Nationalizing Failure

I am not so sure that "financial crisis" is as real or as bad the media and the government wants us to believe. Sure, there is a problem. But, let's just consider the fact that yesterday's Dow dropped 778 points. That sounds just terrible, doesn't it? But wait! When it comes to a PERCENTAGE drop in the Dow yesterday isn't even in the top ten! I don't remember Katie Couric mentioning that fact last night!

I don't know about you, but with every day that passes I'm starting to doubt that this crisis is as dire as they say it is.

The proper answer here is to let private institutions that make bad decisions fail. No government bailout. The only one mitigating factor in favor of intervention might be the Congress' involvement in the Community Reinvestment Act and support for various community groups who used those laws to browbeat private institutions into making bad loans.

The plain fact of the matter is that the Federal Government is in the process of nationalizing failure. Under the ideals being tossed around on Capitol Hill profits would belong to private businesses and losses would belong to the taxpayers.

Advice

The company I work for leases office space in a building. We share some "common-areas" with some other tenants. An older guy who works for one of the other tenants as a "gopher," is a great guy. He is very friendly and personable but I don't think he is quite "all there."

Anyway, when we pass in the hallway and exchange pleasantries, he keeps calling me "Rick." So, do I correct him and tell him my real name? If so, how do I do it without embarrassing him?

The "Common Sense" Fix to the Economy

Dave Ramsey has written a three point proposal for getting cash back into the market at a fraction of the cost of the bail-out.

The proposal is one page with bullet points. It makes a lot of sense.

STOCKS PLUMMET!!!!

The media goes into hysteria as the stock market drops after the House votes to NOT bailout the banking industry.

WHAT A SHOCKER!!!

It only makes sense that the stock market would drop. See, the stock market it just an indicator of how confident people are in the economy. The fact that we were talking about a bailout show that there is a problem. Why would people be confident? The only thing keeping it from happening it earlier was the hope that the government would resurrect the banking industry. Although why people would be anymore confident when the government 's finger is in the middle is beyond me.

So, people LOST confidence in the economy a couple of weeks ago. The market didn't show that loss because of a pending government bailout. When the bailout didn't happen, the people were able to act on the confidence they lost weeks ago.

It will be important to note that the stock market didn't crash today because government failed to act. It failed TODAY because the government promised to act weeks ago. The promise of "doing something" only delayed what should have happened...

Let's see how many pundits point that out. (I wouldn't hold my breath if I were you).

Is the Economic Bailout Wise?

While preparing announcement and scripture slides for church tomorrow, I ran across a scripture slide I made a while back. It made me smile thinking about Congress' current plan to help the economy. My main view is that a bailout is short-sighted; it will fix the problem here today, but will cause many more problems in the future. Man that sounds an awful lot like this scripture:

Proverbs 11:15

Everyman's Guide to the Financial Crisis

I've been trying to really wrap my mind around the so-called "Financial Crisis." I am confused because I don't see a crisis. Nobody I know at church, work, or family seem to be affected by the "crisis." Sure, prices on gas and groceries are higher, but most people are just cutting back or making small changes in their lifestyle. So, I'm not sure what the crisis is.

However, even smart, economic people seem to think that there is a crisis. So, even though I don't see it, I need to understand it because my children and I look like we will be paying for "the solution." Here is my very poor attempt to distill the complicated problem into a simple explanation that can be understood by "everyman."

How banks work
To understand the problem, we need to first understand how banks work. Banks make a profit by loaning money. The funny things is that they don't loan their own money, they loan our money. We deposit our money in a bank to keep it safe for us. The bank then turns around and gives it to someone else in order to make money for itself. Banks can legally extend considerably more credit than they have cash. Still, most of us have total trust in the bank's ability to protect our money and give it to us when we ask for it.

Think back to Jimmy Stewart in "It's a Wonderful Life." There is a scene where there is a "run on the bank." A "run on the bank" is a panic that occurs when a large number of customers of a bank withdraw their deposits because they fear the bank is about to fail. So, all of the people who have deposited their money with George Bailey are clamoring for their money back. George tries to explain that he doesn't have their money, that it is tied up in other people's homes. He says,

"No, but you... you... you're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house...And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why,you're lending them the money to build, and then, they're going to pay it back to you as best they can."

George ends up using his own money to give his customers the cash they want and saves his bank.

