Want to know if this crash is serious? Then gather round, let's look at it objectively, rationally

The collapse in prices on the stock market today is a very, very bad sign, and we are in very, very dangerous territory. But it doesn't necessarily mean we are in a depression, a recession or even a bear market.

If you want to know if this crash has significance for the real economy, I can give you some indicators to look for in the coming days. The thing is, though, that you're going to have to learn a little about the stock market, stock prices and how anyone figures out whether the market price of a share of stock reflects what a particular stock is worth.

If you think the stock market is just a big casino where people gamble, you should probably stop reading here. Because I want to explain how in many ways it's not just a big casino. If your basic feeling about the financial system is "let it collapse" then this is not the thread for you also. If you think that the best thing is for everyone to get a rifle and live off squirrel meat for the next 10 years, then once again, this isn't the thread for you.

Ok, so if you are still reading, you are not dismissive of Wall Street as a casino, you don't want to "let it collapse," and you haven't resigned yourself to squirrel meat for the foreseeable future.

Now, the main question, really the only question, in circumstances like this is: Are these current collapsing stock prices justified? How do we know if the price of a stock or a basket of stocks like the Dow, reflects what the stock is worth? If the collapse doesn't reflect what the stock is worth, the market could recover. If the collapse does reflect what the stock is worth, the market will not recover, and we are in for a long, ugly bear market, and recession or depression. The kicker is that the collapse itself, even if it does not reflect what stock is worth, can ultimately affect what stock is worth.

So what is a share of stock worth? Why is the stock market not just a big casino?

First you need to try to understand how markets and investor value any security.

Imagine a stable economy in which the stock market, bond market, and banking system are functioning smoothly. Imagine the economy of the late 90s in the last years of the Clinton administration -- the so-called Goldilocks economy: "not too hot, not too cold, just right."

In that kind of economy there is a fairly stable "prevailing interest rate." That's the rate that people will pay you if you deposit money in the bank or buy a bond. Because all the markets are working smoothly, the rates tend to be similar in different markets -- the bond market, the money markets, the stock market, and bank accounts.

Let's say the prevailing interest rate is 5%. If you buy a bond for $100, then you expect to get $5 interest for the year. If you deposit $100 in a bank account, you will have $105 at the end of the year.

Now here is an important concept you need to understand. Let's say that several years ago, interest rates were higher, like 10% and some company issued a $100 bond that paid 10% or $10. That's twice as much as the market is currently paying. So bond buyers will try to buy that bond because it pays better than the market prevailing interest rate and those bond buyers will bid the price up on that bond. When the price of that bond is $150 but is still paying $10, the interest rate stated on the bond on its face value is still 10%, but the buyer didn't pay the face value of $100, he paid $150. So the buyer's effective interest rate is not 10%, but 6.6% ($10/$150 = 6.66%). It's still a good deal because it's better than 5%, so buyers continue to bid the price up. When the price reaches $200, the interest of $10 on the face value becomes $10/$200 = 5%. Now the bond is exactly like a $100 bond paying $5 or 5%.

That means the bonds are in equilibrium.

Notice that the interest rate on the bond's face value of $100 is stated to be 10%. But anyone who bought the bond at $200 is actually getting 5%. It is, economically, just like any other $100 / 5% bond in our smoothly functioning market. But we need a word to explain the difference between its stated interest rate -- 10% -- and what the guy who bought it at $200 gets -- 5%.

That word is its "yield."

The bond has a stated interest rate of 10% but a yield of 5%.

Stocks, like bonds, pay something like interest. The "interest" on a share of stock is called its "dividend." The big difference between a dividend and an interest rate is that dividends change; interest doesn't change. If interest changes, the bond is in default. But the managers of a corporation have absolute discretion to "declare" the dividend rate depending on how much profits the company made.

So if there is a prevailing interest rate, like 5%, stock prices vary up and down until the dividend rate "yield" is equal to the prevailing interest rate. (It's actually often calculated backwards in a number called "price to earnings ratio" but that's a different story.) The entire game of the rise and fall of stock prices has to do with making the price of a stock and the amount of its dividend look something like the "yield" on a bond.

So let's say Microsoft shares are selling at $100 per share and paying a dividend of $5. Then the price of the share is perfect. Its price and dividend reflects the prevailing interest rate.

But if Microsoft announces a new office suite, and suddenly makes mega profits and can distribute $20 in dividends, then its share price will rise -- must rise -- to $400. The price of Microsoft needs to be the number that makes its yield equal to the yield of a bond bond at the prevailing interest rate -- which in this example is $400 ($20/$400 = 5%).

That's how stockholders make money in a good, solid, rational economy -- because the company they bought stock in comes out with a cool new product, makes lots of money, raises its dividend, and therefore raises its stock prices.

Now, what does all this have to do with the current panic? It's this: The collapse in stock prices in a panic does not necessarily reflect a change in the profits of the underlying companies.

Therefore the decrease in stock price may not be justified. If for example, the $400 share of Microsoft collapses to $200, but is still paying a dividend of $20, it will be like a bond paying 10% in a market where the prevailing interest rate is 5%.

In a few days, we could expect bond holders or stockholders of lower performing stock to start snapping up Microsoft and bid the price back up to $400.

After both the 1929 crash and the 1987 crash, the prices of stocks rose back to where they had been in a few weeks or months after the crash. That's because the underlying profits of the companies hadn't changed in the short run.

But 1929 ended up being different from 1987 -- why?

