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Ch. 2: Finance: The New Real Economy?

#60: Jan. - Feb. 2009 (Non-Fiction)
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Chris OConnor

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Ch. 2: Finance: The New Real Economy?

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Ch. 2: Finance: The New Real Economy?

Please use this thread for discussing Ch. 2: Finance: The New Real Economy?.
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realiz

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DWill from Introduction.
(Do I recall that realiz is a bookkeeper/accountant type?--great.)
Sorry, this is way above my head and I deal with Canadian tax laws on a small scale...the greater world of finance and the market is way above me. I've spent a few days on the internet reading up on terms I don't really understand. I had thought that 'subprime' ment a mortgage starting at a rate below the prime rate, but have learned that this is a pre-eighties meaning and that a subprime mortgage is one given to high-risk clients who do not qualify for regular rates.

I did read this on Wikipedia:
Contrary to other nations, the US Tax Code allows 100% tax deductibility of all interest payments and part of principal payments on loans for housing. This means a tax break of 30% to 50%, not only of the real interest but also of the inflation part of nominal interest rates. This tax break is what fuelled second and third mortgages, used to buy cars and other consumer goods. Interest rates on car purchases are not deductible, but second mortgages are. This tax give away is what makes America become the most personally indebted nation in the world. Countries like Brazil that do not use nominal interest rates in housing loans, and do not give such tax breaks do not have a prime nor a sub-prime housing problem.
Which confirms my thoughts on this matter that I posted on the introduction thread. It is also sad that complicated 'subprime' mortgages are offered to a group that has the least likelihood of understanding what they are getting into, and little chance that they will be able to live up to the financial commitment. They are basically being preyed on by lending institutes.
I do think that Phillips is saying that the US general public has been misled in this influence to go into debt, to spend, and to invest in the stock market that has been greatly inflated by the spending and the private debt load. The worst thing about this whole scenario is that the savy investor, the top few percent, who make the most while the bubble grows, also can weather the storm and then be in a position to buy again when things bottom out.
Deregulation is another big issue. I have never really understood the American banking system as it differs quite radically from Canada.

The stock market itself has become so much more available to the
average person that it was in the past. I think that many do not realize that there is always a risk and money invested should always be money that can be lost. I have been surprised the past few years when so called 'investment specialist' have encouraged so many people to invest retirement savings in mutual funds.
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DWill

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realiz wrote: Sorry, this is way above my head and I deal with Canadian tax laws on a small scale...the greater world of finance and the market is way above me.
OK, but I still think you protest too much! I want to try to understand a BIT of this stuff, too.
I do think that Phillips is saying that the US general public has been misled in this influence to go into debt, to spend, and to invest in the stock market that has been greatly inflated by the spending and the private debt load. The worst thing about this whole scenario is that the savy investor, the top few percent, who make the most while the bubble grows, also can weather the storm and then be in a position to buy again when things bottom out.
And remember G. Bush's first term, when he wanted us to invest our social security contributions in the stock market (privatizing)? We all were told to accept on faith that mutual fund investing for retirement was the only way to go, and very few of us knew what we were doing.
Deregulation is another big issue. I have never really understood the American banking system as it differs quite radically from Canada.
It's too bad, then, that Canada and most of the world is sucked into the vortex of our financial flushing.

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Grim

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Yes I found it quite interesting when Phillips says that,

"Bubbles aside, other financial terms used by the media - credit derivatives, securitization, and even current account deficit - do not lend themselves to conversations in neighborhood bars or beauty parlors. Americans are excusing themselves accordingly. Still," Phillips continues," if the farmers of more than a century ago could study and understand Sherman Silver Purchase Act provisions and details of the nationwide currency shrinkage - and many somehow managed - can't we expect as much today?" Phillips questions. "Alas, probably not." His chagrin is apparent.

This is the best explanation in his book thus far to explain public ineptitude when it comes to America's most important sector. They don't understand because they simply don't want to not because they lack the resources. I can relate, and the sector encourages it. It is one thing to read about derivatives or fiat currency it is another to read about it in a way that you could comment on it. What better way to keep the meddling masses out of your institution than to tell them they do not understand what they are talking about?

You think that derivatives are poorly designed? You do not work for a large bank what could you possibly know?

It's like trying to defend yourself in the court, the judge really just wants you to get a lawyer. The lawyer has received some type of formal training and certification and is undoubtedly useful, unless you were trying to change the system of law he has come to accept and understand. You would be matching understandings and without insider information individually you are most likely to lose without an expert majority.

