flwyd: (mathnet - to cogitate and to solve)
[livejournal.com profile] mackys asks
What is a reasonable estimate for the ACTUAL value of the mortgage-backed "junk" securities that $810 billion of my tax dollars bought?
The answer to that question has fluctuated every few days recently, so note that everything I say could be wrong soon.

First, a timeline.
  1. US Financial System: OMG! We paid way too much for all these mortgages and nobody wants to buy them from us! O noes!
  2. US Treasury Secretary: You guys are too big to fail. I'll save you!
  3. Lehman Brothers: Save us, Henry!
  4. US Treasury Secretary: Wait, not you, Lehman.
  5. Lehman Brothers: <is dead>
  6. US Financial System: OMG! Did you see what just happened to Lehman, guys?!? I'm not going to give you any of the money I don't have in case you're the next Lehman.
  7. US Treasury Secretary: Ruh roh.
  8. US Treasury Secretary: I has a 3-page plan; let me show you it! Let me offer you a $700 billion "bailout" by buying all your "toxic waste." No oversight, no accountability. Sounds great, huh fellas?
  9. US Taxpayers: WTF?!? You're bailing out a bunch of bankers by buying toxic waste?
  10. Karl Rove: What happened to the Bush administrations public relations team after I left? That's the worst sales job ever.
  11. Senate Banking Chairman: Hey, I've got an 8-page better idea. The government should buy shares in banks. They'll get a liquidity injection and the government will make money when the banks do.
  12. US Financial System: <flail wildly>
  13. John McCain: In my many years in Warshington, I've fought wasteful government spending. And as president... Wait. For the next two days, I don't want to be president. I need to rush off to help the government hastily approve $700 billion in spending.
  14. Political Pundits: You're not a maverick. You're a loony.
  15. US President, US Treasury Secretary, Federal Reserve Chairman, Speaker of the House, Committee Heads, Attention Whores Presidential Candidates: Buying $700 billion of toxic assets sounds great. Here's a 100-page proposal.
  16. House Representatives in Tight Races: O noes! Our constituents found our phone numbers! Halp! I want to get reelected, screw this bailout.
  17. US Financial System: Well shiiiiiit.
  18. Emergency Conference Meeting: You know what people think is tasty? Bacon. Let's add 350 pages of pork.
  19. Somebody In The Meeting: *psst* Let's slip the stock purchase option back in there.
  20. US Senate: Tastes great, we're willing!
  21. US House of Representatives: Okay, I guess...
  22. Financial Commentators: So... the government is going to invent a price for a bunch of stuff which has no market value because nobody wants to buy it.
  23. Economists (some): Something must be done. This is something, therefore, it must be done.
  24. Economists (others): This is a terrible idea.
  25. Economists (still others): This might work, but I've got a better idea.
  26. US Financial System: I'm going to drink heavily for a week and then turn on MTV and the radio at the same time.
  27. US Treasury Secretary: I know I said there might not be an economy by Monday, but I'll need five weeks and some Wall Street executives on staff before I can do anything.
  28. Germany: Scheise! Now our banks are in trouble. Immediate action! Your money is safe in German banks!
  29. Europeans: Hey, now we have to guarantee our banks!
  30. Economists: Hey... that sock purchase plan is in the bailout plan. Let's try that.
  31. United Kingdom: Bollocks! Now our banks are in trouble. Immediate action! We'll take major shares in you chaps. kthxbai.
  32. World Financial System: Whoa... I think I'm still drunk.
  33. World's Major Central Banks: All together now: lower interest rates! That usually works!
  34. World Financial System: Crap! I mean Great! I mean... maybe?
  35. Iceland: We're melting! And not just because of global warming.
  36. US Treasury Secretary: World leader huddle!
  37. World Financial Leaders: Okay... we're not making progress running straight into the line. Let's run the option.
  38. US Treasury Secretary: But I hate the option. My fans always boo.
  39. World Financial Leaders: Henry... you can run the option or you can lose the game.
  40. US Treasury Secretary: Fine! I'll run the stupid option.
  41. World Financial Leaders: Okay, everybody. I know we've all trumpeted the wonders of the free market system for years. But the free market is having trouble, so we need to save it. Our plan is often called "nationalization." We're going to become part owners of major banks so they'll have money they can use to lube the wheels of the economy.
  42. Financial Commentators: Wow. The best option is socialism.
  43. John McCain: I'm gonna go ahead and NOT mention that in my campaign.
  44. US Financial System: Well... okay... I guess. But I won't move until everybody else moves too.
  45. US Treasury Secretary: Dear diary... the last month has sucked ass. But I think we're going somewhere.
So... what's the value of what taxpayers are buying? Like most questions in finance, the answer is "That depends on the future market." What are the pieces?

