lack of leadership

One thing was very apparent yesterday: there is a total lack of leadership in Washington. The president is a lame duck, the speaker of the house preferred to engage in partisan politics at the worst possible time, and neither one of the presidential candidates lifted a finger to avert the crisis. One was hiding for fear of being blamed, while the other went on lecturing about the excesses of the past.

As a result $1.2 trillion in equity disappeared over a span of six hours. That is a lot more money than the proposed $700 billion bail-out plan so hotly debated.

What is happening you may ask? 

First, the country is angry. People, who once gladly participated in spending money they did not have, are now faced with foreclosure, job losses, high food and gas prices, and endless bills. In many cases, the situation is entirely of their own doing, but they want someone else to blame. And what better candidates than the rich bankers and CEO's on Wall Street?

Second, the country does not understand. Their anger blinds them. They have an aversion towards taxes, preferring to get things for free and not have to pay the bill. Their representatives are too busy blaming the other party to explain to their constituents what is really happening and the news media are making things worse by proclaiming the crisis too complex to understand. It is not.

Third, everyone in Washington is too busy trying to figure out how they will benefit from this mess. How they can most efficiently blame it on the other guy. For many that means, how they can get back at the White House for all the pain and frustration it has dealt them over the past eight years. Bipartisanship disappeared under Bush and now that it is needed it is nowhere to be found.

Lastly, those very same politicians are afraid of their own seats. The more unsure they are about re-election, the more likely they were to vote no on the rescue package. Rather than doing the hard thing and trying to explain to their constituents what is wrong, they prefer the easy way of "teaching those greedy bankers a lesson."

The solution is extremely simple folks. The $700 billion is, as one journalist called it, the most expensive psychotherapy ever. It is all about confidence. People need to trust one another and they need to feel confident that the US will stand behind its financial system. If that confidence fails, nobody will be willing to lend money and the economy will come to a standstill -which will be good for the environment by the way, so why complain?-.

Once people lose confidence and trust, things can quickly unravel. Very quickly and very profoundly. A Great Depression II is not out of the question. I don't buy the WSJ argument that the wealth of doomsayers will prevent another GD scenario. While it is true that most disasters happen when people least expect it, some disasters do happen even when they stare you in the face.

and miles to go before i sleep

If you think the crisis is over, think again. The worst is yet to come. I don't want to sound like an alarmist, but it should be obvious to everyone now that this is true. There is simply no other way. Even if the Fed can restore normal lending in the weeks to come, the fallout from what went before, and what is underway is still to hit. The lag could be as long as six months to one year.

Banks have failed while others were taken over for peanuts. What that means is that many are out of work and soon many more will be. Of those who survived, the mergers are likely going to be followed by massive rounds of layoffs. People out of work will result in more foreclosures, and more losses. To say nothing about reduced spending. Remember, 2/3's of our economy is based on consumer spending. And much of that spending is on credit. Up to half of it comes during the holiday season. A season that is now upon us.

If the holiday spending is much reduced, and it will be significantly reduced, many retailers will go under. That too won't happen for another six to nine months. Apart from hitting pocket books, it will hit commercial real-estate. Other highly-leveraged businesses will fail soon too. Many in California got a bit of extra "help" here from the delayed budget. That budget has also pushed some cities over the brink. Vallejo went bankrupt, Oakland is considering 120 layoffs, San Francisco has problems.

Even in the mortgage arena there is more to come. The majority of the so-called option-ARMs have yet to reset. Sixty percent of these ultra-toxic loans are in California. Many have been negatively amortized for their entire life-span. So not only will people now have to pay the full price, which they were never able to, their loan balance is now higher than it was before they started.

Unfortunately, that is not the only problem. A key problem is that the recession will be world-wide. What that means is that exports will get hit and exports are -for now-the only bright spot left.

It has been said that we are a long ways from Great Depression II. As of today, there is no doubt. However, experts have been surprised before about how quickly and how profoundly things can unravel. The wizards from the Treasury, the Fed, and the Administration have all gone on record months before the current crisis, stating how solid the economy was, and how resilient the markets were.

I think it is time to buy some gold.

infrastructure

We often neglect to see how infrastructure plays a key role in environmental protection. If you live in a low-density suburb you are going to pollute a lot more than people living in a city. A lot more. And there is very little you can do about it. Your whole life-style is a polluting nightmare.