And of course Phillips is soon to reverberate, echoing again that "disinterested experts, of course, could pull back the curtain."

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DWill

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I was intending to comment on the same passage that you did. What he said about the complacence or laziness of Americans regarding finance hit home, because I had whined a bit myself that we poor citizens can't understand what's going on. But part of it is inattention and not wanting to be bothered. The other part, which you point out, is probably very true as well: that these wizards do want to be seen as such (or as high priests), and their names for various vehicles are meant to be imposing and indicative of special knowledge needed to understand them.

I'd say the main points I got from this chapter are: 1) for many years public indebtedness has recieved all the attention, but it is private debt that has soaked into our whole economy and done much more damage. I never even thought of that, figuring that if somebody couldn't make mortgage payments and got foreclosed, that was simply a problem for him. 2) Deregulation of the banking industry (including what is called the finance industry, too, I guess) created all of thse new possibilities. It was total faith in the "invisible hand" of the market that led to the reins being let go. Now, it looks as though an opposite reaction may set in, with government replacing the untrustworthy market.
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realiz

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What he said about the complacence or laziness of Americans regarding finance hit home,
This probably stems from a 'if ain't broke, don't fix it', the majority could not see that there was a problem, even some experts could not see how dire this situation was. The American dream is about getting ahead, earning money and living a good life. There is an inner greed in all of us and that greed can take hold of large groups of people and make them blind to reality or at least future consequences. To be fair, there are good idealistic reasons for encouraging debt and spending and deregulation to a certain degree, but taken too far, way too far, the whole thing blows up.

In our world, we all have dozens of areas that we really should understand more, rather than leaving it to the 'experts'. Finance is just one of these, others are our own health (which covers a whole range of things), the environment, government, law, the list could go on and on. We realistically could not spend all our time learning about all these areas, and many times we do have to put our trust into experts. But we do have to learn enough to figure out who those experts we should be listening to are. I think many times we listen to the experts who are saying what we want to hear rather than those saying things that will make our life more difficult.

Dwilll
I never even thought of that, figuring that if somebody couldn't make mortgage payments and got foreclosed, that was simply a problem for him.
I think that in isolation, this would be true. The greater problem here was the fact that these subprime mortgages were quickly unloaded on unsuspecting investors leaving the lending institute to repeat this procedure over and over again. This is really fraud, but it sounds like somehow it was being done legally, but obviously not morally. I would have thought with what happened with Enron that more regulation would have been put in place, rather than less.
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Listening to an excerpt of George Bush's farewell speech this morning, I thought about free markets and how free market political ideology has risen to power in many places around the world, including here in Canada. Many of us seem to like the free market when it (apparently) works well for us, the ideology seems to make sense and things go like gangbusters. There is evidence of that here in Canada. We re-elected a government recently that is ideologically bound to free market thinking.

If things go wrong we cast about for answers, prescriptions, like more or better regulation. But is it good enough to just call for tighter regulations or does that leave us on the merry-go-round, destined to return to the same spot over and over? Do we seriously question the underlying ideology and related public policy? Are we willing to consider systemic change or just tinker on the surface? I'm curious to see what position Phillips might take on this and what arguments he brings to the table.
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I suppose it would depend on who's ideologies you wanted to compare.

"Adam Smith would have been amazed at the new financial services sector and its close interconnection with government, politics, and power; Jean-Baptiste Colbert, the French architect of seventeenth-century mercantilism, would simply have smiled."

There is no question of an on-going debate as to the role of government in a free-market, as acts and laws are enacted which do their best to skirt around a multitude of sensitive issues. There is no index section on "ideology" or even "free-market" so I must scan for appropriate quotations. I think that Phillips would agree with the principals of the free market across all sectors; however, he has undoubtedly shown the folly of governmental deregulation and a myopic focus on the financial sector.

"For Washington to have made such a tentative choice in 1988 was momentous. Finance become the chosen sector of the U.S. economy - the one that would be protected and promoted because it was too important to fail. Manufacturing would receive no such help, however excited members of Congress might get from time to time."

