now why can’t the Republicans lock all their elected officials in a room, if they don’t get busy they all will fit in a room, and make them recite this story like scripture from the Little Red Book or Talking Points Memo is for the Democrats? McCain never could make these points but he could have been schooled if everyone else was willing to come to the aid of the party. I still think that the trail to Soros and Putin and Acorn are part of the story. They are exploiters and short sellers. Just as you can’t cheat an honest men if the Democrats weren’t already emotionally vested in debasing the currency then they wouldn’t have provided cover for the Fannie/Freddie Ponzi scheme. They provided a mechanism for Soros and the oil mafia to exploit. The crash hurts Putin and company but the withdrawal of America from the stage is worth it.

For Tolkien geeks remember how Gondor at its height was sapped by the plague? The forces of evil suffered also but all there Master needed was for the watch to be relaxed before his next push.

Dec 16, 2008 - 11:41 pm 6. Leo Linbeck III:

A factoid that I left out of the original post:

If you analyze oil prices and exchange rates from 1 Jan 2007 through 16 Dec 2008, you’ll see that the correlation is 0.93. This doesn’t speak directly to causality of course (see AGW discussion above), but it strongly suggests these two variables are not independent.

L3

Dec 17, 2008 - 6:25 am 7. Leo Linbeck III:

Some of the sources for the data in the post:

Mortgage equity withdrawal, and the trade deficit:
http://www.calculatedriskblog.com/2008/03/trade-deficit-and-mortgage-equity.html

Daily oil prices (West Texas Intermediate crude):
http://tonto.eia.doe.gov/dnav/pet/hist/rwtcd.htm

Weekly gas prices:
http://tonto.eia.doe.gov/dnav/pet/hist/mg_tt_usw.htm

US T-Bill yields:
http://online.wsj.com/mdc/public/npage/2_3051.html?mod=mdc_h_dtabnk&symb=UST1MO&page=bond

Share of US oil consumption for transportation:
http://www.eia.doe.gov/basics/quickoil.html

USD-Euro exchange rates:
http://www.x-rates.com/d/EUR/USD/graph120.html

Cheers.

L3

Dec 17, 2008 - 6:40 am 8. RWE:

This is exactly what I thought happened. And I might add the following:

1. The Housing Bubble led to a huge increase in the number of new homes being built but for which ethre was but a false demand created by people buying them
for short term investments. This not only led to capital being tied up in unproductive areas but to a lot of artifical stimulation in the construction industry. Thus a lot of investment went into the construction industry because it seemed to be doing so well. This was the equivalnet of the entire nation taking its liquid assets and converting them into concrete blocks which were then just stacked in the back yard. Note that Obama’s new plan to get us out of this is to do a lot of new construction.

2.The Housing Bubble led to a need to keep reducing interest rates because so many people who bought houses and could not afford them kept getting into trouble. A recent report said that over half of those who were saved from foreclosure earlier this year are in trouble again. And the Fed just dropped interest rates yet again. This is the equivalent of stopping a drunk from driving his car by getting him so drunk he will pass out and then leaving him lying in a parking lot full of Corvettes with the keys in them.

Dec 17, 2008 - 6:42 am 9. Cascajun » The invisible hand of Adam Smith:

[...] Oil troubled waters 2 All of this goes back to the mortgage debacle, in which Jack and Jill went up the hill to fetch a big new home. Eased underwriting standards drove up home values (money flowing into housing faster than supply expanded); rising home values created phantom equity; phantom equity was converted by consumers into cash through additional debt; consumers spent that cash on stuff made overseas, driving down the value of the dollar and increasing global energy demand; the falling dollar and rising demand drove oil prices into the stratosphere. [...]

Dec 17, 2008 - 6:45 am 10. David Joslin:

Excellent analysis. What does it tell us in terms of how the financial debacle will play out?

Dec 17, 2008 - 6:49 am 11. Leo Linbeck III:

Dave,

You know what they say: just because you’re paranoid doesn’t mean they’re not out to get you!

Actually, there’s plenty of room for manipulation in the short term. But the scale of these capital flows (tens and hundreds of billions of dollars) makes manipulation unsustainable in the long run. Even for our friends the Saudis. Billions of consumers simply swamp them.

It’s like trying to stop the incoming tide – you might have a bulldozer and I might have a pail, but neither of us has much chance of success.

And the Bush-Cheney is so powerless right now that it’s unlikely they could manipulate the market for baseball cards, much less crude oil.

Cheers.

L3

Dec 17, 2008 - 6:52 am 12. dan:

That was an outstanding analysis Leo – thank you. It’s reading posts like those that make me realize how little I know about economics. So, just another domino set up to fall by irresponsible borrowing. Interesting. Well, it will be interesting to see whether OPEC, or all members of OPEC, meeting in Moscow today radically cut output, and by exactly how much.

Dec 17, 2008 - 6:58 am 13. Leo Linbeck III:

RWE,

Re: Your 1.
Just so. This growth of residential construction also created an enormous demand for semi-skilled and unskilled labor. This led to a huge increase in illegal immigration. That flow is now reversing. This is good news for the US labor market (it will keep wages relatively stable) and decrease the chances of a deflationary spiral. But this is really bad news for Mexico.

Re: Your 2.
Well put. But one of the interesting things that’s happening now is that Fed rate reductions are not having an impact on borrowers. One of the reasons is that banks are not cutting their interest rates.

Our bank, for instance, has not cut its Prime rate, even as the Fed has lowered its lending rate by almost 2%. There are two reasons for this:

1. They need to improve their balance sheets, and that means they need to make more money. Fed rate cuts lower their cost of borrowing, so if they keep their lending rate constant, their margin increases. Normally, they’d be forced to lower their rate because of competition, except…

2. Banks are not taking on new customers. They are looking for depositors, not borrowers. So even good middle market companies who have access to credit with their existing banks find that other banks are not really interested in their business. This means borrowers have to stick with their existing bank, and this gives the bank pricing power. This prolongs the credit crunch. (I hear the same thing is true for credit card rates.)

We’re at a point in the credit crunch where banks have capital, but they’re not lending it. If you ask bankers why, they’ll tell you it’s because the OCC (Office of the Comptroller of the Currency) is being absurd in their requirements for writing down existing loans. I have heard stories about loans against retail real estate that are not in default, payments are continuing to be made, stand-by guarantees are in-place, but lose a non-anchor tenant, and the OCC is forcing the bank to take a 30% write-down in the note. This further erodes the capital base of the bank, and decreases lending capacity.

So the right hand of the government shovels money into banks, and the left hand keeps that money from being deployed into the market. Sheesh.

Remember: a bank has to have both deep pockets and long arms. Treasury is filling their pockets, but the OCC is shortening their arms.

And I think we all know just how painful that can be.

Cheers.

L3

Dec 17, 2008 - 7:09 am 14. Jim Nicholas:

My thanks to Leo for the very helpful analysis and to Wretchard for hosting a site that attracts contributions like this.

Jim

Dec 17, 2008 - 7:17 am 15. programmer:

Wretchard,

Thanks for highlighting L3’s post. L3, Occam’s razor always hurts. I still prefer to think that our lads and lasses in the economic Black Ops section used economic akido to assist several less than friendly countries to go from where they were to where they thought they wanted to be, only at highly accelerated velocities. It is easy to throw someone to the mat when gravity is working in your favor.

