Now and then

The President then and now “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. government can’t pay its own bills. ... I therefore intend to oppose the effort to increase America’s debt limit.” — Then-Sen. Barack Obama, floor speech in the Senate, March 16, 2006 To even entertain the idea of the United States of America not paying our bills is irresponsible. It's absurd," Obama said in a press conference. This is not just an Obama problem, it represents politics in general. Its Party trumps Country. There are many such examples with many politicians. Seasoned politicians have learned to tell people what they want to hear.

Budget

A friend of mine sent me a simplified way to look at the US budget. He just subtracted 8 zero’s and called it a family budget and it looks like this. Family income $21,700 Money the family spent $38,200 New debt on the credit card $16,500 Outstanding credit card balance $142,710 Total budget cuts so far $38 I would like to add some further details to explain why this family budget is allowed to get so far out of control. Money to take care of aging parents $1,600 Money to take care of people not working $4,200 Money spent on interest on our debt $2,470

AIG

We have heard the phrase, “too big to fail” and a perfect example is AIG, the large insurance company that insured all of the bad mortgage loans that banks had provided. Recall these were loans given to people who did not have the where with all to repay unless the housing market continued its climb. The market did not cooperate and the buyers lost their homes. As the value of homes declined the mortgages that backed these loans lost value and the banks called on AIG to cover their losses, since that was the purpose of buying the insurance. As an aside, AIG did not call these products insurance because that would have meant oversight by the state insurance department so they called them credit default swaps. Now it was AIG’s time to step up to the plate but everyone knows that insurance is based on the concept that not everything will go wrong at once but that is just what happened. AIG’s stock went from $70 to one dollar and they were facing bankruptcy. Keep in mind that filing bankruptcy generally means your liabilities exceed your assets. AIG was a conglomerate that owned many different businesses and many not associated with the mortgage scene still had value but the losses suffered with the mortgage crisis exceeded the total value of the company. Now comes the fun part. The government stepped in and anted up 180 billion so that AIG could meet its commitment to the banks. Then AIG sold off some of its assets and the value of these toxic mortgages begin to rise. Keep in mind we are not talking about the actual value but the perceived value, that is, what a willing buyer will pay a willing seller. This increase was accelerated as the home market bottomed out. The end result is that AIG stock price begin to rise and when it hit $30 the government sold off its shares and made a profit. These shares became so in demand that the government sold them at auction and many bidders participated. The same banks that got hurt the first time around buying these mortgage bundles are now outbidding one another for the same bundles. They are betting that the recession is over and that housing prices will continue to rise. They are also assuming that if the bottoms drop out that the US government would once again come to the rescue. This is what is meant by the term, “moral hazard”. They are willing to take a greater risk knowing that the government will cover any downside loss. This is also what is meant by too big to fail.

Slippery slope

When it comes to the abortion issue you can call me a middle of the roader as I feel that in the first trimester the mother in consultation with her doctor and husband, if available, should be able to choose. The third trimester it should only be allowed for rape, incest or physical life of the mother and in the second trimester it must be on a case by case basis with experts from different areas involved. I bring this up because pro-choice people often argue about rape and incest to make their point and this is often brought up in the press. One argument for the pro-life people I have not heard involves late term abortion. Would you allow an abortion at 8 months and 30 days? Would you allow an abortion at 8 months and 30 days if the mother did not like the color of the baby’s eyes? If the answer is no then you ask about 8 months and 29 days and so on. I bring up these arguments, to show the weakness in the arguments on both sides where abortions are allowed for any reason and abortions are not allowed for any reason. Each side is unwilling to give an inch because the fear the slippery slope and it has been my experience when that is the excuse for any decision it is likely to be faulty. You can see this same reasoning when it comes to gun control. Those for do not want any restrictions on guns and those against want to get rid of all guns. Once again the driving factor is the slippery slope argument. If we finally agree to ban large clips and assault weapons, I don’t believe this will satisfy those who oppose guns. Let’s hope this ban is passed and we can see what happens next to find out if the slippery slope argument is valid.

