Email to the Employees, Part II
Part II, where I give background. I tried to keep it from being too political, moved whole sections out on shorts, naked shorts, the exchange markets, etc. Anyone with a working knowledge of economics could argue points, and that'll be fun for us, but I'm hoping i Painted a reasonable picture for the layperson.
Q: Man this shit is so confusing, how did we (the United States) get here?
OKAY. This is the really long one. Apologies. To answer this, we have to go back to a few events all the way back in the 1980's.
In the 1980's, responding to another economic recession, and some practical matters regarding the nature of retail banks (think: Wamu) and investment banks (think: Goldman Sachs), the United States government began a system of deregulation, giving banks of all varieties greater leeway in how they operate. Three things sprung out of this that are relevant to our story:
These were both done for good reasons at the time, taking the lessons of the 87 crash to heart to "fix things." The easing of asset requirements made it so banks carried more debts on the books, which is why banks like Wamu and Northern Rock in the UK were more likely to fail. The ability to offer new financial products lead to the invention of something called Collateralized Debt Obligations, or CDOs. This was a clever product that took a bunch of mortgages, put them in a portfolio together, and sold parts of the portfolio. CDOs were actually really clever, and were supposed to mitigate risk. They were also mainly a product for rich people, who had money to lose, and other financial institutions. Except:
Except the "other financial institutions" were retail banks, like Wamu, who were actually investing your money and mine. Retail banks bought CDOs in a big way throughout the 90's and early 00's.
Okay, so, next. After the dot com bust in 2001, the Fed, under Alan Greenspan, aggressively lowered interest rates. They did this to make money cheap, to keep the economy rolling. It broadly worked, and they nicely managed the 00/01 crash, confining it to the tech sector. However, at the same time, they sparked the beginning of a housing bubble. This would have been, presumably, dealt with quite nicely had 9/11 not happened, but it did, so they kept interest rates low, and lowered them more to get our economy "back on track." This, too, worked broadly well, and we should all give a golf clap to the Fed for handling it.
So, then, Greenspan retired and Bernanke came into office and he was dealt a third kind of shit hand: that of astronomical oil prices, a second war in iraq, $3 a gallon gas and a dollar that was insanely weak in the world market. Everyone was scared of a recession early last year. Ah, how simple that all seems now. Bernanke started off strong and kept interest rates low to plow through a third hit to the economy using the tried and true tools of low interest rates. There was some grumbling about inflation - low interest rates mean cheap money means money buys less means it takes more to buy something means higher prices. If everything had gone swimmingly late last year, Bernanke was turning his eye toward fighting inflation, and would have started raising interest rates, making money more expensive, making it more expensive to buy a house.
Unfortunately, after keeping interest rates low through three economic events, what happened was money was cheap, and everyone borrowed a lot of it to buy homes and houses and apartments and condos and prices of those kept rising. High oil prices and the lagging economy eventually made it so the housing prices got so expensive in proportion to people's incomes that the housing bubble burst.
Okay, so, cool. Housing bubble burst. That's happened before, right? I remember one in '96 or so. Houston, Texas got hosed (and man, it was crazy down there), but, broadly speaking, just like the dot com bus, it should be confined to one sector, right?
RIGHT. Except, remember those CDOs? Basically, the "bad mortgages" had all been packaged up into funds that were bought piecemeal by everyone who owned part of these funds - ie, basically everyone. And not only that, because the banks had no asset-to-liability regulations any more, some of them owned a shit ton of these. So all of the sudden what should have been confined to one or two banks were, in fact, owned by everyone. It's as if suddenly $5 bills were useless. No one knew how much of each bank's assets were in CDOs, and no one knew who actually was worth anything.
One more thing that exacerbated things. In the history of the US, there has been a back and forth between politicians who believe in "market forces" and those that believe in the government that helps. Since both sides broadly command support of roughly the same number of people, what happens, sometimes, is that they generally compromise and make strange public/private hybrids in an effort to further the social goals of the United States. Since the United States, insanly in my opinion, but whatever, believes that it is a good thing for its citizens to own homes, they have passed a lot of laws through the years assisting citizens in this quest. Two of these were Fannie Mae, created in the 30's under Roosevelt and Freddie Mac, created in the 70's under Nixon. Both of these were created in response to previous economic crises (you'll see this theme a lot). Basically, Fannie Mae and Freddie Mac are private corporations, endowed with certain special advantages, created to help them provide loans to US Citizens. This is all well and good (this isn't a political discussion here), but there were two oversights: First, their competitive advantage allowed FM&FM to corner the market on "safe" mortgages, forcing other banks to pursue the mortgages on the low end and high end that did not quality for FM&FM financing. Second, incredibly, as a private corporation with a shit ton of money, FM&FM actively lobbied the federal government, like a company, for more special rules.