Dec 17, 2008 - 7:22 am 16. programmer:

L3,

By the way that “prefer” is probably wishful thinking on my part. I always like to believe that in some small quiet part of the huge mass of humanity that is our government, there exists a small bright group of true patriots. My cynicism is growing deeper every day.

Dec 17, 2008 - 7:26 am 17. Leo Linbeck III:

David Joslin,

Great question. It looks to me like the financial crisis is in the 7th inning. There are still problems out there (pension insolvency, tight credit, etc.), but the worst is over for financial firms, IMHO.

The rest of the economy, however, is in the 3rd inning, and the starting pitcher is struggling. You can’t simply turn off the flow of capital for 6 months and expect everything to keep on humming along. I think we’ll start to see lots of bad news from industrial, manufacturing, and core service businesses, with bankruptcies and lots of job losses. I’m guessing unemployment will get to 10%, maybe higher. Many firms have not yet cut capacity, and industries that were on the front line (e.g. home building) employed lots of illegal labor which don’t show up in the statistics and will simply disappear as they return to their country of origin.

I expect the recession to bottom out in late 2009 or early 2010. If you look at previous recessions, the stock market bottomed out 6 months or so before the end. So I would guess that the DJIA will hit bottom in the summer of 2009.

The big unknown in all this is what the Obama administration will do. If they really pump $1 trillion into the economy through public projects, you can add another 6-12 months to these dates. The reason is two-fold:

1. This will increase the supply of US Treasuries, since this money will have to be borrowed. This will put a lot of upward pressure on interest rates, and higher interest rates will slow the rest of the economy. It’s basically taking money that would otherwise be invested in the recovery and investing it in much lower-yielding projects.

2. To fund this, marginal tax rates will have to increase. Such increases will further erode incentives for investment and risk-taking, which drive productivity growth. Productivity growth is the only way out of a slowdown, and this growth comes only from investment and risk-taking.

Finally, if Obama really completes the nationalization of healthcare (it’s already partially nationalized through Medicare), then all bets are off. The long-term growth of government will accelerate, and we’ll be looking at a 10 year period of stagnation. Or worse.

But, then again, these are just guesses. I don’t really know for sure. Nobody does. But in the long run, I still believe we have a remarkable, robust system that will bounce back. And given capital flows into the US over the past four months, it appears that the rest of the world agrees with me.

Cheers.

L3

Dec 17, 2008 - 7:29 am 18. Leo Linbeck III:

programmer,

First of all, thanks for all your insightful posts here at the BC. I’ve learned a lot from you.

Second, there does not exist any small group of people who are bright enough to control the economy. The true patriots (and they exist in government) rely upon the collective dedication, hard work, and smarts of the average American to make things work, and do things better.

The real danger I see is people who are smart enough to understand economics, but not humble enough to understand their limitations. Although I have been pleasantly surprised by Obama’s picks for his cabinet (with a few notable exceptions), my fear is that his is too smart for his own good, and not humble enough for our own good. But we’ll see…

The US is not a community in need of an organizer, it is an organism in need of a community.

Enough posting for now. I better get to work.

Cheers.

L3

Dec 17, 2008 - 7:43 am 19. RWE:

I might add that there were other indicators of what was going on:

1. To support its expansion made possible by all that overextended ARM money that went to buy new flat screen TV sets, China was building like crazy. This drove up the cost of materials internationally. A Civil Engineer I know told me a couple of years back they were avoiding the use of steel in new buildings and using concrete instead because the Chinese use had made steel so expensive.

2. Because of 1. above, people were stripping unoccupied buldings of copper and aluminum and selling it. Locally we had homeless guy stealing the aluminum bridge railings. In some northern cities they have had organized gangs stealing the street light poles in broad daylight. Stores no longer dared to stack their empty plastic milk cartons outside because they would be stolen and ground up into plastic powder to be shipped to China.

The popular wisdom is that people went nuts over investment in the stock market and that led to the Great Depression. In reality that is not what happened. But that is very close to what happened this time around, except that it was not primarily stocks but real estate and its attendant trappings.

Dec 17, 2008 - 7:57 am 20. James:

China is aggressively devaluing the Yaun, which is bad news for the US economy – the money is going into US treasuries instead of investment in US industries.

Dec 17, 2008 - 8:00 am 21. bvw:

It’s a theory that as testability goes has nothing more than the audience acclaim for a well-written coherent narrative. Where are those quantitative thingies that Lord Kelvin dottered on about?

When you can measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge of it is of a meager and unsatisfactory kind; it may be the beginning of knowledge, but you have scarcely, in your thoughts, advanced it to the stage of science.

Sir William Thompson, Lord Kelvin (1824-1907)

Dec 17, 2008 - 8:35 am 22. slade:

RE: Lord Kelvin

The mathematics of String Theory have no (testable) basis in reality (yet – maybe after they fix the melted magnets at CERN facility).

So you have measurement with no substrate.

Dec 17, 2008 - 8:57 am 23. bvw:

Perhaps by Lord Kelvin’s measure string theory would not a science. Yet there is a deep wisdom in his comment too — for it refers by similarity of phrase to the proverb “the beginning of knowledge is the fear of G-d”. “Fear of” is not a perfect translation of the Hebrew — some translate it as “Awe of”, but even that is deficient. It refers to making the persona, the self, small, humble, before G-d so as to make room for the perception of G-d — of the concepts and duties G-d would have for us abide by.

Belief, which must be left unmeasured to be belief, is no beginning of knowledge. It rejects knowledge. You have to have some way to measure, to “express in numbers”. Numbers are quantitative thingies that are subject to rules of combination and rules of extraction of value.

In Lord Kelvin’s statement words applied in grammatical order constructing a reasonable narrative are not quite yet science. They may be the beginning of knowledge, but not yet science. Further, by his use of the proverb phrase, he alludes to an uplifting of the sense of the G-d/Spiritual sense beyond the level that mere belief would achieve, that mere reasoned narrative would achieve, by use of a higher form of reasoned expression that applies measurement thingies like numbers, and that he would call this higher form of expression “science”.

At the level of reasoned, coherent narrative, empty belief can enter, sustain and even for some time prosper. This is what Lincoln meant in his saying, “You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time.”

Lord Kelvin wanted dearly to work with reality and not get shanghaied into the Navies of “Believers”. His ticket out of that port of thieves, brigands and liars was that concept thing called Science, being a higher form of reasoned expression that applied number-thingies in testable measurements against actuality. He was so close.

When we apply numbers so as to measure things, we take the ego out of it. Anyone else can make a similar measurement, using similar numbers. A Truth can be discovered without recourse to Authority. By humbly submitting our dear theory, our hard worked upon coherent narrative, onto the the open field altar of numbered measurement sliced into pieces and laid down with the help of explicit process step blades and equational tongs we allow it to be accepted or ignored. Not rejected, really, just ignored. Ignored could mean not up to snuff, or not useful, or something else — who knows. In any case, we made our ego small. We tried to actually verify! That’s a good thing.