Because 1987 was basically a pure panic. Corporate profits, and therefore dividends didn't really change. "Bargain hunters" rushed in and bought undervalued stock. By January, the share prices were back to normal and continued to rise, and those higher prices reflected the profits that were distributed as dividends.

Why didn't that happen in 1929?

Because in 1929, the crash itself ended up affecting corporate profits. In 1929, the crash occurred in the fall. By January, share prices were back to where they had been, but then, share prices went into a long, slow, miserable, inexorable decline to where they had been at the lowest point of the crash or even lower.

The reason was that the stock market crash affected the corporate profits underlying stock prices by drying up credit.

That's the danger we face now.

If, for example, the market for commercial paper remains frozen and actually gets worse because of panic in the stock market, then most companies will be unable to roll over their commercial paper. They will be unable to buy supplies or meet payroll. They will lay people off and produce less products and therefore make less profits. The laid off workers will buy less, which means profits for other companies will also go down. The market crash, which should have meant nothing, will mean something. We will be in a vicious cycle of declining employment, declining household incomes, declining production, declining corporate profits and declining stock prices.

So look for layoffs, a continued freeze in commercial paper, plant closings, and other indicators of whether the stock market crash affects corporate profits.

I know this sounds like heresy for a liberal blog site, but if you don't want a depression, you should hope that corporate profits and dividends are not affected by the current market turmoil.

We just have to hope that the credit freeze can be overcome.

Any idea how quickly the government can start their commercial paper purchases? My impression is that it may take several weeks to get it started. Those will be nail biting weeks.

:bounce:

When we went south for the third summer of August every year for our family reunion on my grandma's farm, my uncle would go squirrel hunting, and he would cook a huge pot of squirrel stew. It was very delicious. We would have to spit out the shot gun pellets in our plates, though.

We kids got to keep the squirrel tails, which we took back to New York and tied to the back of our bicycles.

I just don't think all 300 million of us can live off squirrel for very long.

as well as they MOVE in the weekend to partially nationalize banks and get the EBS going

It will hold on the panic... and will get the credit unstock

I always enjoy your posts.

the worse it becomes. Everyone tightens their wallets automatically, which does nothing for the circulation of funds, which does nothing for the profit margin you speak of. Before all this started we were already in a recession,so there's nothing out of the ordinary, but it's like reading a medical symptom book, one starts to take on all kinds of diseases if it is perceived that one has a reason to. Of course, I admit I am a definite financial dummy, but I am a real skeptic when it comes to how the media is always paid to report certain things.Why would they say the sky is falling all the time, even if it isn't? I don't know. But we were also told that Iraq had WMD, and that things were going well over there...remember??? It's bad, sure, but really is it THAT bad??

People fear that their incomes will drop and thus consumption goes down, triggering layoffs, causing consumption to actually go down, causing more layoffs, etc. and thus you have a vicious cycle. the less confidence there is the deeper the vicious cycle will get. The number of people going "Abandon ship! invest in gold and mattresses" indicates to me that there is going to be a substantial retrenchment and thus we are going to have a bad recession.

It's all psychology IMO.

And would that not mean that stocks, measured in dollars, are worth less also? For example, if the dollar loses half of its value, should not the stocks that are measured in dollars, also lose half their value, generally speaking? Do you deficits really matter??

Bear in mind that this is not just a US problem. If it were, others would naturally be dumping the dollar with the hope of buying dollar-denominated assets later. However, the credit crisis is global in scope, as Europe and Asia have also been wallowing in easy credit for the last several years, and thus many other places have also experienced a housing boom and are now experiencing a bust.

So our economy is sinking, but not relative to other countries' economies; rather it is sinking relative to the wildly unrealistic expectations that were built up in recent years by an unsustainable fiscal policy.

The same is true of all dollar denominated investments. A big driving force of the 1970s bear market was the high level of inflation, which eroded the value of investments and investment returns.

although I've lost enough paper profit to represent almost 2 decades of what I made as an RN, my income hasn't changed. I own the same things I did before.

"It's this: The collapse in stock prices in a panic does not necessarily reflect a change in the profits of the underlying companies."

Your stock is worth what it always was. Your earnings per share will be what they were. Only a bunch of numbers have changed and if you weren't using those numbers to leverage debt, nothing much has changed for you.

However, the real danger in all this is the credit squeeze caused by the partial collapse of mortgage based derivatives like CDSes and CDOs and Structured Investment Vehicles and all the other creative crap hedge funds came up with to fool institutions into thinking they weren't just bum house loans in California and Florida.

Panic sellers are being shaken out of the market and panicky types probably shouldn't have been there in the first place.

The company he use to work for was bought out by an Indian communication mega corporation. They decided to shut down the Chicago office. My hubby had been looking for a new job for almost a year since he saw it coming. He took the first substantial offer. It is in Portland, Or. He left two weeks ago. Our house went on the market last Tuesday, the day the market had it's largest drop in history. So far no showings. I don't know when my kids will see their Dad again. Yesterday I was officially laid off. Today I wait for the phone to ring. It's so quiet......except for my pounding heartbeat.

:hug:

It's been a rough day! :hug:

...big :hug:

I'm sittin' in the crapper, too. I bought my first condo in July 2007 then got laid off in December. Sure would have been nice NOT to have turned all of that savings into equity, equity that I can't access now since I can't even find enough temp work--forgetabout full-time--to open an equity credit line.