The Bank's Cash Reserve
So, banks make money by making loans. The amount of money a bank can lend is set by the Federal Reserve. This money that the bank is not allowed to lend is called the reserve (the reserve requirement is currently 3 percent to 10 percent of a bank's total deposits). This reserve is used to pay-out when bank customers need to use their money.

How The Mortgage Loan Industry Works
So, this crisis has its roots in the "sub-prime" mortgage industry. Basically, it used to be that to get a loan from a bank to buy a house it took a 20% down payment, several years at the same job, a great credit score, etc... These are all hard things to get. Saving up 20% of the purchase price takes fiscal discipline over a sustained period of time. It showed banks that you were a responsible and disciplined individual who could be trusted.

As you can well imagine, these requirements were a barrier to home-ownership. It was hard to get in a position to be eligible for a loan. Home-ownership is one of the primary means of building wealth. The government thought it would be good to help people achieve home ownership so that people could build long-term wealth. They, therefore, set up some programs with lower hurdles to jump.

One can now get FHA loans, VA loans, and other loan programs that do not require the same standards of fiscal discipline. I actually have an FHA loan and was able to get a mortgage with a pitiful 3% down-payment. The banks are willing to give people without a proven track record of financial discipline a loan because these types of loans are insured by the Federal government. If I fail to pay my mortgage, then the bank knows that the Federal government will pay-off the loan. The bank will not lose its money so it loans the money to people that are more likely to default on the loan.

In an effort to loan even more money, banks created new type of loan known as "sub prime" loans. These are loans that are made to people that do not meet Fannie Mae or Freddie Mac guidelines. Reasons for this might include credit status of the borrower (they have declared bankruptcy in the past, are consistently late on credit card payments, etc...), income and job history, and income to mortgage payment ratio (FHA guideline don't allow for the mortgage payment to be more than 38% of your income). So, now banks are loaning money to people who are at a much higher risk of defaulting.

Reselling Loans
Now, this where the banks began to be "greedy"¹. Most banks and mortgage brokers DO NOT HOLD the loans they make. Once the loan is made is to an individual, the bank will then sell loan to another bank or investment firm. So, say the bank gives you a loan for $250,000 for 30 years at 6.5%. Over the next 30 years you will pay a total of $568,000: $250,000 (principle) and $318,000 in interest (i.e., that is the bank's profit). Well, a bank doesn't want to wait 30 years to get thier profit. So, they will sell the loan to someone else for $350,000. The bank gets an immediate $100,000 in profit and the investment firm is happy with $218,000 in profit (after 30 years).

Of course, the bank doesn't just sell one mortgage to the investment firm. Instead, they will package 100 mortgages that they originated all together and sell those to the investment firm. The investment firm doesn't look at the risk associated with each individual loan the bank originated, but a the package at whole. Some unscrupulous banks and mortgage brokers (knowing they would resell loan and not be liable for the risk) gave loans to people they knew could not repay the loan. These unscrupulous lenders would then misrepresent the risk of the package to the investment firm by mixing the package with both low-risk and high-risk loans.

The Housing Bubble
Easy access to home loans led to lots of people wanting to buy homes. At first, homes for sale were scarce and there were lots of demand for homes. Due to the "supply and demand" principle, home prices began to rise. Lenders became even more free with their approving of loans because they felt that the risk was mitigated. Their thought was that if the mortgage holder defaulted, then the equity in the house due to the rising house prices would offset the costs of the foreclosure. People didn't care about having homes that were too expensive because they thought that if they got into trouble, they would just sell the home for a profit.

Of course, as home prices rose, contractors and home builders had more incentives to build more houses. A wave of home building took place. This increased the supply of homes for sale leveled off the price of homes. Now, homes are not increasing in value. There are now more homes for sale than there are buyers...and the price of the house is falling.

The built-in risk mitigation method from the bank and the plan of the loanee are gone. The home-owner can't afford the rising payments and he can't sell the house. He is going to lose money. The bank forecloses on the home, but they can't sell it for what the loan value is. They are losing money instead of creating it. Investment firms and other banks have wised up to the misrepresented packages and don't want to buy mortgages from other banks.