And yet, since string theory does apply numbers in algebraic expressions, there is more that just a “beginning of knowledge” in it. It is pretty darn close to Science in that Lord Kelvin meaning.

Dec 17, 2008 - 10:04 am 24. slade:

Leo describes the process train as follows:

Eased underwriting standards drove up home values (money flowing into housing faster than supply expanded); rising home values created phantom equity; phantom equity was converted by consumers into cash through additional debt; consumers spent that cash on stuff made overseas, driving down the value of the dollar and increasing global energy demand; the falling dollar and rising demand drove oil prices into the stratosphere.

… Debt markets seized up; mortgage underwriting standards dramatically tightened; home prices fell as buyers left the market, unable to borrow on the same terms; existing mortgages went “under water”; mortgage equity withdrawals fell to zero (or negative); with no cash to spend, and lots of debt to pay off, demand for goods fell; falling demand led to falling production and the threat of deflation; the threat of global recession and deflation led to a financial flight to quality; the flight to quality led to a dramatic strengthening of the dollar; the strong dollar and falling demand led to plummeting energy prices.

I see the Smart People aren’t going to argue so I guess I’ll have to do it.

First, rising home vales leading to phantom equity that was converted into cash. When this thing first broke into public awareness, we were told it was a problem with sub-prime mortgages (5% of total market), which was subsequently expanded to include so-called alt-a mortgages, bringing the percentage up to 11% of the market. Well that’s not peanuts, but neither is it enough to bring down the world markets – that fast and that long. I’ve never argued against the F/F and Frank et al connection. What I have argued is that it wasn’t enough because the percentage of “contaminated” mortgages was not large enough to have global impact – or even large enough to have the kind of domestic impact we saw in 2008. That’s where the Wall St investment houses took over using complicated vehicles to disguise and distribute risk while the regulatory agencies went into a collective coma.

Second, “debt markets seized up”. This is a critical milestone. Was it all the fault of the consumer as this scenario suggest? What role did short-selling – close to 50% of the investment houses trading volume – have on the credit seizure (which sounds like it should be illegal)? And suspension of the so-called “uptick” rule to contain naked short-selling (which sounds like it should be illegal)? What role did mark-to-market accounting play as real estate with no market seized up institutional credit? The very simple point here is that the Frank-Dodd axis in Congress started the ball rolling, but the investment houses gave it a huge push and sent it out of the ballpark.

Third, to pick up on the point that “yeah, but I still think [conspiracy/collusion/orchestration]“, I have to agree, although I didn’t get to that point until late Nov/early Dec. I can’t draw the road map, but it stinks. I doubt that the events of 2008 were a fully orchestrated, but I equally doubt that the financial opportunities created by the Congressional backdrop were ignored out of a sense of discipline, patriotism, and general good guy sense of duty, honor, and responsibility. The point at which these latter day shenanigans cross over into conspiracy is grey, but cross over they did. In my view. Death by a thousand little pushes.

Lastly, I’m not too keen on reducing the backbone of a free society – the middle class – to cute caricatures like Mr and Mrs Sixpack or Jack and Jill with their willy-nilly materialism and devil may care we’re on the gravy train now. I don’t know these people. Maybe someone else does. The Lord Kelvin quote applies – probably not in the way the poster intended – but the numbers don’t add up unless you include the role of the financial services sector. And the statistics are a little bit improbable unless you include the component of collusion.

Dec 17, 2008 - 10:12 am 25. ctc:

A couple points 1)Japan also increased it’s supply of JGB’s in the 90’s. Their interest rates have remained virtually unchanged since th mid-90’s. There is no reason to beleive that it will be any different here in the near future. Maybe 3-4 years out but not any time soon. 2)As to demand for credit it has virutally disappeared at the consumer level. People have seen their net worth eviscerated while their debt and income remains unchanged. The consumer will attempt to pay down debt, not expand it. In Q3 the consumer paid down about $2.9 trillion worth of debt. Corporate levels of cash on the balance sheet are around record levels.

It was a long-term secular cycle that saw the expansion of credit. It will be a long-term secular cycle that sees the credit expansion reversed.

Dec 17, 2008 - 10:26 am 26. slade:

When we apply numbers so as to measure things, we take the ego out of it. Anyone else can make a similar measurement, using similar numbers. A Truth can be discovered without recourse to Authority. – bvw

As I expect you know, the early stumble in quantum mechanics was the discovery that the observer and the observed form an inseparable unity that defines reality. Truth literally became relative, a hippy phrase that annoys the h^ll out of reputable physicists but there it is. The search for God continues.

Dec 17, 2008 - 10:35 am 27. fred:

Leo at #13

Yes, the federal government is constraining banks from lending the money that Paulson pushed so hard for. I distinctly remember Newt Gingrich saying that unless the mark to market rules are altered or suspended this thing is going to take longer to play out than initially estimated.

Newt’s one smart guy. I knew about the mark to market rules back in the late Eighties when I was in Boston College’s MBA program. During that time I had a class in late 1990 where I had to analyze three major regional bank stocks. I had to make recommendations to investors whether or not these banks were good plays. I went thumbs down on all of them, because I knew that their commercial and residential real estate portfolios were going to be continually written down, imploding bank capital, and making the bank’s public stock go to zero. An Analyst for Shearson Lehman at the time, Catherine Hensel, in HER latest report put up “buys” on all three of them. Well, the rank amateur won that bet.

Dec 17, 2008 - 10:52 am 28. programmer:

The butterfly flits from flower to flower in America.
Wind and lightning stir the skies in Europe, China, Russia.
An old man laughs and tends his garden.

Dec 17, 2008 - 10:58 am 29. dan:

For kicks, L3, would you take a stab at a plausible conspiracy/collusion/orchestration theory? I’m curious. For example, i remember bush going to saudi arabia twice to essentially beg for increase in oil prices – two events that preceded the oil spike, I believe. He was twice-denied. That is only one of the indications of unusual visible oil politics over the last few years. The confluence of dynamics you describe sounds plausible. It’s just difficult to believe that in a world where a cartel of little criminal autocracies control the preponderance of the world’s oil that actors within that cartel had nothing to do with price manipulation. Does that really pass the smell test? But I don’t want to wallow in delusions. I’d just be curious what conspiracy scenario – strategy, really – you might imagine. Or is just impossible?

Dec 17, 2008 - 11:01 am 30. fred:

Leo,

Two things. The first is that my in-house economist where I work (a small investment boutique in Portsmouth, NH)thinks that by late 2009 or early 2010 we will begin to see some light at the end of the tunnel. My guy’s more optimistic than you are, but you make a very good case for your scenario. Ultimately, we’re all trying to make educated guesses.

I think Obama will be constrained from tax increases and nationalizing health care. The revenues are just not there, plus the people on his team are not all dumb. They know what happens when you raise taxes in a recession. I hope he is humble enough to accept their advice. He is a lawyer, after all, and lawyers are perhaps the least humble of all professions (my God, even physicians are more modest in comparison, even though they do more good). Economics and finance, I gather, are serious blind spots in his academic training and life experience. And watching him from afar I honestly do not think he understands most of it.