SO, not only were the regular mortgage providers hosed because the housing bubble burst, they were doubly housed because they held mainly less ideal, or "sub-prime"mortgages. Double whammy.
This all went down last november and december. A few banks failed fast - most notably Bear Stearns in the US and Northern Rock in the UK. A lot of banks took their licks and were mocked and took serious stock hits back then as they reported their CDO exposures, but ironically, the ones in the early year that took their licks and raised more capital got out of the worse mess we're in now. You'll remember things like Citibank taking $XBillion from Qatar and Oman, and UBS getting a ton of shit before they raised more capital.
SO, then. All was sort of well and good, and this summer, people thought "well, okay, that was a bit of a doozie, but it seems to be clearing up." That's what we all thought.
This is where "Mark to Market" comes in. Basically, Sub-prime-based CDOs were impossible to sell. Like no one wanted them. Theoretically, of course, they should still be worth something, right? Sure, they're low now, but if the economy turns around, then their value should go up, so maybe I could buy low, and sell high, later?
Except no one did. No one wanted them at all. banks were busy shoring up their balance sheets with cold hard cash, to look solid, to keep their stock prices up, so they wouldn't be the next to fail. SO, since the market basically fell to zero, any bank carrying a significant amount of these assets on their books had to mark them as, basically, Zero. Which meant they appeared to have even less money. Which meant they started to fail.
So, then, all the banks freaked and went into turtle mode.
A quick note about how banks work. When you write a check, Banks don't actually FedEx money to one another, they loan it to the other bank. Banks basically loan each other money every day at different interest rates. If I write a check on my Bank of America account, and you cash it on your Wamu account, Wamu puts the money in your account, and the next night collects it from Bank of America. So, for that day, Wamu has, essentially, loaned Bank of America that money. Every night, all the banks reconcile billion of dollars of loans from one another, at interest rates that the markets bear. They do this with stocks, with mutual funds, with every type of financial product. They're loaning each other billions every night. Sometimes for a night, sometimes for a week, sometimes for a month or quarter. This is the banking "system." Every transaction depends on it.
SO: with banks failing every week, and your capital tight, and you not being sure if the bank you're paying will even be in business the next morning, you start to charge a lot more for a loan from one bank to another. What would happen if you're Bank of America, and you loan Wamu $12 billion one night, and they don't give you your $12billion and they go out of business the next day? Not worth the risk.
Banks have essentially stopped lending money to one another. Almost completely. Without credit, banks can't operate. Without banks, we can't operate. Neither can you.
Q: So what is the "bailout?" Why are they bailing out Wall Street big wigs at the cost of Main Street?
The logic of the bailout is as follows: Rationally, we know that the "toxic assets" (CDOs) have some value, unless every single homeowner in america defaults on their mortgage. But they are priced at zero, because the market has evaporated. The thinking is that if the federal government steps in as a buyer for assets that clearly are not actually worthless, the market will wake up. Banks can get this shit off their books, and credit and liquidity will ease, because banks asset-to-debt ratios will no longer be opaque, and they will be higher. Then the federal government holds the assets, waits for the markets to ease up, and starts selling them off once confidence is restored. This is a completely rational plan, though obviously not very politically sensitive.
The public hates it because it seems like it is rewarding wall street for its greed and idiocy. You can debate the merits of this view - personally, if you ask me the fed is as responsible as wall street for this, since they 1) eased asset-to-debt ratios for banks, 2) didn't illegalize CDOs, 3) basically caused the housing bubble through extended low interest rates, and 4) passed mark-to-market laws. All of these acts were rational, and maybe even good ideas, but they were not done by Wall Street. Wall Street just reacted to them.
ANYWAY, the markets are frozen, and it was assumed the US Government would fix the problem. With a republican Treasury Secretary and President and a Democratic Congress more or less willing to play ball, everyone assumed the fix would happen. It didn't. So, today, the market responded.
Q: What will happen next with the bailout?