Stocks, in those days, never paid as much in dividends as CD's did in interest. At least not for most stocks. However, because it was a six year bull market, "investors" didn't care about the dividend yield, because they were raking it in with capital gains.

I also do not understand the bond market. A $100 bond may pay 10% and that is all well and good, but as an investor, I myself, do not care that much about yield. Whether a bond pays 10% or 5% is not that big a deal to me. It is not nearly as important as GETTING BACK MY FRIGGING PRINCIPLE. At some point, doesn't the bond have to give me back my $100? How does that work if I am some kind of moran who bought a $100 bond for $200 because of its high yield?

Same thing with stocks. It is very easy to buy a stock, like I did with Consumers Power. At the time I bought it for $19 it paid a dividend rate of about 20% (which was kinda standard in those days for utility stocks). However, because of some safety problems that I was clueless about, it dropped its dividend to 40 cents a share and the price also fell to about $10 a share. The loss of dividend income was not as important as the loss of $900 in principle (even if one may have followed the other). So anyway, unlike bond and bank investments, stocks offer the possibility of higher yields than just their dividends and also the possibility of loss.

Two weeks ago, you said there was a crisis which absolutely, positively required our hundreds-of-billions of tax dollars to fix -- right away.

Now, the biggest market plunge of all is, amazingly, not a sign of a crisis after all.

Er, yeah. :eyes:

So we don't know whether it will work.

And of course, to write what you wrote, you must know the difference between the stock market and the fixed income (bond) markets, right?

The credit markets are still frozen and we are still in crisis mode. The Fed is thinking of buying commercial paper, something that has never been done to my knowledge.

To recap: the credit markets are in crisis. The stock market is an epiphenomenon of the credit market crisis. But the stock market could through a feedback loop, make the credit market crisis worse. If you read the OP, you would realize that I'm saying situation is dire.

As I wrote earlier today, food shipments are grinding to a halt because of the credit market crisis:

http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=389&topic_id=4200077&mesg_id=4200077

But until we get the credit markets moving again, the stock market will continue to be in the toilet. And the bailout was a late solution to a pressing problem, one which requires several weeks to take effect. What the stock market is doing now is pricing in the losses from the delayed action.

The market has been overinflated just like the real estate market. It needs to get back to reality.

faith. People no longer have faith in the system because they are convinced that the system is rigged, which in effect it is.

I was trying to write a primer, not a thesis. But you point out a very important phenomenon, and economists call it the problem of "asymmetry of information," a fancy way of saying one guy in a transaction might be lying or withholding information.

So if you think that the CEO of a corporation whose stock you are buying is madly selling on insider info, economists would say that you are experiencing an asymmetry of information, and you could call it lack of faith as well.

thanks for the explanation but why no mention of who or why this mess was created...

Credit Default Swaps, Commoddities Futures Modernization Act or Gramm-Leach-Bliley Act

Stock prices are not just a multiple of current corporate earnings. They are a multiple of expected corporate earnings.

Various measures of economic activity are falling. Retail sales for many stores are down 10 to 15% year over year for comparable stores in September. Gasoline consumption is falling, not just in total $ value, but also in gallons consumed.

Plus, the US is now an 80% services economy. Once people start doing their own nails, how are you going to easily restart demand for nail salons? A 0.5% cut in overnight lending rates isn't going to do it.

The key issues are that:

a. American's weren't saving, but instead running up debt, and

b. Importing more than they exported, with foreign investment coming in to fund the debt.

Foreigners are unwilling to fund our debt.

Therefore, consumption must go down and savings must go up.

Meanwhile, this will cause a huge dislocation in an economy which is geared to consumer consumption, to over spending, and to a negative trade balance importing cheap goods.

An important point. Corporate profits in the financial sector were falling badly, which is what started dragging down the rest of the market. In fact, several financial stocks simply disappeared (practically) when the companies collapsed. Fear that that could happen to other financials brought down financial stocks in general, which helped precipitate the panic. Now, as a result of the credit freeze, corporate profits are falling all around. The question is: is the fall in corporate profits temporary such that if the Fed gets credit moving again it will recover?

... but I don't have the patience to go into all of it.

But I will say this, looking at trailing P/Es is a joke, because profits are going to be hard to come by in this economy for YEARS. Stock prices should be based on earnings, EARNINGS will be in the toilet for a long long time.

So, it's not a crisis for me because I got out of the stock market long ago, but it is damn sure a crisis for folks who are losing a fortune on their "investments".

but otherwise, I am confident the country will come back from this.

It is important for people to understand the valuation process, but valuations have been so high that even seasoned investors get disoriented. The trailing PE is IIRC 20, which is still historically overvalued, and will get worse with the next earnings season.

If I hold 100 shares of a stock valued by the market at $12.85 each today and the price drops to $10.13 tomorrow I will not lose a dime unless I sell at the lower price. If I just go about my business and wait the price wil come back - providing the company survives. This is true simply because over time inflation, even if very slow, is omnipresent.

We're still pretty fucked, but maybe the screwing won't last as long. :o

The 1987 crash, believe it or not, was much worse. The Dow lost 22% in one day. That would be like if the Dow had losing 2000 points yesterday rather than 700.

But within months, the market rebounded. That was a panic but it wasn't a bear market. This could be both -- a panic that leads to a bear market, but we won't know for some weeks or even months.

Different economic situations, different psychological aspects. IMO it is ultimately the psychological aspects that impact the ultimate economic situation.