Second thing. He, his party, and his cabinet are under enormous pressure from powerful people in the U.S. and overseas to slap on the carbon tax regime. I am far more worried about this than I am of Obama having a brain fart and raising taxes. That will most certainly have a dampening effect on any economic recovery, perhaps shaving off 1 to even as high as 3 percent of GDP growth. I’m not sure if he and his people have thought that one through. I keep hearing the mantra of those phantom “green jobs” that are supposed to be “created” under this regime. No one in the investment community that I know of who has a more skeptical mind really believes all that pap. But I think the Obama people really drink that Kool Aid.

Dec 17, 2008 - 11:06 am 31. NahnCee:

Agree with Dan. I think there was manipulation because it was all timed to peak and collapse on a Presidential election cycle timeline. The question then becomes who / what is a big enough player to try to manipulate not just America’s economy but the world’s, to seriously damage America and perhaps to affect the outcome of America’s elections.

(I have to believe who-ever was tinkering didn’t foresee the global impact of an American economic collapse, however. So that’s a big tee-hee to him / them.)

My candidates would be four: China, Saudia Arabia, Soros, and maybe Putin. I don’t know that Russia is rich enough to play — then maybe but not now — nor is Chavez and probably not Iran. You pretty much have to be an oil-source to be a player in this game because Europe, Japan, South America, Australia — none of the other big populaiton centers would be wealthy enough to throw that kind of weight around.

I’m excluding Bill Gates, Queen Elizabeth, Warren Buffet, Oprah Winfrey, et al, because I think they have other hobbies besides world domination and simply lack the time and interest.

Soros would be in it for political gain — the Bond bad guy carrying a white Persian cat and seeking world domination for whatever mad personal reason he may have.

China and Saudia Arabia just because they are America’s enemies and want to hurt us but know they can’t do it mano-a-mano. Check out how many Chinese names are on the Forbes’ billionaires list.

Someone in the comments above mentioned ACORN — ACORN is in the business of ballot-stuffing but I don’t see it as being a fund-raiser. However, it *could* be a money-launderer for overseas donations that flooded into the Obama campaign via the internet, again with the end goal of buying an American President, and thereby affecting American policy.

L3’s analysis is excellent, but it just *feels* like there was more to starting off this natural avalanche than millions of pebbles of personal greed.

Dec 17, 2008 - 11:35 am 32. Staring in Disbelief:

I hate to break it to all you X Files fans but NOBODY is smart enough to manipulate anything like as big and as complex a gig as world oil prices. The timing around the election was just dumb luck for Obama. L3 has graced us with perhaps the most succinct and readable synopsis penned anywhere. Well done, sir, well done indeed!

Dec 17, 2008 - 11:57 am 33. dan:

Staring: maybe so, but OPEC just cut 2.2 million barrels out of oil production in order to change the prices, so OPEC disagrees with you at least to some extent…

Dec 17, 2008 - 12:01 pm 34. fred:

As rich as the Saudis are, I don’t think they could have acted alone, if they were trying to push oil prices and our economy in opposite directions. They’d need help, and my money is on both Putin and Soros.

I’m not a person inclined towards conspiracy theories. Really, I’m not – I tend to run the other way when someone is holding forth about them.

However, the timing of it all was just so fortuitous for the fortunes of the man whose platforms and Red Diaper Baby creds dovetail with their interests. There are two very large international pressures being brought to bear upon the United States:

1. A carbon tax regime to approximate Kyoto (kills our economy and weakens our ability to project economic and military power)

2. The cessation of the strategic ballistic missile defense system.

Obama falls squarely in their camp on these issues. And Putin and Russia were indeed rich enough to have people making the kinds of currency plays via oil futures that Leo talks about. Soros and his people certainly are wealthy enough to play a role in nudging things in a certain direction.

Read this article about what was happening in the hedge funds and oil futures. It will add another piece to the scenario that Leo laid out. It isn’t entirely incompatible with the rational linkages he describes.

http://www.globalresearch.ca/index.php?context=va&aid=9042

Dec 17, 2008 - 12:10 pm 35. Unsk:

Leo- Brilliant analysis-

Though, as good as it is, I don’t think your anaylsis completely explains the collapse.

First, I think ACORN and some key leftist Democrats, many of which ended up at Fannie/Freddie created a lending culture that encouraged abuses above and beyond the initial Community Redevelopment Act nonsense. There were too many scams approved that went way beyond anything that can be justified as a subprime loan. Here is LA, the Foreclosure Capital of America, there was a culture of fraudulent appraisals and practices in the low end of the market that was not nearly as prevalent in the middle and upper class neighborhoods.

Second, construction costs skyrocketed over the last ten years. Replacement cost pushed housing prices too some extent. Ridiculous environmental and planning policies, the demand for oil, the resultant decline of the dollar and the tremendous growth of the world wide economy all had a had in that construction cost increase. Also more than a little gouging as well. Replacement cost as a result is still higher in many areas where demand is still high than would allow housing prices to fall much.

Third, the Demcrats, with their known aversion to oil production, created an opportunity for some market manipulation by the Irans and Russias of the world, and a perception by the market that the US would not allow a rise in the price in oil to increase domestic production, when the Democrats took Congress in 2006. That is not to say that market demand did not have a great deal to the increase in oil.

However, when the Fed started to tighten credit in late 2005, everything else being equal, the price of gold should have fallen. Instead, beginning almost at the same time the Democrats took over Congress in January 2007, both the price of oil and gold started to rise rapidly. And it appeared that the rise in gold was following the rise in the price in oil. The bubble price of oil did not crack until the very week that Bush removed the Presidential ban on offshore oil.

IMHO the Fed was playing a losing game in early 2007, which magnified the housing collapse. The Fed was trying to restore sound money policies to the dollar, when at the same time the Democrats were undermining the Dollar and America’s position in the world with their absurd no drilling policies and their weak policy on the War on Terror and national security.

Dec 17, 2008 - 12:28 pm 36. RWE:

Nahncee: I think you are right. But I think that the Dems had planned a mild panic tiemd to favor them at election time – witness Schumer’s strange remarks about IndyMac – and truly did not realize what a house of cards they themselves had constructed.

The head of ACORN has said it wasn’t THEIR fault – how were they to know that the funny money loans they had pushed would be part of a huge global scam?

Barney the Dinosaur has said much the same thing – sure they should have regulated more closely way back when but they didn’t and so what?

They both have admitted culpability, but it was like something in an Indiana Jones movie – you move one little thing that is part of something that was built up over a long time and then you suddenly find yourself being chased by the world’s largest pet rock. The fact that your own pals ultimately set up the linkage to the rock up is something you probably know full well but don’t advertise.

They have deen this before. South Vietnam, for example. I don’t think that the Dems of the early 70’s really planned to assure a communist takeover. It had not happened in Korea or in Europe despite their best antics, so why would it happen in Vietnam?