Henry Paulson (Secretary of the Treasury) wanted to solve the problem by spending $700 billion to buy mortgage-backed assets. (Essentially, that's a bunch of assets tossed in a pile. Except then somebody pulled pieces out of each mortgage and stuck them into other piles. It's like everybody in a neighborhood having spaghetti, but each noodle is really long and is on everybody's plate.) What would the value of these assets be? In some approaches to value, something is worth exactly what someone else is willing to pay. So in a sense, we'd be buying $700 billion of mortgage assets because we're willing to pay $700 billion. But then they'd be immediately worth much less because nobody else wants to pay $700 billion for them. In fact, nobody wants to pay much of anything for them. Part of the problem is that, under mark-to-market accounting rules, if nobody wants to buy a bank's piles of mortgages, banks can't pretend they have a bunch of money instead. And if they can't pretend they have a bunch of money, they have problems doing their normal bank activities like borrowing and lending money.

Under other approaches to value, the piles of mortgages are worth significantly more than nothing. Some percentage of the people who mortgaged their homes are making monthly payments, so the piles of mortgages are earning income. But investors don't think they can make a good guess about how many people will keep paying their mortgages, so they aren't willing to gamble on invest in them. If the U.S. government owned them, they wouldn't have to worry as much about accounting rules. The government would get the money that homeowners pay each month, meaning they'd have some real value. After a few years, once the economy settled down and investors felt like buying stuff again, the government would sell the piles of mortgages back and recover some of the taxpayer's money. In the mean time, the federal government would be the country's biggest landlord and end up owning a bunch of houses. I'll come back into that in a bit.

The main problem with the Paulson plan (aside from the world's worst marketing job) is that it put the government in the role of a really dumb investor. One of the main goals of the "OMG, save the banking system!" plans is to inject liquidity (i.e., money that's easy to spend) into financial system. If the government drove a hard bargain (what a private investor would do), they'd get a bunch of really cheap mortgages (great for the budget when the market improves later!), but banks wouldn't get much money they could spend. If they paid enough to get the money flowing (what a government would do), they'd probably end up losing a bunch of money in the end. The government has some smart people working out some rules for a reverse auction The federal government is good at losing money (call it an Investment Portfolio to Nowhere), but a lot of economists looked into the proposal and thought it wasn't very good.

Finally, Paulson bit the bullet and followed the European lead to the government buying major shares in banks. Some key things to note:
  • The government gets "preferred stock." That means that the government gets company profits (from dividends or sale of assets in case of a collapse) before normal shareholders.
  • The Treasury has said, on their honor, that they won't use the shares to influence the decisions of the bank.
  • This provides an immediate infusion of liquid cash (technically it's electronic, which is kind of like liquid... there's electrons flowing through wire instead of water flowing through pipes...)
  • Nobody has to make up a price for the piles of mortgages. The government's buying shares which currently have a market value.
  • If the banks get better, the government makes money when they sell the shares.
  • If the banks fail, the government gets a chunk of their assets.
  • This guy thinks there are some devilish details the banks can twist to connive with the sudden infusion of taxpayer money. (He lists "rotisserie baseball" as an interest. I hope that doesn't involve hitting a chicken with a stick.) Listen to the Planet Money podcast for his points. (As usual, Adam Davidson does a better job than I do at explaining this stuff.)
  • I think Treasury is still planning to buy "toxic assets," but their total available cash for toxic waste and bank stock is around $350 billion and the latter will take about $200 billion.
So what's the real value of the mortgage-backed securities taxpayers are buying? Hard to say. But we aren't spending $700 billion on them. What's the value of the bank stock we're spending $200 billion on? Hard to say, but if things get better the value should be more than $200 billion. The bankers don't really like the stock plan, but their collective overvaluing of the market got us into this mess, so tough cookies.