(Y'know, those things that McCain fondly believed were "strong" up until he realized that was a politically untenable belief...)

Unfortunately, the structure of our economy has accreted a great deal of irrational and uncontrolled/uncontrollable motivating force that distorts its function far out of the simple and rational value vs. price equation. (See this hilarious satire for a quick take on some of that: http://bigpicture.typepad.com/comments/2008/10/bird-and-fortun.html)

And the components of our economy are very far out of balance. The economy is supporting, and (was) being supported by a vastly inflated financial services sector that represented far too much capital, far too many jobs, and far too little actual value. The perception that the financial services industry offered fabulous opportunities for profit and wealth-building sucked far too much life blood (liquidity and currency and CASH, essentially) into a bizarre escalating spiral of trading intangibles-- the kinds of things that Warren Buffett always claimed he wouldn't invest in, because he couldn't get an accurate valuation.

A tiny germ of actual value (Granny's mortgage, or Uncle Kyle's business loan, or Cousin Anna Mae's IPO shares, or a thousand acres of scrub land in the Amazon basin) gets mutated into packaged and re-packaged "products" that have been bought, and sold, and re-sold, and insured, and re-insured, and turned into security and recategorized a dozen different ways, all in order to generate revenue for the financial services industry. By the time they've been part of a dozen or more transactions they carry a weight of hypothetical value all out of proportion to their actual value. They've produced far more revenue in transaction fees and interest and service charges, etc., than they initially sold for. And every time some clever MBA thinks of yet another way to re-package them and add more hypothetical value they're recycled through the market again, creating paper profits that are eventually sucked out of the economy and squirreled away into offshore accounts and real estate and bonds in some rich oligarch's net worth.

In the process, they do create jobs, they do enable the people working in the financial services industry to buy houses and cars and occasionally pay a few cents in taxes and actually cycle cash through the tangible-value economy that most of us depend on. But it's a fragile and unbalanced benefit. Yes, in one sense it is the great strength of our economic system that a single $100,000 in tangible value can, by cycling through the banking and investment and insurance and other market sectors, end up generating far more than $100,000 in cash cycling through the economy, over and above its potential concrete earnings as the mortgagee pays off the loan. But it also carries the weight of that additional revenue and the risk that its value will become inflated far beyond the actual $100,000 and someone will end up holding the bag.

That's why intelligent nations and markets and economies set limits on how much and in what way tangible value can be manipulated, sold, re-sold, increased, etc. How much risk can accrue and to whom. To preserve a sensible price to value equation. But that limits the potential revenues and profits in the financial services industry and keeps the size of that sector comparatively small.

I think we're seeing the collapse of that sector of the economy and I would speculate that once the dust settles, the skeletons are dragged out of the closets, new regulations and structures are designed and put into place, the financial services industry in the U.S. will be nearly thirty percent smaller than in 2007. And it will represent a much smaller share of the GDP. Possibly as little as six or seven percent.

That will entail an awful lot of economic fallout. We're going to have to replace those jobs with something. Without substantial investment and incentives to re-invent our power infrastructure, our transportation infrastructure, and our physical infrastructure, we could be in for a very long and nasty slump. The question is, will an Obama administration and a Democratic-controlled Congress have the guts to pile deficit spending onto the already huge national debt, in order to do that jump-starting?

pessimistically,
Bright

From what I hear Obama saying is that he and his economic advisers are fully aware of the steps that need to be taken in concert with other central banks worldwide. We need unprecedented global co-operation at this point to prevent a further "silent" run on the banks which feeds on the already existing panic, which in turn would doom us to a death spiral of national bankruptcies.

Few people seem to get how totally interconnected the global organism and its networks have become.

Thank you. So the news we have to watch out for is layoffs, continuing credit freeze & business closures.

I feel much better now.

Companies do not sell their stock in the stock market and the price of shares has no effect on the company other than that a constantly rising share price makes for more satisfied shareholders and is the devoted duty of the managers the company is entrusted to.

So if the price of General Motors stock goes from $40 up to $100 or from $90 down to $30 it won't put a dime into or take a dime out of the vault at GM. The stock market is a secondary market, the place in which second hand shares are bought and sold. So just as the price of a 2004 Chevy on the open market has nothing to do with GM's profitability today neither does its share price reflect its current conditon other than that it inspires would be buyers to bit the price up or down.

1) the price of a stock reflect's the market's expectation about future profitability, giving rise to a feedback loop with suppliers of everything from raw materials to finance

2) it limits the company's ability to raise capital by issuing stock

3) to the extent that wealth is destroyed in the market, it's not available for the purpose of buying goods and services

So while a plunging stock doesn't affect day to day operations directly, it certainly does so through secondary psychological channels.

Publicly traded companies absolutely sell and buy their own stock on the market. The number of "Authorized Shares" that are publicly traded is called the "float" but almost every single publicly traded company will retain on issue a percentage of the authorized shares and can and will from time to time either sell a portion of them to raise money or buy them (share re-purchase) from the market for any number of reasons, such as they have excess cash on hand and the share price is depressed. They might also buy back large blocks to shield them from a takeover. http://www.investopedia.com/articles/basics/03/030703.asp

It might not put a dime into the vault at GM but a rising share price most certainly boosts the firms value and it is reflected on their balance sheet because they hold shares in their own treasury. Likewise a plummeting share value has a negative effect on the companies finances and balance sheet.

And there is absolutely nothing stopping a publicly traded company from participating in that market.