Dec 17, 2008 - 12:39 pm 37. dan:

and couldn’t it be a simple conspiracy – i mean, it’s already an oligarchy for god’s sake – to enrich the oil-producing countries?

it doesn’t need to conform to the false collapse of Communism/stealth Communist take-over thesis. i’m just sayin, that quick 300% up and down out of virtually nowhere just smacks of somethin’ slick. i just can’t imagine Khamenei and Ahmedinejad were watching MSNBC one day and looked at each other with complete innocent astonishment as they watched oil prices climb astronomically and idiots began spouting off about “say goodbye to $3 gas forever! europeans will pay $10 a gallon now! aahhhh!”

if nothing else, it’s obvious those people got it way wrong.

anyway i’ll shut up now, but that’s the thing about the false collapse of communism thesis: the timing is way, WAY eery.

Dec 17, 2008 - 12:47 pm 38. fred:

Isn’t it interesting that right about the time of the fall of the Soviet Union the Greens and the AGW began to gain traction? I think the Greens are proxies for a new kind of Marxism that was taking shape, by plan, behind the scenes. Get and read Robert Chandler’s “Shadow World: Resurgent Russia, The Global New Left, and Radical Islam.” Years ago Golitsyn began to talk to our CIA about The Andropov Plan. It seems that Gorbachev, Andropov, and later Putin all think the cultural Marxism of Antonio Gramsci will revive and strengthen worldwide Socialism and that they will best Islam, all the while using Islamic nations as proxies against the West.

The Greens are proxies in this fight against capitalism, the United States, and Western Civilization. Kyoto and its backdoor carbon tax/hard cap and trade regime is one of the ways they will kill us and our civilization. I am convinced of this. Why do you think that despite all solid scientific evidence that the powerful people are ramming the carbon tax regime forward full steam? There is power behind this, not some feckless, stupid rationale.

They will do it despite the fact that more and more people are on to the scam of AGW.

Dec 17, 2008 - 1:30 pm 39. LarryD:

Semi-random thoughts:

Speculation amplified the last part of the oil price run up and the first part of its fall. If the price of oil is going up, then not selling oil now vs selling it later, at a higher price, makes sense. When Bush announced the end of the executive order limiting drilling, the underlying assumptions became questionable. Now speculation is working in reverse, driving the price of oil way down. Giving what that’s doing to certain hostile Governments, Iran, Venezuela, Russia, I’m not crying.

The Democrats are dumb enough to turn this into a 2d Great Depression, some of them are even nostalgic for it. But this isn’t the 1930s, there’s a lot of debt built up, much of it in government at the state and federal levels, a depression could cause the big government they so love to collapse, rather than grow sustainably.

The sun is way late for the 24th sunspot cycle, something like a Dalton Minimum could well be in the cards. Maintaining the belief in AGW could become very hard to do.

China, Europe, and Russia are finding out the hard way that economic woes in the US aren’t just the US’s problem. We’re a big customer, we pull our heads in, they hurt too.

Dec 17, 2008 - 2:19 pm 40. cthulhu:

While their might be room for conspiracies pushing the timing one way or another, I think L3’s main point — though not directly stated — has validity.

Our fate was sealed when they started broadcasting “Flip This House.”

Dec 17, 2008 - 2:41 pm 41. NahnCee:

LOL – cthulhu — what about “greed is good” from Gordon Gekko in 1987?

Dec 17, 2008 - 2:53 pm 42. NahnCee:

I wonder what would be discovered if someone simply took the time to follow back overseas contributions to Obama’s campaign.

And to track the short-selling that went on when Bear Stearns went down.

Or to do an Enron-type audit of Lehman Brothers and who did what when there.

And then published all three of the above findings.

Dec 17, 2008 - 2:58 pm 43. slade:

And then published all three of the above findings. – NahnCee

A “narrative” is being written to provide cover for the “Harvard model” of investor and manager. It is the same protection [racket] provided by federal statute to protect against fraudulent brokers that may/will bail out the Madoff investors. Cynicism is keeping the skepticism alive.

And rightly so.

Dec 17, 2008 - 3:16 pm 44. NahnCee:

Just posted by Instapundit: “OIL PRICES TUMBLE below forty dollars. Just a few months ago, people were projecting high prices into the indefinite future. Remember that as you hear other projections today.”

This is why I think there was something artificial over and above market demand going on when oil prices were speeding upwards last summer. And once that “something” was removed, those prices have precipitously declined, even as market demand surges again as people start driving more.

Dec 17, 2008 - 5:11 pm 45. fred:

NahnCee,

I had made a bet with my wife (and other people)last Spring and Summer. They thought oil would just keep going on up and up and gasoline would blow past $5 a gallon. I said that oil was in a speculative bubble and that it was unlikely that it would go beyond $150 a barrel.

They paid up. Including my wife, who owed me dinner at a restaurant of my choice.

Dec 17, 2008 - 5:45 pm 46. fred:

One last rambling thought for the evening, about energy. I’ve always thought that the way to protect our modern economy from the bad shocks that oil and gas prices can deliver to it, is to diversify. Do it all. Do wind and solar, but know that those will never replace the majority of the grid. Do nuclear power. Drill for more of our oil resources. Produce synfuels from coal. Enact achievable efficiencies by raising the mpg on autos.

If you do it all, you won’t be caught in a bind.

But the Obama administration is going to slam down on fossil fuels, do nothing about nuclear power, and impose the carbon tax regime. They have this crazy notion that wind and solar are going to make up the deficit. What are these people smoking??

Dec 17, 2008 - 5:50 pm 47. Leo Linbeck III:

slade,

Re: your #24

I certainly didn’t mean to create a “cute caricature” of the middle class. And not everyone spent their MEW on plasma TVs and BMWs. A lot of folks used it to pay for college education and to start a business. To be sure, there was both crass materialism and thoughtful investment.

But, in aggregate, we know that MEW rose dramatically at the same time that consumer spending rose – maybe not causation, but certainly correlation. MEW increased disposable income, and the consumer disposed of it – very little went into savings, which is not a surprise (why borrow money to put it in the bank at a lower interest rate?).

I guess the central point was that lax underwriting standards allowed a huge amount of borrowing that led to rising home prices. A lot of this was good (people can live in a bigger, better house for the same money), but a lot of this was unsustainable based upon the income of the borrower. To be sure, this overleverage was enabled by Wall Street and mortgage brokers, but it takes two to tango.

The question you raise about Alt-As being only 11% of the market is an interesting one. The fact that it is not 50-90% of the market doesn’t really change the analysis materially. After all, a very small percentage of a company’s stock is traded each day, but we mark the entire company to market. So what we’re talking here about marginal impacts.

If I can borrow $100,000 to buy a house with $25,000 down, I can pay $125,000. If that’s the same as everyone else, the market value of that house will be $125,000. But if some guy comes along who can borrow $150,000 with an Alt-A and a teaser rate and no money down, the market value of that house rises to $150,000. After 2 or 3 houses in a neighborhood sell at that premium, appraisers will increase the appraised value of all houses. This process creates “phantom equity”; the fact that the Alt-A guys default when their rate resets doesn’t change the fact I was able to do a MEW on my new-found “wealth.”

The problem is that when the home prices fall to a sustainable level (determined, say, using the Schiller index), I’ve now borrowed more than my home is worth. For most people, they will simply suck it up and keep paying the debt. Default rates are still relatively low on conventional mortgages.

But then I get a one-two punch: I can’t borrow anymore to finance new consumption (left jab) and I now have more debt I have to service, lowering my disposable income (right hook). The result is a really fast fall in consumption, which is 70% of GDP. This inevitably leads to recession.