A caricature of the Soviet economic system is that everybody gets an identical place to live (owned by the government) and gives most of their money to the State. America, these caricaturists say, is better because we let each person decide what house to buy with their own money. But in the end, everybody ended up buying a house that looked just like all the other houses in their subdivision. And under the Paulson plan, the government would've owned a bunch of them and everybody would've paid their mortgages to the State. Under socialism, government men start with a plan to exploit their fellow men. Under capitalism, it just ends up that way.

Part of me thinks it would be really interesting for the government to own a whole bunch of suburban real estate. They could embark on projects to create local centers of employment and commerce, reducing the distance people would have to drive and thereby reducing dependence on foreign oil. They could turn vacant McMansions (in Denver lingo "Prairie Palaces") into housing cooperatives. The other part of me thinks housing cooperatives and local community development must grow bottom-up to have a chance of success. The federal government is good at doing big things like running national parks. A half-dozen hippies are good at doing small things like organizing a house inhabited by a half-dozen hippies. But I think there's a chance that the anonymous sprawl suburbs will become the new ghettos while former industrial buildings (aka lofts) become the hip expensive places to live. Centennial will be a really swank ghetto, but it'll still be a ghetto. Maybe we'll be listening to rap songs entitled "Straight Outa Rancho Cucamonga."

I've come to understand some interesting things about macroeconomics in the last few years, but hard-core capitalism still bothers me. At its root, it's a bunch of people doing stuff in exchange for imaginary pieces of paper. The main advantages of money are that you can do math with it and it can be exchanged multiple times. If you give me $10, I can later give the $10 to somebody else. Or I can divide it in half and give $5 to two people. But money isn't the only thing that can be exchanged. Much of the time, it stands in for time, effort, or information. If I give you an afternoon of my time and energy moving all your stuff from one apartment to another, you can't necessarily give that afternoon to somebody else. If you and I have sex for ten minutes, it has no (necessary) impact on your ability to have sex with somebody else for ten minutes... or two other people for five minutes. If I tell you a funny story and you want to tell it to two other people, there's no need to tell each only half the story.

Money is a tool to enable zero-sum games. But a very effective path to success is for multiple individuals to team up and play a game that's not zero-sum. Maybe that's why society gets so skittish about prostitution: it tries to mix a zero-sum game (paying money) with a non-zero-sum game (two people helping each other have an orgasm).

Remember that investing is essentially gambling with two important differences: Nobody's quite sure what the odds are and the house doesn't always win in the long run. When you invest money, you might get more of it back or you might get less of it back. When you invest time (hanging out with friends, playing games, having sex, relaxing in the sun on the porch) you know that hour of time won't come back, but you also know it won't suddenly turn into just half an hour. Remember that money isn't the only thing in the world worth exchanging with another person.

So that's all the economics questions I was asked on my original post. If I didn't bore you to tears and you didn't learn what you want to know from Planet Money, ask more questions!
flwyd: (mathnet - to cogitate and to solve)
[livejournal.com profile] slyviolet asks
For those of us with relatively insignificant (in comparison... obviously not insignificant to ME) bank holdings, no credit debt to speak of, no large loans outstanding and no stocks/bonds/other things of that nature, what will the practical personal fallout of the bailout be, if any?
The correct answer to that question requires predicting the future. Economists spend a lot of time predicting the future. But there's a lot of variation between economists' predictions, so you can often pick the prediction you like best and pretend that's what the future holds. "What will happen?" is not nearly as clear as "What could happen?"

First, what won't happen is losing the money in your bank account. The FDIC and NCUA just raised their insurance amount from $100,000 to $250,000. That means that even if your bank or credit union collapses because their loans all fail, you'll keep all your money (checking accounts, saving accounts, money market accounts, etc.) up to a quarter million dollars. So you don't have any reason to withdraw all your cash and stuff it under your mattress.

The key part of the current financial crisis is a halt in lending. Investors have been very reluctant to lend money to businesses and other banks. A lot of companies run on debt—retail stores often don't turn a profit until Christmas season so they borrow money during the rest of the year—and if they can't get loans they may have to fold. I haven't heard of a sudden rash of collapsing companies outside the financial sector. The government has taken a fairly active role in trying to stabilize things and if a lot of companies were suddenly about to collapse for lack of credit, the Federal Reserve would probably step in (which it did a week or so ago when it announced it would buy commercial paper). This is therefore probably a low risk right now, but it wouldn't hurt to check in with anybody you're receiving a regular paycheck from and ask what the company's financial situation is.

