Andy
Well-Known Member
- Joined
- Jan 6, 2008
- Messages
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This question was asked by Lagboltz, and I thought it worth having it's own thread since the other fell into flame pit mode.
The answer is multi-fold.
First, is our economy in free fall? I contend no, that only the stock market is in free fall. Remember stock prices are largely based on perception, not the real out put of the economy.
Look at this graph.
What this graph is demonstrating is that prior to WWII, down spikes in our economy of 2.5% to 7.5% negative growth, happened frequently, with some over 10% negative growth. (I count 12 times)
Today our economy, in the 3rd quarter '08, we are at 0.25% negative growth. This does not seem like a free fall to me.
Second, the principals of Capitalism, do not exclude individual failure. For example, Chi-Chi's restaurants all closed in 2004 after it's owner filed for bankruptcy several times. People simply didn't want the product sold, and this the business failed.
Although this is an individual failure, it's a success of Capitalism. Failure is a necessary part of Capitalism. Without it, bad companies producing bad or unwanted products, are kept in business.
With that said, let's look at the cause of the wide spread failure we see.
What caused the sub-prime loan melt down?
In 1995, the Community Reinvestment Act (CRA), was changed in order help the goal of equality in home ownership among minorities and the poor. Further, the government department of HUD, had taken control of Fannie Mae and Freddie Mac prior, and had set a goal for Low Income loans.
Between these two dynamics, the government legitimized the sup-prime market, and made it grow. With Fannie and Freddie purchasing sub-prime loans, banks could make the loans even to the least qualified, without worry since the risk of default would be passed on to the government sponsored corporations. Further, the CRA provided incentives to banks in the form of credits for low income loans.
This creation of the market, spawned more sub-prime loans via the appearance the market was sounds. If everyone is offering sub-prime loans, then obviously they are safe. Thus more private mortgage brokers and companies not regulated by CRA, nor working with Fannie and Freddie, were willing to offer these now legitimized loans.
So with sub-prime loans, the situation was setup by government through regulation and government controlled companies. In other words, socialism.
So what is causing the stock market melt down?
The stock market melt down is caused by a change in general accounting practices. Some may, or may not know, that general accounting practices, the way in which companies do their budgets and manage their money, is instituted by the Federal Government through the SEC, which authorized the Financial Accounting Standards Board (FASB) who manage generally accepted accounting principles. This is a necessary evil.
However, changing these standards on a whim can cause massive effects in the market.
The problem goes all the way back to Enron. The Enron scandal covered many things, but largely centered around the fabrication of a profit, by using contracts that were over-valued, making it look like there was profit on paper, while losing money in real terms.
Now, the general conservative view is, the system worked, the fraud was detected, the criminals put on trial, and the issue resolved. The general liberal view is, the system failed because there was a problem. A working system means the absence of all problems. (laughable to me since, socialized systems have the worst problems, and no system with humans will ever be problem free)
Thus, pressure was placed to change the rules so the issue would never happen again. (still laughable) The result was a change in the general account practices called "Mark-to-Market".
Mark-to-Market, is a system by which contracts and other assets are "Mark"ed, on the budget, at the "Market" value they have at the time, regardless of their long-term, or total value.
Example: You have a home worth $250K, and on your budget, you could mark that $250K asset (home), as part of your net worth. But say a hurricane was coming. How much would someone be willing to pay you for that house before the storm hit? Not much. Maybe $100K. If you did a budget, your net value would fall by $150K because the "Market" value of the home is now $100K and you must "Mark" it on your budget as that. Even though after the storm blows over, it will still be worth $250K.
Similarly, say you are a company and hold Insurance contracts in Florida. Those contracts might be worth $500 Million, but if a hurricane starts toward FL, their market value might be worth very little. This would show on the companies budget as a "loss".
Or a current day example. Say you owned a bunch of sub-prime loan securities. Let's say all of them are paying on time, and are in good standing. Even if the loans are fine, and they are all paying reliably, because the contracts are not selling on the market (as in no one is interested in buying sub-prime loan securities right now), they would be horribly undervalued.
What this means is, all these companies are reporting losses of value on their budgets, that actually are not "real". They are not actually losing money, they are losing the projected value of these assets. But that doesn't help in the stock market, because like I said before, perception rules the stock market.
Bottom line, knee-jerk reactions to Enron led directly to the stock market fall we're seeing right now.
If anyone still doesn't understand, just ask, I'll explain in more detail.