Now, as far as the “debt markets seizing up,” there is no doubt that you’re right here: the consumer is not to blame. In fact, consumers have stayed put, since their deposits are insured by the FDIC; the panic was a panic of the pros. But some of the issues you raise – short selling, uptick, etc. – are really equity market issues. The debt market seized up for four reasons, as far as I can tell:

1. Asset quality deteriorated rapidly, which decimated bank balance sheets. With less equity due to the write-downs, banks couldn’t lend money and stay within their prescribed capital ratios. The reason for the deterioration can pretty much be traced back to residential real estate, and lax underwriting standards driven by CRA and other such “social lending.”

2. Uncertainty about bank asset quality shut down interbank lending. Banks are huge lenders to each other, and this interbank market is the main mechanism for balancing supply and demand of loans and deposits. Once this stopped, banks were left with unbalanced loan/deposit books, and couldn’t lend. The bankruptcy of Lehman and the takeover of AIG exacerbated this.

3. Investment banks were acting like commercial banks, but with a lot more leverage. The Lehman Brothers of the world were acting like banks, holding assets on their balance sheet, but with leverage ratios that were 20:1 or 30:1, instead of 10:1. And the assets they kept were garbage, so they had no design margin. Assets didn’t have to fall far to wipe them out.

4. General fear. The flight to quality caused all assets that were not backed by the full faith and credit of the United States Government to fall in value. Credit spreads widened, and buyers left the market altogether. This is not rational necessarily, but neither are most stampedes. They can still trample you, however, so it may be rational after all…

Finally, there was certainly room for conspiracy/collusion/orchestration. But it seems more likely – to me, anyway – that it was a classic bubble.

Anyway, thx for the comments and criticisms.

Cheers.

L3

Dec 17, 2008 - 6:17 pm 48. Leo Linbeck III:

bvw,

You’re correct, of course. To paraphrase Monty Python, “It’s only a theory.”

But since a good theory should have predictive power, one test could be this: if the change in exchange rates really does account for half of the change in oil prices, then once things settle back down again, and capital flows back out of the US in search of better returns, we should see a rise in oil prices.

Cheers.

L3

Dec 17, 2008 - 6:32 pm 49. Ash:

17. Leo Linbeck III:

“The big unknown in all this is what the Obama administration will do. If they really pump $1 trillion into the economy through public projects, you can add another 6-12 months to these dates. The reason is two-fold:

1. This will increase the supply of US Treasuries, since this money will have to be borrowed.”

The flaw in this Leo, and the ensuing analysis is that the money does NOT have to be borrowed. The Fed. can simply write the checks and not borrow to cover. They do not have to “balance” the books at the end of the day/year/whatever.

24. slade:

“The point at which these latter day shenanigans cross over into conspiracy is grey, but cross over they did. In my view. Death by a thousand little pushes”

Slade, take a look at the history of crashes and illustrate for us where blatant market manipulation led to the crash? The closest historical reference I can think of is when the Hunts tried to corner the silver market but that didn’t lead to a general crash that I know of. My knowledge of history is indeed limited but if you can point to historical antecedents it would be helpful…or are you suggesting this crash is unique?

Dec 17, 2008 - 6:52 pm 50. NahnCee:

Ash – it’s unique in that if it were helped along or started by outside factors and plots, it’s a new form of terrorism: fiscal terrorism. Not just a crash.

Part of a crash is panic. The end goal of terrorism is also panic. So this time they blew up Wall Street internally, rather than running airplanes into skyscrapers.

Dec 17, 2008 - 7:05 pm 51. Ash:

“if” Nahncee, you need more than “if”. It seems much more likely that the cause is similar to all its historical antecedents. In fact the evidence suggests this is the case. Barring that you need some pretty good evidence to support the claim that it is all ‘the terrorists fault’.

Dec 17, 2008 - 7:08 pm 52. Ash:

please pardon my mangled english…

The historical precedents are similar. You need provide convincing evidence it is all the terrorists fault.

Dec 17, 2008 - 7:10 pm 53. Ash:

Osama Bin Laden, I’m sure, is having a very satisfied laugh at what he set in motion and, like you, claiming it is all ‘the terrorists fault’.

Dec 17, 2008 - 7:12 pm 54. slade:

Leo,

I will have to digest your comments, but a “classic bubble” doesn’t reach 50% deep into equity markets (more like 20% to 35% based on last five recessions), doesn’t freeze up credit to the extent that a $700B TARP is required, doesn’t burst with the sanguine help of regulatory agencies (SEC, F/F oversight) that don’t regulate, and doesn’t require a “comprehensive” stimulus package filled with new green jobs and politically sensitive policy initiatives. And this is the first one to go global. Call it a bubble but it is far from classic.

Dec 17, 2008 - 8:36 pm 55. Charles:

The best money spent by the incoming administration will be on energy and water projects.

Dec 17, 2008 - 9:54 pm 56. Leo Linbeck III:

Ash,

The flaw in this Leo, and the ensuing analysis is that the money does NOT have to be borrowed. The Fed. can simply write the checks and not borrow to cover. They do not have to “balance” the books at the end of the day/year/whatever.

Not sure I agree.

Scenario 1: Treasury sells $1T worth of debt
In this scenario, the debt is repaid with tax proceeds. This means that the cost of the expenditures is borne by taxpayers. Since 67% of taxes are paid by the top 20% of income earners, this means that the costs are borne directly by the high-income taxpayers. The catch is that these folks would have invested these dollars more efficiently than the Federal Government, so economic growth slows down, since it is driven by productivity growth which is driven by investment.

Scenario 2: The Fed inflates the currency
In this scenario, the cost is spread across the entire asset base of the economy. Assets that generate fixed cash flows (e.g. fixed-rate debt and unindexed pensions) are penalized, and assets that generate variable cash flow (e.g. real estate and equities) are rewarded. Interest rates rise, because lenders have to be repaid with future money that is worth less than current money. This slows economic growth and penalizes wage earners because wage increases generally lag price increases, and wage inflation pushes workers into higher tax brackets.

So, in both cases, the net effect is the same, although the distribution of costs is somewhat different. The $1T is paid by the private sector, and it decreases productivity growth, and therefore job creation and income growth.

Another way to put it, although it’s a bit oversimplified, is that the first scenario hurts wealth creators, the second hurts wealth preservers.

Sorry, there is no free lunch. Someone always has to pay. The only question is who.

Cheers.

L3

Dec 17, 2008 - 9:58 pm 57. Leo Linbeck III:

slade,

The Internet bubble saw the Nasdaq fall from 5048 on 10 March 2000 to 1119 on 7 October 2003. This is a drop of about 78%. Even today, Nasdaq is only at 1579.

The breadth of the current housing market, and its reliance on debt financing, help account for the size and breadth of its impact. The closest thing to it in recent memory is the Japanese property bubble of 1986-1990. The Nikkei hit almost 39,000 on 29 December 1989. The Nikkei is now at about 9,000 (it fell below 8,000 in November). This is a drop of about 77%. And it was accompanied by a brutal credit crunch.

And then there were the British South Sea bubble, the Dutch Tulip bubble, etc. They were not only locally devastating, but had geopolitical impacts.