Putting it all together
Remember that $100,000 in immediate profit that the bank received when they sold your mortgage to another bank/investment firm. Well, that $100,000 becomes part of the cash reserve. What happens when investment firms and banks STOP buying mortgages or are unable to sell mortgages? Well, if they can't resell the mortgage, then they quickly reach their federally mandated cash reserve. Since they have to keep so much money in reserve, and they can't sell their loans...they can't give out anymore loans. Remember banks make money by making loans. If they can't make loans, they can't make money. They can't pay their employees. They can't pay their utility bills. They can't return their customers money when the customer calls for it because they don't have any. Its tied up in "Joe's house."

The banks that have been sold are those that could no longer manage to keep enough cash reserves to meet their own obligations.

The problem will trickle down to us everyday folks soon. See, people looking for loans for business opportunities can't get loans right now. The inability for banks to make loans or sell loans is FREEZING the economy.

See most business make by "leveraging" other people's money. This just a fancy term that means, a business will borrow a set of money to produce a product that will sell for more than what they borrowed. For example, let's say that I have a product that will make me $1,000,000. However, to produce the product it costs $200,000. Well, I don't have $200,000. So I go get a loan and "leverage" other people's money to make my $800,000 (yeah, I have to pay back the loan).

This is how many big companies do business. They don't have the cash on hand to produce new products for us to buy. They get a business loan. Since banks can't make loans, businesses can't make products. A steady demand for the products with a limited supply will cause those products to raise prices. So, we will shortly see even more stuff becoming more expensive. The more expensive, the less people buy. The less people buy, the less profits for companies.

People's incomes will not be going up (people may actually be laid off as their companies can't afford to pay them). Higher prices, same wages or lower wages. If more and more companies can't pay their people, more mortgage loans will default. As more loans default, there will be less incentive for banks and investment firms to buy mortgages...and you can see the downward cycle...

Conclusion
So, the government's plan is to "grease" the wheels of the economy by buying the bad loans. This will give the banks and investment firms the cash reserves they need to be able loan money and keep our economies wheels moving.

I still don't agree with the solution, but at least it makes more sense to me now.

¹ I don't like the term "greedy" because it is so hard to really define. I know it is one of the "seven deadly sins." I think it just is bantered about too much and is very subjective.

Discipline is a Dirty Word

Discipline.

Nobody likes discipline. In our postmodern world we have shunned the concept of disciplining. Discipline is about boundaries. The postmodernist, though, sees rules as antiquated ideas used by those in power to control. To the postmodernist, there is no absolute truth, so there can be no boundaries.

Therefore, we don't practice self-discipline, indulging ourselves in whatever we fancy. We don't discipline our children for fear of hurting their little self-esteems. We live for the present, not caring about future consequences, under some illusion that because there are no boundaries, there are no consequences. After all, how can you have a consequence for crossing that which does not exist?

Our current "crisis" in the mortgage and financial sector are a result of a lack of discipline. Not fearing a consequence of their actions, they made irresponsible decisions. Now, with looming "bail-out," Congress is poised to ensure that they don't feel the consequences of their actions. They won't learn a thing!

The Hebrews writer reminds us that, "No discipline seems pleasant at the time, but painful. Later on, however, it produces a harvest of righteousness and peace for those who have been trained by it." (Hebrews 12:11). Yes, it would be bad for everybody if these companies were allowed to fold. It might even bring on a Depression. BUT...that is just the disciplining process. The end result of that happening, though, is that people and corporations will learn to be responsible. They will learn to be self-disciplined.

We are at a crossroads of philosophy. Do we listen to Timon's "Hakuna Matata" philosophy have "no worries" about how our present day actions will affect the future? Or, do we realize that the best way to teach people that a stove is hot is to let them get burned?

Inspired by John Stossel's column, "What happened to Market Discipline."

Ron Paul explains the Economic Mess

Here is an editorial by Ron Paul on the bailout. While I personally like Ron Paul's philosophy an and views, I find that so many of of his other supporters are just whacko. Anyway, it looks like he has economic problem well analyzed. Here are some quotes:

Laws passed by Congress such as the Community Reinvestment Act required banks to make loans to previously underserved segments of their communities, thus forcing banks to lend to people who normally would be rejected as bad credit risks.

...

The government doesn't like this [the fact that the market correcting itself producers winners and losers], however, and undertakes measures to keep prices artificially inflated. This was why the Great Depression was as long and drawn out in this country as it was.

...

Using trillions of dollars of taxpayer money to purchase illusory short-term security, the government is actually ensuring even greater instability in the financial system in the long term.