I think a bigger risk to companies is a weak Christmas sales season. I heard one time that "If Christmas were canceled one year, the whole American economy would collapse." A lot of people have reduced spending recently due to all the media attention on economic collapse. (Would you buy an iPod after the Secretary of the Treasury says "If we don't pass this bill, we might not have an economy by Monday?") If a lot of retailers collapse due to week holiday spending, you'd probably have some friends that were out of work, you might not be able to buy some of the stuff you want, and so forth. It would be a big sign of wide-spread economic hard times, a recession/depression hitting most Americans. I don't suspect this Christmas Crash scenario will happen, though. September of 2001 also featured a sudden change in market atmosphere and public worry about the future, but January 2002 didn't feature a major collapse of the retail sector (though it was a rough season).

If you're considering taking out a loan soon (to buy a car or a house or start a business or something) you may find it hard to get credit at a reasonable interest rate since lenders are reassessing who they ought to give money to. Depending what options in the bailout plan get activated and what new mortgage-relevant laws get passed, the housing market could go in several directions. If the government takes steps (changing mortgage terms or extra cash or whatever) to help current owners keep homes then I wouldn't expect a big change from the current housing situation, though home prices may continue to fall. If a lot of mortgage holders can't keep their properties, things may get exciting. If you rent a house, or condo (etc.) and the owner can't pay the mortgage, it'll go into foreclosure. If it's bought and the new owner wants to move in, you'll need to find a place to go. On the plus side, if you can afford it there may be some reasonably-priced foreclosures you could buy in such a situation.

Tied to the general economic situation (and not particularly to the bank bailout), commodities prices have fallen recently. Oil was trading around $90 a barrel this week, down from over $140 this summer. You've probably noticed gas prices are down; some of this is seasonal, but some is due to commodities traders selling in the face of uncertain financial future. (I keep typing "commodoties." When their prices go down, it's a nice whirlpool effect.) Food may also get cheaper.

Another thing that could happen: Your parents might get worried about their retirement savings and call you for advice. I spent around an hour explaining recent financial news to my mom last week. I advised her not to withdraw a bunch of money because she wouldn't have a chance to earn back what she's lost in the market. Calls from parents will give you the opportunity to reflect on things that ups and downs of financial markets can't take away: having conversations with people you like. Also: going for walks/hikes/bike rides, lying around in the sun, and socializing over board, card, and role playing games. Anybody want to play Monopoly?

Longer term effects: As the presidential debate moderators have mentioned, the next president will probably need to scale back some of his proposed projects in light of the state of the economy and the fact that $700 billion may be tied up in chunks of mortgages. So if you're hoping for particular proposals to come into effect next year, you might need to brace for disappointment. But really, that's sound advice for any political campaign. On the flip side, if there's a government program you're not fond of, 2009 might be a good time to organize a campaign to defund it. Like, say... "Hey, we've just spent $700 billion on a bank bailout. How about we don't spend another $700 billion on Iraq?"

As things ripple throughout the world, foreign economies may be rather volatile. It might be a great time to go to Europe if the Dollar regains significant ground against the Euro. It sounds like Iceland could use some cash... It's possible that countries who weren't closely tied into the scene become (relatively) better off -- maybe South America will be the place to be instead of China. But unless you're planning on international travel or business, changes in foreign markets won't have a direct effect on you and indirect effects are largely speculation at this point.

Further listening: This American Life: Another Frightening Show About The Economy. NPR: Planet Money podcast and blog. Adam Davidson from NPR (who's also the main guy in the This American Life economy shows) is the best business/economy reporter I've heard. I also like Steve Evans, the sometimes host of Business Daily on the BBC. He has a very engaging interview style
flwyd: (mathnet - to cogitate and to solve)
[livejournal.com profile] dr_tectonic asks
If I were informed about the situation at more than a casual level, are there actions I could take that would have a substantial impact on my current or future well-being? (I have some retirement funds, they're all TIAA/CREF and not easily accessible to do anything with them, and I'm not really planning on trying to do anything with them for another three decades.)