This is not to say that our glorious leaders didn’t help create the problem. I agree with you – they sure as hell did.

But that’s pretty classic too.

Cheers.

L3

Dec 17, 2008 - 10:29 pm 58. fred:

Leo,

The housing market has always relied on debt financing. My Dad’s first mortgage was in 1960 on a “fixer-upper” and cost a little over $8K. He put 20% down on a FHA loan. In 1975, when my parents moved to New Hampshire (I was in the Army then)they got about $35K for the house and paid off the mortgage. My Dad’s mortgage was roughly the equivalent of 1/4 of his TAKE HOME PAY. When they moved they only had to borrow very little and that mortgage was paid off in ten years. Everyone I know who has bought a home had to get financing. I sure did. But my wife and I put down 20% in 1999 for our first house. We bought a home that was about $20K under what we were pre-qualified for. We did this intentionally. I know plenty of people who were similarly sensible.

The problems come in when people pay too much for a home and put nothing down on it, and use variable rate financing. And there’s been plenty of that. My wife and I rented for 11 years. We saved a down payment. It was not easy, because during our first two and a half years of marriage I was in graduate school. I worked part time while she worked full time. She had a good job as an occupational therapist. And then I graduated right smack dab in the middle of a bad regional recession (in New England in 1991 was a BAD time)and it took awhile for me to find a job. Those were not easy times. Anyway, I’ve rambled a bit but my larger point is that both of us grew up learning to DELAY GRATIFICATION. If one is disciplined and smart, eventually you will realize your goals.

Too many people want their first house to be a McMansion and they want that first house right when they get married in their early or mid twenties. Instead of saving for at least a few years. They never think about the fact that in times when one or the other is laid off or some other calamity happens it may be difficult to pay that big monthly mortgage payment. Then that McMansion becomes a millstone around their necks.

Dec 17, 2008 - 10:53 pm 59. Dave:

Here in Las Vegas, the need/demand for new homes peaked at an (optimistic) 25,000 units per year. Yet for a period of two years,
between 35,000 and 40,000 units were built.
I imagine over 40,000 when nearby areas like Pahrump and Mesquite were thrown in.

Now it say here that too much supply and not enough demand means falling prices. Yet, Vegas prices more than doubled. The reason was simply because earmarked credit expanded even faster than the oversupply. But then the borrowers ran out of money with which to pay all those too-easy-to-get mortages.

Result was defaults, illiquidity, and all the rest. Then prices nescessarily cascaded downwards so that a good 80 to 90% of price gains have been erased. Very little of the debt has disappeared though so we are still in the doldrums.

This is the classic bubble L3 mentioned. No more, no less.

While real estate plummeted, gold zoomed up so that, for a while, a Double Eagle was equal in price to a Peacemaker. This could not be put down to “inflation”. Fewer people had the loose change with which to buy gold; there was no real change in the “money supply”. And sure enough, shortly thereafter
gold fell to its normal level of 80% of the 1873 Colt. A speculative runup if rather obvious.

Then oil ran up to $150 a barrel. I’ve little doubt that this price increase was enhanced by Putin, Chavez, Ahmedinejad, et al.
These worthies are all up to expensive shennanigans and greatly enhanced cash flow is the only way they can pay even their immediate bills.

And again, the bubble burst, oil headed south. I thought the market price would hover in the $80 to $90 a barrel range. But instead it kept falling to $60 and then the bottom dropped out.

Just like the spike was enhanced, so is the fall. And the fall can be maintained for a longer period of time than the spike. When high prices hit, buyers look for how to use less. At low prices buyers are not too concerned with conservation.

Who stands to gain from low prices? The US, the industrialized West, India, China, and the Saudis and some of their friends. Only fly in this ointment is the danger of bankruptcies in the domestic oil bidness.

Who stands to lose? The bad guys. The trick that worked for Reagan-Bush looks like it is working for Bush-Cheney. Obama gets a free ride. Hope he appreciates it.

Dec 17, 2008 - 11:31 pm 60. programmer:

I have oft lamented that I skipped economics courses in college for other pursuits that have, in the long term, perhaps provided less benefit. Reading the commenters here at BC is a cram course in practical economics. What a deal!

Dec 18, 2008 - 6:54 am 61. slade:

Leo -

The DJIA dropped 30% during the Dot.com bubble. The breadth of the current bubble impact – as opposed to confinement within an specific industry sector as per the dot.com episode – leads me to believe that institutional dysfunction – regulatory, financial, and political – played a larger role than historically.

What I fear with this classic-or-not argument is that blame will be disproportionately assinged to the “evil” middle class over-consumers rather than reform banking, finance, and congressional oversight institutions. Already Blagoyevitch has a possible out, what will happen to Madoff is anyone’s guess, Rangell is still in Congress, the TARP took care of Wall Street banking, which is another subject I know but putting it out there to indicate that every player, except the middle class is getting compensation or dispensation. And now the end conclusion of this class-or-not argument is the middle class did it to themselves. As I said above, crash with a thousand little pushes.

But I feel like I’m now stuck in a bad Quentin Tarantino movie describing my dish of crow as classic or burnt to le crisp.

Dec 18, 2008 - 8:43 am 62. slade:

And that’s why past bubbles have real names like tulips and dot.com.

There were no tulip police involved and those early investors who shunned the flower sector were not impacted.

Dec 18, 2008 - 8:50 am 63. peterike:

@Fred: I’ve rambled a bit but my larger point is that both of us grew up learning to DELAY GRATIFICATION.

Spot on. The fact that huge masses of the American public can in no way delay gratification is a source of many, many problems.

@Programmer: I have oft lamented that I skipped economics courses in college for other pursuits that have, in the long term, perhaps provided less benefit.

Agreed. Whatever I know about Eco I learned on my own. The larger tragedy is that the population at large understands next to nothing about economics, which makes them fall for all kinds of political snake oil. I bet if you took a poll, you’d find 30-40% of the populace, at least, thinks in some way that Bush was responsible for the oil price spike. They don’t have the slightest clue about supply and demand. Gas just comes out of a pump. For goodness sake, Nancy Pelosi didn’t even know natural gas is a fossil fuel.

Well that isn’t really economics, is it? The problem is more of a noxious brew. Americans at large don’t understand economics, basic science, the nature of the US government or history. That mix turns them into a pack of suckers for every scam from Global Warming to “stimulus spending.”

Dec 18, 2008 - 8:56 am 64. slade:

And for the record, my casual reading was sufficient to keep me out of tech stocks. Not one dime did I invest in sector-specific tech – there may have been some marginal nibbling at the edges through a mutual fund but no direct investment. The nakedness of the dotcom bubble makes this episode look like Einstein behind the curtain.

God have mercy if the American people are as stupid as this board thinks. Stupid enough to recognize that the Republican Party had disappeared in all but name. Stupid enough to go with the lesser of two evils. Stupid enough to think that regulators were serious about watching our backs. Stupid enough to think that Congress had or has any real regard for the middle class who will continue to pay while the rich remain rich and out of jail and the poor go back to being poor and out of sight.