The largely unchosen ideology of America: financial mercantilism, "to describe a nation's favoritism to its own exports through subsidies or easy financing." I don't expect Phillips to go much deeper than this. He has yet to make any recommendations in fact, and I think to begin talking in a much deeper sense would essentially become a legal debate for limitation on freedom (i.e. it is not your right to speculate etc). Needed as discussion about inherent restrictions/intentional directionality may be, the brick wall rises quickly to divide imagination and reality. Both imagination and reality have their natural places; however, Phillips is firmly on the reality side in this book, he has given no indication thus far that he even has an imagination!!

Chapter 3 Bullnomics seems be more where this discussion is heading.

I have my own thought's and opinion's. What specifically do you have in mind for fundamental revisions, ideologically speaking?

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giselle wrote:There is evidence of that here in Canada. We re-elected a government recently that is ideologically bound to free market thinking.
More worrisome we see a Canadian government dedictated to ill-conceived neoliberalism and subsidization of fossil fuel production. Essentially tying the dollar to the price of oil and a great cost to the potency of diversification. Phillips would see this one-sidedness as a grave fallibility.

"Either officialdom didn't really understand what was happening or there wasn't much interest in measuring it."

To reverberate I don't expect Phillips to get political in any partisan sense. I expect a fair round will be taken out of Thatcherism and Reaganomics as well as the effects and implication of the Bush legacy. Clinton will not escape un-sullied. The political commentary has been and I expect will continue steadly to be of the stripe seen in these quotations:

"As a further pledge of allegiance to the eighteenth-century British free-market apostle, many Reaganites took to wearing Adam Smith ties."

"Northeastern finance was realigning toward the Democrats, but in contrast to the 'Arrogant Capital' dominating the Republican Party, the Democratic financial element represented 'Humble Capital.'"

"Humble proved to be humbug."

About GWB2, "many pundits assailed him for urging consumption, not the shared sacrifice usually propounded in wartime."

Again, nothing too futuristic....yet.

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Last edited by Grim on Sun Jan 18, 2009 11:11 pm, edited 1 time in total.
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CDO's are tranches. So whenever Phillips is talking about either, he's most likely talking about the same idea.

The selling of bum goods to consumers is nothing new. The markets have a way of finding out quickly which products are bum goods and which aren't. The companies that produce bum goods don't get our money. Consumers rely on word of mouth, consumer reporting agencies, and other outlets of information to help us make an accurate decision when buying something.

The reason I gave Realiz a thank-you was because there is no possible way to get the information necessary to make an informed decision when accurate information is withheld or when that information is above the comprehension of the average individual.

Who was the common American to know the inner workings of the financial sector? Those who claim to know it get it wrong themselves on occasion. It feels like our leaders have hung us out to dry. The only consolation I have is that it has provided fertile soil for change.

The packaging and selling of risky debt should have been seen as an obvious no-no. I'm still not convinced where it went wrong. It seems like someone should have recognized all the risk and put an end to it... and if they didn't then they should have been allowed to fail or succeed like any gambler.

Taking down the entire economy? That sounds like the duty of the government to make sure that never happened. Why is it that government handed over the reigns so easily? More than that, they colluded and fostered the financial sectors massive growth and power. It's the government's job to set up ground rules FOR the market so that costs are lowered and there are clearly defined boundaries to promote fair competition - not to hand the fate of the country to greedy individuals.

Possibly the worst thing is that the debt could have been used for creative purposes that added value to everyone's lives - rather than the lives of the top 1 or 2 percent. The money could have been used to make the country more productive and richer as a whole. What a waste.

Phillips brings this point to light when he says that the debt the United States has been piling on in the last few years has provided only 30%-40% as much stimulus per dollar to the national economy as did the debt added 25 or 40 years ago.

The money that could have been used to produce stuff was "borrowed by 10,000 hedge funds to double the leverage of their various self-serving speculations."

I had no idea that the FED did covert market buying and selling. I think that's some funny stuff. WOW. Go PPT - you shady bastards!

All this stuff, to me anyway, destroys free competition. It's a total perversion. It's disgusting. So so two faced. To promote free competition and then make sure it doesn't really happen isn't what Milton Friedman wanted. I feel Phillips sometimes uses him as a scapegoat for freewheeling berserko markets - but from what I can remember from his lectures - he wanted government to intervene only in order to set ground rules for fair competition.... not to make sure markets or companies had a helping hand no matter what.

Friedman WANTED rules - just not unnecessary ones. There seems to be some necessary rules needed here. SOMEONE sold this country out and now those same someones want us to dig it the f*ck out. Sh*t on them.
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