Our economy is now in free fall. Why do you say free-market capitalism never loses? Please, don't interprete this to mean I prefer Socialism. I don't.
I just want to know why you think that.
The answer is multi-fold.
First, is our economy in free fall? I contend no, that only the stock market is in free fall. Remember stock prices are largely based on perception, not the real out put of the economy.
Look at this graph.
What this graph is demonstrating is that prior to WWII, down spikes in our economy of 2.5% to 7.5% negative growth, happened frequently, with some over 10% negative growth. (I count 12 times)
Today our economy, in the 3rd quarter '08, we are at 0.25% negative growth. This does not seem like a free fall to me.
Second, the principals of Capitalism, do not exclude individual failure. For example, Chi-Chi's restaurants all closed in 2004 after it's owner filed for bankruptcy several times. People simply didn't want the product sold, and this the business failed.
Although this is an individual failure, it's a success of Capitalism. Failure is a necessary part of Capitalism. Without it, bad companies producing bad or unwanted products, are kept in business.
With that said, let's look at the cause of the wide spread failure we see.
What caused the sub-prime loan melt down?
In 1995, the Community Reinvestment Act (CRA), was changed in order help the goal of equality in home ownership among minorities and the poor. Further, the government department of HUD, had taken control of Fannie Mae and Freddie Mac prior, and had set a goal for Low Income loans.
Between these two dynamics, the government legitimized the sup-prime market, and made it grow. With Fannie and Freddie purchasing sub-prime loans, banks could make the loans even to the least qualified, without worry since the risk of default would be passed on to the government sponsored corporations. Further, the CRA provided incentives to banks in the form of credits for low income loans.
This creation of the market, spawned more sub-prime loans via the appearance the market was sounds. If everyone is offering sub-prime loans, then obviously they are safe. Thus more private mortgage brokers and companies not regulated by CRA, nor working with Fannie and Freddie, were willing to offer these now legitimized loans.
So with sub-prime loans, the situation was setup by government through regulation and government controlled companies. In other words, socialism.
So what is causing the stock market melt down?
The stock market melt down is caused by a change in general accounting practices. Some may, or may not know, that general accounting practices, the way in which companies do their budgets and manage their money, is instituted by the Federal Government through the SEC, which authorized the Financial Accounting Standards Board (FASB) who manage generally accepted accounting principles. This is a necessary evil.
However, changing these standards on a whim can cause massive effects in the market.
The problem goes all the way back to Enron. The Enron scandal covered many things, but largely centered around the fabrication of a profit, by using contracts that were over-valued, making it look like there was profit on paper, while losing money in real terms.
Now, the general conservative view is, the system worked, the fraud was detected, the criminals put on trial, and the issue resolved. The general liberal view is, the system failed because there was a problem. A working system means the absence of all problems. (laughable to me since, socialized systems have the worst problems, and no system with humans will ever be problem free)
Thus, pressure was placed to change the rules so the issue would never happen again. (still laughable) The result was a change in the general account practices called "Mark-to-Market".
Mark-to-Market, is a system by which contracts and other assets are "Mark"ed, on the budget, at the "Market" value they have at the time, regardless of their long-term, or total value.
Example: You have a home worth $250K, and on your budget, you could mark that $250K asset (home), as part of your net worth. But say a hurricane was coming. How much would someone be willing to pay you for that house before the storm hit? Not much. Maybe $100K. If you did a budget, your net value would fall by $150K because the "Market" value of the home is now $100K and you must "Mark" it on your budget as that. Even though after the storm blows over, it will still be worth $250K.
Similarly, say you are a company and hold Insurance contracts in Florida. Those contracts might be worth $500 Million, but if a hurricane starts toward FL, their market value might be worth very little. This would show on the companies budget as a "loss".
Or a current day example. Say you owned a bunch of sub-prime loan securities. Let's say all of them are paying on time, and are in good standing. Even if the loans are fine, and they are all paying reliably, because the contracts are not selling on the market (as in no one is interested in buying sub-prime loan securities right now), they would be horribly undervalued.
What this means is, all these companies are reporting losses of value on their budgets, that actually are not "real". They are not actually losing money, they are losing the projected value of these assets. But that doesn't help in the stock market, because like I said before, perception rules the stock market.
Bottom line, knee-jerk reactions to Enron led directly to the stock market fall we're seeing right now.
If anyone still doesn't understand, just ask, I'll explain in more detail.