There is a HUGE difference between a company's product and their common stock. The two are in no way whatsoever comparable, even in an analogous way.

Of course companies go onto the market and buy back their own shares, and yes, it is possible for a company to sell directly into the market (though I don't think that is possible on the New York Exchange) but in fact it is not the norm and certainly doesn't make up the bulk or even a significant percentage of everyday sales. That said its is your last quote and statement that is most absurd. I said jut as the first has nothing to do with the second and you counter by saying I am wrong because they are not comparable. How is what I said any different than what you said? Jeesh ...

This is a retirement town with big money. Doesn't matter. Our economy is grinding to a halt. That tells me more than any numbers anywhere.

I certainly don't think that the stock market when operating responsibly is a big casino. But there are a number of high flying traders who do treat it just that way and are not for the most part looking to make make money from dividend yields. They are essentially moving in quickly and then selling on rallies. Does this distort the entire picture? Does this explain at least in part the wild swings in the market over the past week? Is this kind of trading harmful?

Could it be that we are in a situation in which lots of ordinary people are simply getting out of the market altogether? I certainly know people, some with $50,000 to $60,000 and others with hundreds of thousands and more who are simply pulling out completely and putting their money in lower risk investments or just keeping it in the bank or buying gold. I get the impression that this is happening all over the place on a scale not seen in a long, long time. Even on CNBC there are a few advisers recommending doing exactly that. If this is the case, that people are just leaving the market altogether for the foreseeable future, will this not keep pushing the market down and keeping it down until the fundamental fear is relieved?

I understand how a frozen credit market drives down profits and thus produces a falling stock market. What is the basic mechanism in which falling stocks increases the freezing of the credit market?

I'm hearing it said that most major American banks are simply so over leveraged that if they were truly transparent, the majority of them are probably at least technically insolvent. IF this is true, will the credit markets continue to remain at least somewhat frozen until they are recapitalized? Given that such recapitalization would probably cost trillions, is it correct to surmise that only when housing prices start to approach the level near where they were before the collapse of the housing bubble - will most banks find themselves in a strong enough position to return to lending as usual - freely enough to sustain a healthy economy? If that is the case, is it fair to guess that this will take, at the very least a few years?

The overall dynamic you are painting is correct. Lots of people are getting out of the market because of fear, which is justified. Even if corporate profits don't justify the decline (and I don't know one way or another if they do or don't), fear can become a self fulfilling prophecy, inducing more and more selling, driving shares down. Giant hedge funds and investment funds are selling because they expect investors to be demanding their money back. Speculators also get in on the downward slide (although short selling was temporarily banned).

Another feed back loop by which the stock market affects the credit market is that in many instances, when corporations borrow, they use their shares as collateral. If, for example High Tech Startup Inc. borrows money from a bank, the main shareholder-inventor will have to pledge all his shares to the bank as collateral. If share prices are collapsing, that collateral is worth less, making the bank less eager to lend. Banks generally cannot invest in stocks, but they take them as collateral a lot.

I challenge you to repost this in four months. I'm bookmarking this thread; I will not respond in it again.

None of which have be borne out...

:hi:

I said that a bailout was necessary and the key struggle would be over pricing and equity feds.

Looks like the Congressional Democrats agreed with me and passed the bailout bill. And sure enough, the struggle is over pricing and equity for the feds.

We'll see what happens to the credit markets when the mortgage security program gets going, but even when it does, I did not predict it would work and only hope it will, but doing nothing would be catastrophic.

So there is little basis to take your current predictions seriously. :hi:

One of the differences that we are facing in today's markets is that there is/was a 'casino effect' in the mortgage securities that were issued with little to no underwriting, whose value is currently not really subject to valuation because of the larger than usual number of defaults. No one can predict the income stream from the cluster of defaulted mortgages. This was made worse by the credit default swap market which is basically secret. No one knows what is going on with the guarantors of these defaulted instruments. AIG and other insurers are basically guaranteeing an enormous default and their capital is or may be wiped out.

In the 1999 amendment that basically revoked the Glass-Stegall Act, there is actually a provision that states that this federal law pre-empts any state laws prohibiting gaming (read 'gambling'), and that the trading markets that were authorized with little or no regulation couldn't be shut down by states because they resembled gambling.

Another issue that I'm not sure you addressed is that if the credit markets don't unfreeze anytime soon, there aren't going to be any buyers of durable consumer goods basically guaranteeing a very deep recession. Nothing that they have done, has affected the credit markets yet. Today they are talking about limited nationalization of some banks in the US (Treasury buying bank stock) to recapitalize them since many are technically insolvent. It remains to be seen if the government's ownership stake is going to affect the boards of those banks in a way to require them to lend money...which may or may not be in the interest of the other stockholders.

We are in a new paradigm here. I think all bets are off

We are in deep economic shit and probably will be for quite some time to come

First of all, a little clarity regarding bonds, their interest rates and yields.