...

The solution to the problem is to end government meddling in the market. Government intervention leads to distortions in the market, and government reacts to each distortion by enacting new laws and regulations, which create their own distortions, and so on ad infinitum.

It is time this process is put to an end. But the government cannot just sit back idly and let the bust occur. It must actively roll back stifling laws and regulations...

Bailout Expanded

The Washington Times is reporting that the bank bailout is being expanded to include student loans, car loans, and credit card debt.

This makes me so ANGRY. The government wants to take my money and give it to rich people who already have shown they are irresponsible with money.

I don't begin to think I understand the "economic" problem. However, I do know that the "bailout" money is going to banks and investment firms who are run by people paid really, really large sums of money to be profitable.

I also know that the government has NO money of its own. The only way for the government to get money to do things is to take that money by force from individuals¹.

Our government is already in debt for over 9.7 trillion dollars. So, the only way for the government to give money to these banks and investment firms is to either pay with cash (which they don't have) or take out even more debt (which will have to be paid back in the future: so tax increases for me and my children).

I think as a taxpayer I am getting taken advantage of. I guarantee you that if Student Loans and Credit Card debt is added to the bail out, I will still cut two monthly check to Sallie Mae, a monthly check to DirectLoan and a check to Discover. In exchange for increased taxes in the future, I GET NOTHING!

Meanwhile, some Suit who made poor business choices gets to wipe his company's slate clean and start making TONS of money again.

So, here is my solution. If the government wants to bail someone out. Let them bail me out. If they wiped out my student loan and credit card debt, that would free up about 12% of my monthly budget. If they also "bail-out" my mortgage, then 32% of my budget would no longer be pre-set. Wow!!! If sending me $600 helps stimulate the economy, what could I do to stimulate the economy if I had over 30% of my budget free to invest and buy consumer goods EACH MONTH!!! Of course, I don't need a bail out because I am making all my payments.

Who needs to bail out the companies, who don't pay taxes when you can bail out the individuals who do pay taxes?

If the government does bail out the companies, then I want them to seize the assets of the companies and sell them off to subsidize some of the "bail out". Why should the American people get the raw end of this deal? Obviously the people running the companies are inept, so why should they be rewarded?


¹Corporations don't pay taxes. All taxes "paid" by a corporation are really only taxes that the company has collected from individuals and passed on to the government. Corporations pass the taxes they owe to individuals through higher prices paid on products or they may not pay their individual employees as much. They may also not pay as much of a dividend to the shareholders (individuals) Trust me, in the mind of a corporation, taxes are a business expense and are somehow passed on to the individual. The company's profits are not affected by the tax code.

Who caused the "Mortgage Crisis?"

As banks fall all around us and our financial markets take a beating, the media is pointing the finger at "greedy" capitalists.

However, are they really to blame?

Neal Boortz makes a compelling case that it we aren't being told "The Rest of the Story."

In his editorial, Neal recounts that 20 years ago or so the "BIG NEWS STORY" was that minorities and the poor could not get home loans. The media would run story after story showing where RACISM had prevented a minority from getting a loan, excluding the facts that the person seeking the loan had no money saved, no consistent job history, and a large pile of consumer credit card debt.

Congress told lenders that if they didn't shape up and find a way to get mortgages to these people, then congress would start regulating the industry even more. SO...the mortgage companies did find a way to give loans to people who weren't necessarily qualified. They developed a product called the "sub-prime" mortgage.

So. Who caused the mortgage crisis? Was it the "greedy" companies or was it an overzealous government? Or, was it a combination of both?

Book Survey: I Timothy

Erin and I are attending the Sunday School class on 1 Timothy this quarter. When I am a teacher, I hate it when people come to class unprepared. People want to have discussions in class about the subject matter, but how can I, as a teacher, facilitate a discussion when I am the only person who has taken the time to study the subject? That's one of the reasons most of classes are more "lecture" style than "discussion." I've studied the subject. I've become the expert.

Anyway, the teacher of the 1 Timothy class is a discussion teacher, so I am studying 1 Timothy so that I can contribute in a positive manner. I am using the methods that I taught to do the study. So, when studying a book, the first thing to do is the Book Survey method. Here is my Book Survey study of 1 Timothy.

Recent Scripture Slides

I've only created two new scripture slides recently.

Genesis 1:2

Hebrews 2:10