My current assumption is that the answer is "no", and that this is a situation, much like 9/11, where more information has at best a marginal benefit, and could do significant (emotional) harm by making me all upset about something I really can't affect, and so, like the dangers posed by nearby supernovae, asteroid impacts, random spree killers, rampaging sewer alligators, and the like, it's really best to just ignore it for the most part.
Short Answer:

I think "no" is the correct answer. Retirement plans are kind of like trees: make sure it's planted in a place that will, in general, get the right amount of light and water and then don't worry about it. If you start panicking about a drought and try to micro-manage your tree's growth (like digging it up and moving it to the other side of your house), you've got a good chance of doing more harm than good. Periodically check on your trees to make sure they're growing the way you want, but don't do so when you're panicked. Humans often make good short-term decisions when we panic (like "Oh no, house on fire, grab the cat and run!"), but we rarely make good long-term decisions in a state of panic.

So don't make any rash decisions, but make sure your investment portfolio is aligned with your investment goals, is diversified, and has low management fees.

Long Answer:

If TIAA/CREF works like my 401(k) plan, you've got a dozen or two mutual funds you can distribute a portion of your paycheck to. You can also log on and move money from one fund to another. Broadly, there are three types of funds based on what they invest in: stocks, bonds, and income. You don't know which particular stocks, bonds, or income investments are currently held by a mutual fund, but the prospectus of the fund will often provide a focus like "We will invest about 75% in technology stocks."

Stocks are small bits of ownership in a company, traded on a stock exchange. Stocks are the most volatile of these types of investment. They have the potential to increase value quickly, but they can also drop like a rock. (The Dow Jones Industrial Average, an index of a certain segment of the New York Stock Exchange, dropped to almost 8000 yesterday compared to its high above 14000 last July).

Bonds are less risky. Companies and governments borrow money in exchange for a promise to pay it back at interest over a period of time, typically several years. These aren't likely to suddenly drop half their value like stocks, but they also won't suddenly double in value. A specific bond will be worth nothing if the issuing company goes broke and can't pay it back. The value of a bond fund will drop if there are lots of people who want to buy bonds, driving down the interest rates.

Income investments are generally short-term loans at small interest rates. For instance, the commercial paper market lets companies borrow $1 million to cover payroll. They'll pay it back the next day for $1 million plus $10,000 (1% interest) the next day after they've processed sales.

In the case of retirement funds, like TIAA/CREF and 401(k) plans, paying attention to the current value of your investments is rarely a good idea. Since you and I aren't planning on doing anything with the money in those accounts for 30 years, we've got plenty of time for them to earn back the losses they've made this year and much more. The Dow Jones is the lowest it's been since we invaded Iraq in 2003, but it's still 10 times what it was 30 years ago. So your retirement plan is probably worth less today than it was a year ago. But in another year or five it'll probably be worth quite a bit more than it was a year ago and it will probably get back to that point faster if your money is in high-growth funds (stocks) rather than safer funds.

I've heard that the best approach to take to a retirement fund is to check on it every year or two and make sure you still like the risk/reward situation you're in. As you get close to retirement, you probably want to reduce risk (shifting from stocks into bonds and income funds) so that a big crash on your 65th birthday doesn't take out half your savings. But in your 30s, you can take a big loss and still end up in good shape.

If you'd had perfect foresight, you could have moved your high-growth investments at their peak (perhaps the middle of last year) into something safer (bonds or income) and then switch back once the stocks hit the bottom, assuming you can guess when that is. However, the current financial situation is largely a "credit crisis," meaning banks and investors are very reticent to lend money right now, since they don't trust it will be paid back. This fear is so pronounced that commercial paper trading stopped cold until the Federal Reserve stepped in. If banks are unwilling to lend each other money over night because they think there's a significant chance of failure, I'm not sure any investment is particularly good.

Also note that in addition to gains and losses due to the market, you're charged a significant fee. If the share price of the fund increases slightly, you can actually lose money if there's a large fee associated. If the share price decreases, you'll lose even more money. It can therefore be wise to invest in an index fund (the S&P 500, say) with a 0.1% expense ratio than in a fund with a 1.5% expense. In the latter case, you're hoping the fund managers are good enough to do significantly better than the S&P (which isn't always easy). If you've currently got high-fee mutual funds, now might be a good time to consider moving them to a lower-fee fund with similar risk and potential for growth.

If you have stock in specific companies (rather than through mutual funds), this would be a great time to look into their financial situation. If you're worried the company won't survive the current financial crisis, you might want to sell that stock. If you think it'll make it out, you probably should hold it until the price goes up after investors regain confidence in the market.

Further reading: Is My Money Safe? from the New York Times via TheMoneyMeltdown.com. Gotcha Capitalism, a book about hidden fees by Bob Sullivan.
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