Dec 18, 2008 - 9:17 am 65. ash:

Leo,

Your fundamental argument appears to be that any increase in government spending will retard the recovery process. Is this a correct assessment of your view?

Dec 18, 2008 - 9:37 am 66. ash:

Slade wrote:

“What I fear with this classic-or-not argument is that blame will be disproportionately assinged to the “evil” middle class over-consumers rather than reform banking, finance, and congressional oversight institutions.”

I fully agree with you on the need for reform – better regulation and increased transparency are a must and the ideological push to deregulate in the belief that freer markets are more efficient and thus fairer is a canard. Ponzi schemes flourish in unregulated opaque markets. There is also the ‘mistake’ that Greenspan and many others made (which he now admits). That mistake being the belief that organizations act like individuals driven to self preservation, or in Greenspan’s words “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” Nope, each organization is populated by individuals motivated by their interests and self-preservation, not the firms.

Add to that the ‘madness of crowds’ and you’ve got the mess we’re in. Is it a classic bubble? There are plenty of historical crashes to study but the go-go 1920’s followed by the depression of the 30’s does seem to have similarities to our current state. Leo’s prescription, however, seems to mirror that of what they did then – tighten money supply. Now they are printing up a storm and it’ll be interesting to see what happens as it filters through the system. The money that vaporized should mitigate some of the inflationary effects of the printing but it’ll be interesting to see what else occurs. I’d like to figure out how to get some of that newly minted stuff in my pocket…

Dec 18, 2008 - 9:59 am 67. What’s Happening Here? « Arroyo Seco Real Estate:

[...] Posted by leowalker on December 19, 2008 The whole world, I’ll just bet, thinks about the economy every day.

Dec 18, 2008 - 5:18 pm 68. Derek:

Slade: It may not be a classic bubble as you define it.

I think that it is the perfect storm, meaning that multiple failures compound, which is your point.

There was a housing bubble, a commodity bubble (copper is 1/2 what it was a year ago), which generated large revenues for governments creating bloated governments, there was the classic Keynesian overstimulation by the US borrowing the interest on it’s debt, and throw in reduced flexibility due to regulation, and we have a real problem.

Then throw in a generation of people who essentially have run the place all retiring, replaced by inexperienced and overqualified youth who will make the same mistakes their elders did but all at once.

And to mess it up even more, most western nations are facing crises of entitlements, where they need 4-5% growth in the economy to keep ahead.

I’m more pessimistic. 18 months, 2 years before it stops going down. Then a long stagnation. There are going to be cascading failures. Auto and housing are first, being big ticket finance driven. We will see a very large number of bankruptcies in the new year. Leveraged buyouts have stopped firms from failing; they were bought when weak. No leveraging to be had anymore, so firms will go under. I’m watching our customers with a gimlet eye, and expect some to disappear. Next is pension liabilities that will kill, already happening. Without returns, the regulators will force already cash strapped corps to pony up cash to top up their pension liabilities. Oops.

Then with severely reduced revenues, governments will be forced to do something. They will do something foolish, probably borrow or print money to create an inflationary cycle to reduce debt ratios. Or raise taxes. Count on stupidity, which will extend the mess another while.

We will see a number of countries default, and a larger number forced to devalue or cut costs because they can’t borrow. That may include the US if they intend to keep borrowing their way out of this mess.

Conspiracies require intelligence.

Derek

Dec 18, 2008 - 9:07 pm 69. jj mollo:

Here is a nice graphic of the financial crisis. IMO there is more to the housing bubble than subprime. Most of the really wasted investment is in the McMansions built in exurbs, farther and farther from the centers of business, particularly in California. The length of the commute was offset by more and more comfortable, but inefficient cars. At some point, with rising oil prices, however, the camel’s back gets broken. Gas prices pushed people just a little too far. The result is that housing was seen as less valuable, which started a vicious downward spiral, finally exposing the sins committed at the low end of the housing market. By then the lost value in housing was putting pressure on overextended mortgage debt. Exurbia was depopulating and fuel demand was falling.

Dec 18, 2008 - 11:12 pm 70. gdude:

jjm – my thought, too, as I would drive 100 miles across L.A.

slade #64: ah, my boy, you’ve never tasted the thrill of waking up in the morning and seeing your $30,000 become $130,000, literally OVERNIGHT. Man, those were the days!

Anyway, while all the talk of suspect timing for the latest bubble is fun, L3 is right: most all of this is just the confluence of normal market movements — like rogue waves on the ocean. For a bit of perspective on how normal all these markets have been behaving, do some reading on Elliott Waves. Then read the classic book about the behind the scenes of the markets, Reminisces of a Stock Operator.

Dec 19, 2008 - 12:12 am 71. Unsk:

Leo, Ash,gdude:

While in many ways the current financial collapse in a classic bubble, it is more than a bubble. It was bubble pushed to collapse by a long term attack on the ethical and moral institutions and the political, financial, regulatory, legal and judicial systems by the Democrats, the left and the Islamists.

What this discussion should be about is what is the cure; the solution to this mess? To solve this mess, one must first have a correct diagnosis.

So to describe this financial collapse as a ” confluence of normal market movements” ignores the the political and financial chicanery behind much of this. Market corrections are generally the process in which the markets correct and punishes bad policies and practices. This collapse just didn’t happen out of thin air. There were causes. Multiple causes.

The apparent approach of the Obama Administration is to throw a huge fiscal and monetary stimulus package at this recession to bring the market back to where it was before the collapse so all will be well. But this approach ignores the causes in the first place. The Obama dare not search for causes because they know full well, many within the new administration will be tarred with responsibility once the full truth is known.

Dec 19, 2008 - 11:09 am 72. Leo Linbeck III:

ash,

Your fundamental argument appears to be that any increase in government spending will retard the recovery process. Is this a correct assessment of your view?

Not quite, but close. A “recovery” is, by definition, a resumption of economic growth. Economic growth is driven by productivity growth. Productivity growth is driven by investment, primarily in equipment (physical capital) and education (human capital). The best way to measure the effectiveness of investment is to measure its risk-adjusted net present value (NPV).

The Federal Government, because it is a monopoly with a monopoly’s incentive structure and agency problem, generates a lower NPV (with rare exception) than private investors. If you increase federal spending, you either have to increase taxes or inflate the currency (government debt is simply capitalizing future taxes or inflation). Either way, you transfer money from the private sector to the Federal Government. This lowers the NPV of that money, which lowers productivity growth, which lowers economic growth, which retards the recovery.

There are certain situations where this might not be true. For instance, if you taxed private luxury consumption and the Treasury invested the proceeds in the stock market, you might help the recovery. And there are also true public goods where private parties would underinvest because they do not capture all of the returns. Unfortunately, most politicians don’t really understand what a public good is; they think a public good is anything the government funds, when in fact a public good is a good which has a very low marginal cost and a very high cost of exclusion. In reality, though, there are very, very few of these (national defense being the most prominent).

But, with I can state with near certainty that increasing marginal income tax rates or selling $1T of government bonds to pay for “investment” will most definitely retard the recovery. Using Federal Government spending to aid an economic recovery is a fool’s game.

Unfortunately, Washington seems to be a fool magnet.

Cheers.

L3

Dec 19, 2008 - 8:22 pm

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