First off, you have to drive everywhere. Because there is nothing to do in your suburb but sleep and watch TV, you need to drive all the time. You drive to work, to school, to the gym, to the stores. Because your house is stand-alone, and likely way too big -as that is the main attraction of suburbia- you need to buy more goodies to fill it up. (People always fill their houses to capacity no matter what the size).

You also need to heat your mansion more in winter and cool it more in summer. Because your neighborhood home-owners association enforces it, you likely need to keep a useless green lawn and waste tons of water on it. Furthermore, you need to mow it regularly spewing out inordinate amounts of greenhouse gases.

Second, you cannot easily change this pattern. It is built-into your life-style. You cannot really walk to the store even if you wanted to, because there is no store, and because it probably isn't safe to walk outside of your development. There are no side-walks, only wide streets with people driving SUV's at very high speeds.

Believe it or not, but infrastructure is foiling elegant solutions like re-usable shopping bags. Today's WSJ has a long article entitled "An Inconvenient Bag." They discuss the failure of the reusable shopping bag. They highlight how stores like Walmart and Home Depot have given out millions of free bags. Bags that cost a lot more to produce, generate more pollution, and take up more space than the ubiquitous evil plastic "t-shirt" bag we all use. 

The problem, we are told is that people do not reuse the bag. And it is easy to see why. Such bags do not mesh with suburban shopping habits, where people drive to the store a few times a week and load up. A reusable shopping bag works best for an urban user who walks to the store everyday to pick up necessities for just that day.

When you get to your regular supermarket, you need a cart. You will haul so much heavy stuff that you do need the cart. Instead of shopping with your bag as city dwellers would, you need to put your bags in the cart. It is easy to forget. It is also inconvenient as you don't know how many bags you will need.

Then when you get the bags home and unload them you need to remember to put them back in the car for your next trip. Even with your bag, items come with so much wrapping that your gains are rather minimal. Unless you can put your veggies straight in your re-usable bag -which does not work easily and which some shops won't let you do- you will need tear-off plastic bags in any case.

I am afraid these partial "solutions" do more harm than good. What Walmart and Home Depot and others should do, is sell bags. Make people pay. The more people pay the less they consume and the less waste there is. That unfortunately goes against the whole supermarket philosophy. But then again, as yesterday's WSJ hinted at, shopping at supermarkets does not really save you money. It just makes you consume and waste more. The excess far exceeds your meager savings, and you would be better off buying less, better quality, items at your local grocer.

You would spend the same amount, but be leaner, healthier, and less wasteful. You would also support a sustainable and sensible infrastructure.

a primer on insurance

We are told insurance works to protect people against unforeseeable and unexpected tragedy. The concept is fairly simple: a number of people facing risk pool money together so it can be paid in times of need out to the few who become actual victims. There is no cheating, everyone knows they may not become a beneficiary unless something bad happens, and most would choose not to ever "have to benefit" from this arrangement.

Occasionally, a participant will try to cheat and issue a false claim. That is a bad idea, and the industry has the full backing of the government and law enforcement to make sure these bad apples are punished in a highly publicized and visible fashion. This type of cheating does not pay. Besides there is a far easier way to reap benefits. One where the government will give you a helping hand.

First, add a little capitalist twist to the story and you get the insurance company. In return for orchestrating all the logistics the company is allowed to make a profit. That is easy since the company can invest the money people provide and get a return hopefully before it will have to pay the few unlucky souls. Nobody objects to the company charging a bit extra either. People don't even object to companies rejecting those who are considered high risk. Or charging more to those who are high risk but nevertheless "acceptable." After all, companies have to make money.

In short, this arrangement seems rather straightforward and easy.

Experience has taught us to beware of such easy and straightforward schemes. There is ample room to cheat here. People pay upfront and if you can somehow avoid paying them back later, you can pocket all the money. The easy way to do that is to refuse coverage to those who need it, when they need it. You can start by refusing claims, or making it hard for people to file claims. That will turn a lot of them away, while others may die before they can benefit. 

It is now so common for health insurers to deny claims that patients expect to have to argue with their carrier at one point or another. Today's WSJ had some tips on how to argue with your insurer in case a claim is denied. But it doesn't stop there. Insurance companies also try to ditch you when you file claims for more than a few pennies. They will go to great lengths to uncover technicalities in your record that will allow them to break the contract.

It is one of those tactics insurance companies find acceptable or evidence of good business practices. You know, protecting shareholders? How else would you explain their stance on California's bill AB1945?