Quantitative easing

Quantitative Easing (QE) is a euphemism that means printing and borrowing money by the Federal Reserve Bank. We have been through QE 1 and QE 2 and a few months ago we started QE 3 where the Fed would purchase 40 billion a month in mortgage backed securities. QE 4 has now joined QE 3 and the Fed will purchase 45 billion a month in long term government bonds. Recall that a mortgage backed security was a group of home mortgages usually about 100 in a bundle that were sold as securities on the open market. These individual mortgages were purchased by home owners through various financial institutions and then they were sold to other investors around the world. It was joked that the buyers of these securities had no way of knowing what they were worth. The only sure way to determine the value was to open them up and have each of the individual homes appraised and this was obviously too costly and too time consuming. Imagine what this means! Sophisticated buyers around the world were purchasing securities for a set price when they had no idea what they were worth. Now after thinking that through, understand that the Fed is currently buying these securities at the rate of 40 billion dollars a month and no one is the least bit concerned. Taking a closer look at a mortgage bundle we learn some things. First of all if there are 100 mortgages in the bundle and the average mortgage is $200,000 we are talking 20 million dollar which means that there are no small investors in this market. Second say the average mortgage in this bundle has a 6% rate so the return on your 20 million is 1.2 million per year. Understand that when these bundles were most popular interest rates on things like CD’s were 1 or 2 percent. Now let us say that the value of houses drops by 20% and another 20% of these go into default so the new value of the bundle is 12 million and the return is now 3.6%. The value of this bundle has decreased from 20 million to 12 million but no one knows this. People are now just buying and selling paper. If the houses were worth nothing it would not matter. To put this in the proper perspective assume that I bring out a large box wrapped in brown paper and I tell you there is a new car inside and ask you to bid on it. What is the first question you are going to ask?

Printing money

The treasury prints money and loans it to the Fed at zero interest. The Fed uses the money to purchase mortgage backed securities from Fanny Mae and then collects the interest they earn on these securities. This allows the Fed to make a profit and then they pay back the treasury with principal and interest and this year that came to 80 billion in profits. A take-off on this procedure has helped AIG get out of debt as they now advertise on TV that they have paid off their government loans. Recall that the investment banks that purchased the junk bond called mortgage backed securities covered themselves by purchasing an insurance policy from AIG which transferred the risk to AIG. Since these bonds turned to junk, AIG was facing bankruptcy. The government intervened and purchased 92% of the company. This gave AIG time to restructure and come up with a plan to buy back its stock from the government. They completed this and now are bragging on TV commercials about it. The government bought the stock with free money like they bought securities from Fanny Mae. After AIG got back on their feet they used the government money to buy back their stock. While the government was holding this stock they made a profit of several billion. There is a story within the story here worth mentioning. Gold Sachs received some of the AIG bailout money to supposedly pay off their investors but about 3 billion went directly to Goldman and this was not legal. Recall the Hank Paulson treasury secretary who came up with the bailout plan was the former CEO of Goldman. Goldman was the same company who made up a mortgage backed security account filled with losers and sold these to foreign banks totting them as winners. While they were doing this they sold short on this same securities and made 500 million when these securities went south. This coalition of bank and fed is just one more example of the corruption that is so prevalent.

stocks

When I was working as a financial advisor I stayed away from individual stocks for a number of reasons but the most important was that stocks did not seem to rise and fall based on any logical reason. The one example that stands out in my mind was silver. I knew early on that digital cameras would not need silver to process film and I knew that the biggest use of silver was in film processing. Logic told me to sell silver short as the price would decline as demand declined. Even though the use of silver in films declined to almost nothing the price of silver rose and this happened with in a 15 year span. While all of this change is taking place Kodak and Polaroid file for bankruptcy but silver use just kept growing. Amazon came out in 1994 and everyone thought this would be a winner but they didn’t make a profit until 2001 and then they paid one cent per share. Many people who bought early did not hold on and missed out on the big run up later. It is not only what to buy but how long to hold. I found the market was much like people who go to the casino. They tell you about the winning but not about the losing. In the market the spectacular winners get the publicity so others try to pick the next big winner.