You said;
That is not really the case. The interest rate a bond pays (called the "Coupon rate", a term that is a throwback to the days when bonds were issued in paper form with an actual tear-off "coupon" that was submitted to the issuer in order to receive the interest payment) is in large part disconnected from the rate of interest a savings account, a Money Market Fund or a CD might pay. They are completely different animals. Different issuers of debt securities have different credit ratings and a firm like Caterpillar for instance will be able to issue bonds at a lower coupon than a company of similar size that is on shaky financial footing. Also, short term notes tend to have a lower coupon than longer term ones because there is less risk of default the shorter the term. It's a pretty good bet that a strong company will be around in 3 months, so short term paper generally has a lower coupon. But longer terms like 30 years raises more doubt, therefore longer term bonds demand higher coupon rates. The 90 day Treasury is yielding around .5% these days, which means if you bought and held one $1000 90 day treasury for 12 months you would get $1005 back (This is illustrative only, as 90 day Treasury paper is what is known as a "Zero" meaning it pays no coupon, but is sold below par and matures at par. The interest is the difference between the purchase price and redemption price). The 30 year Treasury is yielding 4.07% http://www.bloomberg.com/markets/rates/index.html
The bond market is very diverse and complex and your description here is entirely too simplistic.


Close, but you left out an important point when figuring yield. Time to maturity. Current yield is simply a mathematical result of annual income divided by purchase price. Yield to maturity calculations must include the accretion of value in the case of a bond purchased below par or the amortization of value in the case of a bond purchased at a premium to par. The price of a particular bond is determined by many factors, among them are supply and demand for that issue, changes in the Treasury Rates, changes in the financial health and/or credit rating of the issuer, time to maturity (which obviously changes every day) and many others. BTW, with very few exceptions, bonds have a "Par" value of $1,000.00. They "Mature" at par. A bond purchased below $1000 is called a "Discount" bond and one purchased above par is called a "Premium" bond.


It's not a "rate" per se. Companies declare a dividend as you suggest but it is an amount, not a rate. Caterpillar for instance, pays a dividend of $1.68 per share, per year (unless they decide to either suspend it, decrease it or increase it, all of which is entirely voluntary and it is paid quarterly, so every 3 months a shareholder would receive $.42 for each share owned) and the yield is therefore a calculation of income divided by price. At the end of trading today, CAT's dividend yield is 3.5% but this has absolutely NOTHING to do with prevailing yields in the bond market. If CAT shares are bid up tomorrow, the yield will fall. If CAT falls tomorrow, the yield will rise. It is in no way determined by anything going on in the bond market.

This is incorrect. As I stated above, the share price a stock trades at has absolutely nothing to do with bond yields. Nothing. Stock traders do not push stock prices up and down attempting to get their dividend yield to match prevailing bond yields. Besides, not all stocks pay dividends. There are plenty of major publicly traded corporations that do not pay dividends. If I am not mistaken, Microsoft only recently began paying one and Bank of America has suspended theirs. The Price to Earning Ratio has nothing to do with yield either. P/E is often looked at as an indicator of how expensive or cheap a stock is. Companies have earnings and when those earnings are divided by the total number of shares outstanding, you get the Earnings Per Share (EPS). Divide the share price by the EPS and you get the Price to Earnings Ratio. If a P/E is 9.00, it means that investors are essentially willing to pay $9.00 for every $1.00 in earnings. The higher P/E, the more expensive the stock is considered to be. There is "Trailing P/E" and there is "Forward P/E". Trailing is a fact. Forward is an assumption.

The rest of your post is reasonable. I have read with interest your posts of late and you seem to be fairly knowledgeable. I am merely attempting to provide accuracy. There is an awful lot of misinformation and misunderstanding on this board regarding the markets and their operation and I would hope you agree that accuracy is important.

There are people on DU who know absolutely nothing about the stock market and share prices. This is a primer for them, and is intended to give them a basic understanding of why share prices go up and down, and how that is related to corporate profits and interest rates.

Of course there are many different interest rates -- the rates set by the Fed, the prime set by banks, money market and so on, and they are not the same. However, the rates set by the Fed have a strong influence on the other rates, so although the concept of a prevailing interest rate is a heuristic devise used in macroeconomic theory, it has a correlation in reality. I also left out for those trying to learn about the stock market risk calculations and how retained profits affect stock prices.

But the thrust of your critique seems to be this, which is wrong: "As I stated above, the share price a stock trades at has absolutely nothing to do with bond yields. Nothing. Stock traders do not push stock prices up and down attempting to get their dividend yield to match prevailing bond yields."

That's simply wrong. While not every stock trader trades for the purpose of getting stock yields to match bond yields, interest rates affect the stock market. That's why most times when the Fed cuts interest rates, the stock market rallies. The stock market and bond markets are substitute investments markets and when interest rates fall, money pours into the stock market prompting a rally. A catastrophic long term bear market will keep money out of the stock market and having to be put somewhere, much that money will be invested fixed income markets. Again, this is a schematic for the majority of DUers who no nothing about the stock market and want to learn.

I'll be posting a more nuanced version of the OP at my blog later today.

is fear itself.




Thank you for this explanation.

We're not necessarily in a recession, depression, or even a bear market? 'Scuse me, but can I have some of that rose colored acid that you're taking, because from where I, and most other serious economists sit, we're in a recession bub, one that is quickly becoming much worse, heading for depression territory. As far as the markets go, yes, we're in a bear market, which is roughly defined as a loss of 20% in a two month time period. Sound familiar? For being some sort of stock expert, you really seem unsure of the basics. Or perhaps for whatever motives, you're desperately trying to talk the markets up:shrug: I have no idea, but I find your statements laughable, especially in light of your so called expertise.

Oh, and corporate profits and dividends, they're being affected already, or haven't you noticed the flood of restated earnings reports coming out?