The bill prevents insurance companies from retroactively rescinding coverage. Mind you, it still permits insurance companies to drop customers who intentionally submitted fraudulent applications. But that requires proof and meaning extra work and smaller profit margins. Better to avoid it when we can.

AB1945 is a straightforward honest bill. Yet the insurance companies are fighting it tooth and nail. A spokesperson for the industry said -with a straight face- that they are trying to protect consumers. Not the shareholders, folks, you. You, the insured. They are trying to protect you from those fraudulent cheaters that are causing all our problems.

It turns out insurance companies like to rescind policies retro-actively. They like to dump patients with expensive medical conditions that were diagnosed years after they were approved for coverage. Recently, Blue Cross was fined for dumping 1,770 members, while Blue Shield dumped 450. Kaiser Permanente, Health Net, and PacifiCare were also fined for dumping patients. Dumping it seems is part of the way insurers do business.

Governor Schwarzenegger personally knew someone who was diagnosed with cancer and had his coverage rescinded. According to the insurance company, the patient had a pre-existing condition and should not have had coverage. What was that pre-existing condition, you ask? A knee injury sustained years earlier. The governator was so shaken by this incident, he decided to do something about it. Only so far it hasn't happened. And if the insurance industry gets their way, it won't happen. Because all the money they save goes into their shareholder's pockets. That my friends is their true mission: to collect people's money and stuff it into shareholder's pockets.

In case you doubt if insurance is profitable, look no further than Warren Buffett. And if you wonder what happens when insurance companies do dumb stuff and end up losing money, look no further than AIG. As you can see, the insurance business is a very good business with very little downside risk.

why the rich get richer

Capitalism is a funny system. Suppose you all start out at the same time with the same resources. As soon as someone gains a small advantage, their position improves. It becomes easier for them to amass even more resources. At the same time the others struggle more to stay in place. Suddenly, the ones with an advantage are the favored party to amass more.

It is like the little rivulets in the park. I was hiking the other day in an South Bay park and noticed how erosion had changed the trail from my previous visit. There was a section of trail in a wide swooping turn that was angled downward. Throughout little rivulets carried water across the trail into the canyon below. At one point, all rivulets were of nearly the same size and all must have carried about an equal amount of water.  But in my absence something happened. Suddenly one or two of the rivulets became bigger and they "grabbed" the water from the adjacent ones. Now the trail was largely flat with two or three big gullies instead of an undulating surface with 20-30 little streams.

Today it was announced that the Oracle of Omaha, aka Warren Buffett had made an investment of $5 billion into Goldman Sachs. First, we note that Warren has connections to the firm, granting him wide access to executives and information. Second, we note that he got a sweet deal with 10% extra interest and options to buy more shares on the cheap. 

Goldman did not have much choice, they need the money. Also, Buffett knows his way around at Goldman. Thirdly, giving it to Buffett almost guarantees the value will go up. In times of crisis people look for heroes and saviors. And if there was ever a savior of capitalism, Buffett is the man. It is almost a self-fulfilling prophecy. 

The name Buffett makes it so the investment will attract other money and hence go up in value. And with the government poised to follow, Buffett is sure to become a major beneficiary of tax payer money. And nobody will feel he didn't deserve it. I.e. we are going to pay Warren well and rather quickly too. That should ensure him a 40%+ annualized return.

No such luck for the ones who are left behind. They will pay the bill instead. Like the tiny rivulets supplying water to the growing gullies, while drying out themselves, we will make Warren even richer than he already is. That is how capitalism "creates" wealth. It shift resources from the masses to the few. The few who will then put the others to work to create even more wealth -mostly for themselves, mind you.

This system has no internal checks and balances. It keeps flowing until a few rivers are left. Rivers so wide that the trail will ultimately collapse. Unless us smart people intervene to save the day.

catch-22

You probably heard about the bail-out package. The $700 billion that is needed to "stabilize" the market. The $700 billion that will buy worthless debt "instruments" and straddle tax payers with excess pain for decades to come. But what you may not know, or may not have thought off is that this package will do nothing for struggling home-owners. It will do exactly nothing about the source the mess, the mortgage crisis.

What it will do, is allow banks to write-off or remove from their balance sheet, worthless paper. Toxic debt is the technical term. That will make the bank look better, and up its credit rating. That will make it so the bank can get more money and won't have to raise funding to shore up its collateral.