So, it looks like they're going to try again Thursday. The market may well fall more if they don't. Some people are hedging. If it passes, we should then see enough certainty that the leads we have will stay alive and people will still continue to buy advertising services in the short term.
Q: Aren't there any other options than a wall street bailout?
The only two things anyone has suggested are both a bit Barn Door after the horses:
These are all, in short, vaguely worthwhile things to consider, but are irrelevant on the actual impact in the big picture. There are pros and cons to each, and points of morals and principle to consider, but sort of minor.
Q: Doesn't everyone know the economy is cyclical? Why is any of this a surprise? Isn't this just more of the same?
Broadly speaking, yes... but..
Economic growth consists of two things: cyclical economic ups and downs, and the things we learn from the downs and fix, so the next down isn't as bad, or is further down the road, etc. This is one of the reasons (along with technology, etc) that the economy is greater now than, say, 1911. We learn things, and we fix them. With the great depression we learned it was bad to have a bunch of money in a bunch of uninsured banks, and we made the FDIC. This is why, right now, you still have money in your bank. In the housing crisis of the mid 90's, we learned that the housing market can depress whole areas and spread beyond that, so we made CDOs to distribute the risk. In the 87 crash we learned that retail banks and investment banks and savings and loans were all blending and merging and our regulations were out of step. In the dot com crash we learned one sector could bring the economy down if we don't contain it. Each time, we learn something, and the next time, something new happens. This time, it's something new. It's not a surprise that it's happening, but it's *always* a surprise how long it'll go, how severe it'll be and from whence it will come. Each time, some people are right and some are wrong.
Okay. Thanks for your time. Please, don't hesitate to ask questions to anyone. I'm happy to answer them. Ask privately, if you want, or to cheryl, and we can answer for just you or send out a follow-up email.
r.
Q: Man this shit is so confusing, how did we (the United States) get here?
OKAY. This is the really long one. Apologies. To answer this, we have to go back to a few events all the way back in the 1980's.
In the 1980's, responding to another economic recession, and some practical matters regarding the nature of retail banks (think: Wamu) and investment banks (think: Goldman Sachs), the United States government began a system of deregulation, giving banks of all varieties greater leeway in how they operate. Three things sprung out of this that are relevant to our story:
- First, the government did away with asset to debt ratio requirements. That is, it stopped requiring banks to keep, say, $100 million in cash for every $500 million in liabilities it had on its books.
- Secondly, it gave investment banks like Goldman greater ability to make custom financial products and sell them to rich people only.
- Finally, they instituted "mark to market" rules - this means that banks were required to list the value of an asset as how much it could actually sell it for. This seems like common sense, of course, but banks were valuing them in other ways. It was thought that by making banks value an asset based on how much it could sell it for, that banks would have a disincentive to lie about how much money they had.
These were both done for good reasons at the time, taking the lessons of the 87 crash to heart to "fix things." The easing of asset requirements made it so banks carried more debts on the books, which is why banks like Wamu and Northern Rock in the UK were more likely to fail. The ability to offer new financial products lead to the invention of something called Collateralized Debt Obligations, or CDOs. This was a clever product that took a bunch of mortgages, put them in a portfolio together, and sold parts of the portfolio. CDOs were actually really clever, and were supposed to mitigate risk. They were also mainly a product for rich people, who had money to lose, and other financial institutions. Except:
Except the "other financial institutions" were retail banks, like Wamu, who were actually investing your money and mine. Retail banks bought CDOs in a big way throughout the 90's and early 00's.
Okay, so, next. After the dot com bust in 2001, the Fed, under Alan Greenspan, aggressively lowered interest rates. They did this to make money cheap, to keep the economy rolling. It broadly worked, and they nicely managed the 00/01 crash, confining it to the tech sector. However, at the same time, they sparked the beginning of a housing bubble. This would have been, presumably, dealt with quite nicely had 9/11 not happened, but it did, so they kept interest rates low, and lowered them more to get our economy "back on track." This, too, worked broadly well, and we should all give a golf clap to the Fed for handling it.
So, then, Greenspan retired and Bernanke came into office and he was dealt a third kind of shit hand: that of astronomical oil prices, a second war in iraq, $3 a gallon gas and a dollar that was insanely weak in the world market. Everyone was scared of a recession early last year. Ah, how simple that all seems now. Bernanke started off strong and kept interest rates low to plow through a third hit to the economy using the tried and true tools of low interest rates. There was some grumbling about inflation - low interest rates mean cheap money means money buys less means it takes more to buy something means higher prices. If everything had gone swimmingly late last year, Bernanke was turning his eye toward fighting inflation, and would have started raising interest rates, making money more expensive, making it more expensive to buy a house.