You're relentless talk about how it's not as bad as we all think reminds me of the dance band on the Titanic, grimly playing on while slowly sliding under. Or better yet, the Black Night in Monty Python's Holy Grail. No matter what happens, you're going to continue to deny the reality of the situation and remain relentlessly, and foolishly upbeat until, and even after the very worst has happened.

Well, you might appear knowledgeable and sophisticated, you might even attract some adherents. But your message is dangerously naive, and not only are you putting your own financial security at risk, but you're foolishly attempting to put others' at risk also. Tell you what, why don't you simply back off and allow people to make their own decisions based on information that they know and trust, rather than biased BS coming from an anonymous internet poster who obviously doesn't have a clue, and worse yet, doesn't have their best interest at heart.

After all, how's that bailout going, you know, the one you thought would for sure bring the economy and markets around, the one you were pimping around here like a ten dollar trick? Oh, yeah:eyes:, never mind.

Maybe you should be having this argument with the strawman you've created, rather than with me.

And yes, I am an anonymous internet poster -- as opposed to your famous but unnamed economist wife and all those famous but unnamed economists who advise you.

You are actually sitting there telling people that we're not necessarily in a bear market, when the fact of the matter is that the markets have fallen over twenty percent in the past three weeks which is the very definition of a bear market. Hello, McFly! Worse, you're still spouting that crap that we're not in a recession, when economists started saying exactly the opposite six months ago
<http://www.usatoday.com/money/economy/2008-04-28-economy-survey-recession_N.htm?loc=interstitialskip>
<http://money.cnn.com/2008/03/13/news/economy/recession/index.htm?postversion=2008031315>
Not to mention what economic experts are saying now <http://www.forbes.com/intelligentinvesting/2008/10/06/Recession-consumer-bailout-panel3.html>

Your advice, your so called expertise is not just wrong, not just disingenuous, but it simply ignores the reality of what is happening around, which is flat out dangerous.

You claim to be some sort of expert, yet you have yet to present your credentials to this claim. I've at least let you and others know where I'm getting my information, and yes, I'm keeping my sources anonymous simply because the net, as you well know, is not the place to be throwing around names and identities, as you and others should well know. But at least I've put as much information concerning my credibility out there as I feel comfortable with. Where's your information concerning your credentials? What is your expertise? What is your vested interest in continuing to pump out this disinformation that you do?

Sorry, but your credibility is slipping with each post you make, and frankly one has to wonder what your motivation, or better yet, your vested interest is in continuing to spread lies and disinformation.

He is a true progressive in every meaning of the term. Economics did not even come up on that particular sub-forum. But there is no doubt that his heart and soul is on the side of ordinary people and especially the world's least fortunate people.

I do not know what more he could say to stress the dangerousness of the current situation.

I think people are so angry about the bailout and the massive losses so many are taking that we are turning our anger on each other.

First of all he NEVER said in ANY of his post that the bailout would fix the whole thing. He like Sen. Obama and Biden, Congressman Barney Frank and Sen. Dodd and most of the House and Senate Democrats agree that it was a necessary measure that if it wasn't taken credit markets would freeze up a lot more, there would be more bank failures and the results would be catastrophic and matters would quickly turn much, much worse.

and he said in this OP:

Go read his statements during the run up to the bailout vote. Then perhaps you'll understand why I'm questioning him on the bailout, even though he didn't mention it in his OP.

I also think that you need to go back to the OP and see what he is stating, that we're not necessarily in either a bear market or a recession, when the plain fact of the matter is that both the sheer numbers and the plain fact, along with the learned opinions of numerous economic experts contradict him. The OP is putting out disingenuous and dangerous advice, for reasons that are known only to him. I find this reprehensible, as should you.

Indeed, if one adjusts for inflation we have been in a long-term bear market since 2000, last year's peak was just a short-term bull market in a longer-term bear market. These things tend to be cyclical; a poster on a history message board I frequent who is a stock analyst and economic historian says that the US economy tends to flip back and forth between Bull and Bear every 15 to 20 years.

The big thing, IMO is psychology. We are in a period where people are psychologically primed to go into panic mode and not have any confidence, that is the big difference between now and the 2000 Crash. That is why the credit markets are dried up, confidence has been shattered. Because of the loss of confidence there will be economic retrenchment as consumption falls, unlike in 2001 when Bush told everyone to go shopping.

prior to the Paulson Sunday announcement.

I suspect I will continue to wait.

and in explaining sometimes say what could happen, but prediction is for magicians and clairvoyants.

But if you want a post of mine explaining the seriousness of the financial problems there are plenty of them, and I've consistently called this a "catastrophe" that could become worse than 1929:

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=389x4027506

"That is the picture of a generalized credit crisis. If banks can't trust each other on settlements, then they can't cash your checks or give you money from ATMs other than their own.

That's why this crisis is unprecedented. It's not even like 1929. This crisis actually looks much more like the financial panics of the late 1800s."

<end quote>

It's ironic that the same people who say those of us who were in favor of strong federal action were criticized as "chicken littles" who were "crying wolf" over a "make believe" crisis, but are also criticized for not painting a dire enough picture.

Which is it supposed to be?

:shrug:

Various predictions your OP:

"...I can give you some indicators to look for in the coming days."


"...We will be in a vicious cycle of declining employment, declining household incomes, declining production, declining corporate profits and declining stock prices.

So look for layoffs, a continued freeze in commercial paper, plant closings, and other indicators of whether the stock market crash affects corporate profits.

I know this sounds like heresy for a liberal blog site, but if you don't want a depression, you should hope that corporate profits and dividends are not affected by the current market turmoil."