However, the plan can only work when two things happen. Things that nobody really wants to happen. Or at the very least, things that nobody should want to happen.

The first is the CEO's and other C-executives will walk away with millions in bonuses, severance, and other platinum or diamond-studded gold parachutes. All rewards for "a job well done." And there is nothing you or I or anyone else for that matter can do about it. Because those greedy executives will not sign on to a plan that forfeits their "packages." 

Guess what will happen to bank X if its CEO has to sign on to a plan that wipes out his/her package in order to rescue the company? If you said, he/she will let it go under, you win! Because that is exactly what will happen. No CEO will voluntarily give up their "benefits" in order to do his/her fiduciary duty or protect the shareholders. CEO's are eager to fire workers to protect the shareholders and boost margins, but don't touch their money!

The second is that the Fed will have to pay way too much for all that debt. If the Fed values the debt for what it is worth (nothing), then the cure won't work. Even if the Fed pays a more reasonable rate, the rescue won't work. The cure can only work if the Fed buys worthless paper for its over-inflated and unrealistic face value.

So here you have it. A package that buys useless paper at enormous cost with your money and rewards incompetent executives for their greedy misbehavior over the past five to eight years.

And what will this marvelous package do? It will restore confidence. It will make it so banks don't fail and so credit does not dry up. It will save the financial sector. It will do nothing, absolutely nothing for housing, mortgages, home-owners or anyone else. They will be left to pick up for themselves. It will do nothing about the next wave of upcoming foreclosures. It will do nothing about crashing housing prices, or lost jobs.

The banks sold everyone mortgages that they could not afford and then they packaged these mortgages with plenty of excess fat into investment "vehicles," that are now worthless because the collateral is not there (i.e. the house). So the bank has a problem, and guess what, we will bail them out.

crisis

Postponing recessions just makes matters worse. That is the lesson we learn from the current crisis. Instead of letting the economy suffer a bit after the 2000 stock market bubble, the Fed decided to give it a lift with plenty of free credit. A government subsidy that went on for too long. And what happened? People felt good... for a while. 

They felt so good they started to think how to spend their money. Suddenly, their house was worth a fortune. It had run up during the boom and now with cheap credit there was a way to cash in. Never mind those paper losses on the stock market. Here was real money and and it was easy to get it. Just refinance. Real estate never goes down now does it?

What people did not realize is that real estate does not appreciate at 40% or more year over year. Those crazy numbers were based on paper gains made in an "irrationally exuberant market." Everyone felt rich and when you are rich you pay richly. Especially those who have never been rich before (the so-called nouveau riche). They have money so they want to pay. All those stock market gains drove housing through the roof.

So here we are, after the big bubble, lots of tears about our paper losses, but hey the house is worth a fortune. And interest rates are low. Let's refinance and take some money out. Let's do some shopping. It is our patriotic duty (remember the 9/11 mantra? go out and shop).

And for those of us with gains, let's invest in the real estate market. It is safe, remember, real estate never goes down. Let's buy a few properties and flip them in a few years. After they've appreciated 50-100%. Those are normal returns, aren't they ? Real estate always goes up that way, doesn't it? Plus it is tax-deductible. Free money from Uncle Sam.

Every time interest rates moved down a notch, more calls to refinance. Sure, the Fed enabled the crisis. But mass delusions and greed made it happen. Good news all around. Lots of money to spend on credit, lots of jobs in the financial industry, lots of joy to be had.

The more people you attract the more creative they get. And the financial institutions sure attracted lots of people. It did not take long before these geniuses figured out a way to package all these loans and sell them to investors. With nice added bonuses and commissions. More air in the bubble. Soon enough the insurance guys got in the game too. Insuring debt? Why not, after all the more contracts we write the more commissions we get.

Let's not forget that all of it is safe. No risk! Who has ever heard of no risk and lots of reward? Well, in real estate of course. Real estate never goes down. Look at the last five years. See those double digit returns? That's normal, my friend. Real estate always does that. You didn't know? Better get in now that the going is good.

More air in the bubble.

Let's not worry that nobody can pay their real mortgage. Let's give them five years of low monthly payments. Negative amortization? Never heard of it. What does it mean? Well, never mind, we'll flip it before the bill comes due. Or we'll refinance again and take out some more. This party will never end.

There is an endless supply of money. Just like there is an endless supply of oil. Kool-aid someone?