Unfortunately, after keeping interest rates low through three economic events, what happened was money was cheap, and everyone borrowed a lot of it to buy homes and houses and apartments and condos and prices of those kept rising. High oil prices and the lagging economy eventually made it so the housing prices got so expensive in proportion to people's incomes that the housing bubble burst.
Okay, so, cool. Housing bubble burst. That's happened before, right? I remember one in '96 or so. Houston, Texas got hosed (and man, it was crazy down there), but, broadly speaking, just like the dot com bus, it should be confined to one sector, right?
RIGHT. Except, remember those CDOs? Basically, the "bad mortgages" had all been packaged up into funds that were bought piecemeal by everyone who owned part of these funds - ie, basically everyone. And not only that, because the banks had no asset-to-liability regulations any more, some of them owned a shit ton of these. So all of the sudden what should have been confined to one or two banks were, in fact, owned by everyone. It's as if suddenly $5 bills were useless. No one knew how much of each bank's assets were in CDOs, and no one knew who actually was worth anything.
One more thing that exacerbated things. In the history of the US, there has been a back and forth between politicians who believe in "market forces" and those that believe in the government that helps. Since both sides broadly command support of roughly the same number of people, what happens, sometimes, is that they generally compromise and make strange public/private hybrids in an effort to further the social goals of the United States. Since the United States, insanly in my opinion, but whatever, believes that it is a good thing for its citizens to own homes, they have passed a lot of laws through the years assisting citizens in this quest. Two of these were Fannie Mae, created in the 30's under Roosevelt and Freddie Mac, created in the 70's under Nixon. Both of these were created in response to previous economic crises (you'll see this theme a lot). Basically, Fannie Mae and Freddie Mac are private corporations, endowed with certain special advantages, created to help them provide loans to US Citizens. This is all well and good (this isn't a political discussion here), but there were two oversights: First, their competitive advantage allowed FM&FM to corner the market on "safe" mortgages, forcing other banks to pursue the mortgages on the low end and high end that did not quality for FM&FM financing. Second, incredibly, as a private corporation with a shit ton of money, FM&FM actively lobbied the federal government, like a company, for more special rules.
SO, not only were the regular mortgage providers hosed because the housing bubble burst, they were doubly housed because they held mainly less ideal, or "sub-prime"mortgages. Double whammy.
This all went down last november and december. A few banks failed fast - most notably Bear Stearns in the US and Northern Rock in the UK. A lot of banks took their licks and were mocked and took serious stock hits back then as they reported their CDO exposures, but ironically, the ones in the early year that took their licks and raised more capital got out of the worse mess we're in now. You'll remember things like Citibank taking $XBillion from Qatar and Oman, and UBS getting a ton of shit before they raised more capital.
SO, then. All was sort of well and good, and this summer, people thought "well, okay, that was a bit of a doozie, but it seems to be clearing up." That's what we all thought.
This is where "Mark to Market" comes in. Basically, Sub-prime-based CDOs were impossible to sell. Like no one wanted them. Theoretically, of course, they should still be worth something, right? Sure, they're low now, but if the economy turns around, then their value should go up, so maybe I could buy low, and sell high, later?
Except no one did. No one wanted them at all. banks were busy shoring up their balance sheets with cold hard cash, to look solid, to keep their stock prices up, so they wouldn't be the next to fail. SO, since the market basically fell to zero, any bank carrying a significant amount of these assets on their books had to mark them as, basically, Zero. Which meant they appeared to have even less money. Which meant they started to fail.
So, then, all the banks freaked and went into turtle mode.
A quick note about how banks work. When you write a check, Banks don't actually FedEx money to one another, they loan it to the other bank. Banks basically loan each other money every day at different interest rates. If I write a check on my Bank of America account, and you cash it on your Wamu account, Wamu puts the money in your account, and the next night collects it from Bank of America. So, for that day, Wamu has, essentially, loaned Bank of America that money. Every night, all the banks reconcile billion of dollars of loans from one another, at interest rates that the markets bear. They do this with stocks, with mutual funds, with every type of financial product. They're loaning each other billions every night. Sometimes for a night, sometimes for a week, sometimes for a month or quarter. This is the banking "system." Every transaction depends on it.
SO: with banks failing every week, and your capital tight, and you not being sure if the bank you're paying will even be in business the next morning, you start to charge a lot more for a loan from one bank to another. What would happen if you're Bank of America, and you loan Wamu $12 billion one night, and they don't give you your $12billion and they go out of business the next day? Not worth the risk.
Banks have essentially stopped lending money to one another. Almost completely. Without credit, banks can't operate. Without banks, we can't operate. Neither can you.
Q: So what is the "bailout?" Why are they bailing out Wall Street big wigs at the cost of Main Street?
The logic of the bailout is as follows: Rationally, we know that the "toxic assets" (CDOs) have some value, unless every single homeowner in america defaults on their mortgage. But they are priced at zero, because the market has evaporated. The thinking is that if the federal government steps in as a buyer for assets that clearly are not actually worthless, the market will wake up. Banks can get this shit off their books, and credit and liquidity will ease, because banks asset-to-debt ratios will no longer be opaque, and they will be higher. Then the federal government holds the assets, waits for the markets to ease up, and starts selling them off once confidence is restored. This is a completely rational plan, though obviously not very politically sensitive.
The public hates it because it seems like it is rewarding wall street for its greed and idiocy. You can debate the merits of this view - personally, if you ask me the fed is as responsible as wall street for this, since they 1) eased asset-to-debt ratios for banks, 2) didn't illegalize CDOs, 3) basically caused the housing bubble through extended low interest rates, and 4) passed mark-to-market laws. All of these acts were rational, and maybe even good ideas, but they were not done by Wall Street. Wall Street just reacted to them.
ANYWAY, the markets are frozen, and it was assumed the US Government would fix the problem. With a republican Treasury Secretary and President and a Democratic Congress more or less willing to play ball, everyone assumed the fix would happen. It didn't. So, today, the market responded.
Q: What will happen next with the bailout?
So, it looks like they're going to try again Thursday. The market may well fall more if they don't. Some people are hedging. If it passes, we should then see enough certainty that the leads we have will stay alive and people will still continue to buy advertising services in the short term.
Q: Aren't there any other options than a wall street bailout?
The only two things anyone has suggested are both a bit Barn Door after the horses:
- Some people, conservative republicans who voted against this most notably, have advocated regulations providing for insurance around toxic paper and CDOs. No one really knows what they are talking about since, well, if you could buy insurance after the car crash for $100 and collect $1000, you would, right? In any case it'd be semantics on how the money was distributed, and it would remove the potential upside of actually making some money back if the markets revive.
- A few people have advocated the repeal of Mark to Market rules, which would presumably allow banks to mark their CDO assets as having a positive net worth. This would help a bit, but no one in their right mind would really buy them right now.
- What about these things like equity stakes in the companies, executive pay, mortgages, etc?
These are all, in short, vaguely worthwhile things to consider, but are irrelevant on the actual impact in the big picture. There are pros and cons to each, and points of morals and principle to consider, but sort of minor.
Q: Doesn't everyone know the economy is cyclical? Why is any of this a surprise? Isn't this just more of the same?
Broadly speaking, yes... but..
Economic growth consists of two things: cyclical economic ups and downs, and the things we learn from the downs and fix, so the next down isn't as bad, or is further down the road, etc. This is one of the reasons (along with technology, etc) that the economy is greater now than, say, 1911. We learn things, and we fix them. With the great depression we learned it was bad to have a bunch of money in a bunch of uninsured banks, and we made the FDIC. This is why, right now, you still have money in your bank. In the housing crisis of the mid 90's, we learned that the housing market can depress whole areas and spread beyond that, so we made CDOs to distribute the risk. In the 87 crash we learned that retail banks and investment banks and savings and loans were all blending and merging and our regulations were out of step. In the dot com crash we learned one sector could bring the economy down if we don't contain it. Each time, we learn something, and the next time, something new happens. This time, it's something new. It's not a surprise that it's happening, but it's *always* a surprise how long it'll go, how severe it'll be and from whence it will come. Each time, some people are right and some are wrong.
Okay. Thanks for your time. Please, don't hesitate to ask questions to anyone. I'm happy to answer them. Ask privately, if you want, or to cheryl, and we can answer for just you or send out a follow-up email.
r.