So again, I will ask you: please to link to a single utterance of yours, posted to this forum, in which you predicted this meltdown prior to the Paulson announcement. Obviously, it is ludicrous for you to hold yourself out as an expert with some deep insight into this economy and where it is going unless you have previously demonstrated some deep insight into the same. :hi:

is the most likely outcome at the end of all this?

I think it's more 1929 and in for some very extended bad times (as you say, punctuated with false hope rallies and such)

(and while I have a basic familiarity with finance and howit works, growing every day thanks to Du sources of info and DUers like yourself, I am more than happy to listen to why you might not think my reason below is valid)

The numerous historical parallels in general which make this seem like a "historical loop" in which it is demonstrated that humans beings never really learn much of anything, collectively-speaking.

i.e Republican abuses of the Financial System -> corruption requiring regulation -> loss of trust among "system of theives" -> long-term systemic damage

Which is more or less what is happening today (yes, I know that the circumstances are not exact matches, but similar enough to be trouble in terms of how likely the damage is long-term and systemic vs short and on the surface). Excpet one prequel for today's situation is "Republicans invent a Propaganda Machine designed to melt reality and rewrite FDR and his ideas basically out of history and then dismantle FDR's New Deal regulations in the National Amnesia purposefully created ->"

Plus the Bushies have abused the institutions of State and leeched God knows how much taxpayer $$$$ to pump into the market through the PPT (I am curious to know what you think of that institution - do you believe it is real? - do you believe the Bushies are likely abusing as their own Privy Purse and to keep the bullshit inflated markets of a bankrupt nation in the air a littler longer?).

And if they haven't done it through the PPT, they've doneit in other ways yet undetected, you can be sure of that.

That's my take on it. I am interested to hear yours.

And again K & R for an excellent post! :toast:

Not very partial to squirrel meat, myself. Plus do you realize how fast every squirrel would be killed, every deer, and every tree cut if suddenly any significant percentage of the population was forced to "live off the land"?

:nuke:

The most important is that in 1929, Herbert Hoover was president and would remain president until FDR was sworn in in 1933.

Now, Bush is on his last sorry days. Obama will be sworn in in January 2009 with a Democratic majority in both houses of Congress. Moreover, Obama will inherit a largely nationalized financial sector and cooperative Fed under Bernanke.

I also suspect that international financial powers, hedge funds and speculators are shorting everything in one last orgy of pessimistic speculation and the day that Obama is declared winner, we could have the beginnings of a recovery of confidence. That's my hope.

In the spring, the administration hopefully will raise taxes on the rich and announce military withdrawal plans, signaling an end to massive deficits, ending some of the psychological pressure on the dollar.

In other words, by January we will have a super-empowered Democratic administration with economic tools that were unheard of in 1929.

(and we may have to agree to disagree...so long as it's civil, that's fine)

The caveat is that the Democratic party is SO FAR to the right, in almost every way (thanks to being housebroken for 30 years by the Bushiganda Machine, which even now the Democrats seem mostly clueless towards...but especially our Leadership - or what passes for it, anyway) can they even think in the way necessary (or do they even want to anymore, after years on the Corporate Tit of Wealth Maldistribution?) to achieve those ends.

Certainly after observing these last 8 years, and really everything since Iran-Contra, it seems to me that what the Democratic Leadership wants to do is what the Bushies want them to do and to keep out of the firing line of Hannity/Coulter/O'Reilly/et al.

But one thing Shock Doctrine states is that when crises hit, the ideas used are "the ones laying around". And is not this joke of a theft of a bailout proof positive this is true, when never a moment of alterantive was discussed and the Democratic Leadership NEVER EVEN CONSIDERED ADVANCING THEIR OWN BILL?!?

Yes, things have changed since Amerika was America, and a Free Nation.

Anyway, my point, the caveat is this: Can the Democrats even "institutionally remember" how to behave like ACTUAL DEMOCRATS?

I don't know, but from what I have seen to this moment, the odds are NOT in our favor. Maybe Obama and increased majorities will help them, if that is even possible given the now massively corrupted Amerikan Voting System, but I keep remembering that courage comes from within.

Then I remember how the Democratic Congress, already full of spineless jellyfish (they showed that when they swept the treason of Iran-Contar under the rug because they were scared to impeach Reagan, and said as much at the time) behaved in the years they controlled both houses and the throne in 93-94, and I have serious doubts.

I mean look at the bailout. It got sent to the Senate and they added Bushie TAX CUTS! Come on, now! If this is majority it sure looks almost indistinguishable from the ass-end of minority party.

And I will say one basic, simple truth that is simply as close to a total truth as could be. If the situation was fully reversed from 2002-2006, Obama plus both houses of Congress, it is CERTAIN that the Repubs will NOT behave as the Democrats did in a similar positio. You won't catch THEM serially capitulating to Obama's policies. You won't catch THEM toadying and running scared at Obama's Threats (not that he would even make them, like Bush, but even if he did...).

Like it or not, that is the absolute and unvarnished, almost the wholly unarguable truth. Almost as unarguable as water boils at 100 deg. C and 1 atmosphere pressure. It's damned near that ironclad a certainty.

So in conclusion, let me circle back to my original point. Yes, I hope you are right. But the Democartic Congressional Leadership has so covered itself with grotesque toadying and moral bankruptcy, I am not even sure they are capable of doing anything but what the Bushies want.

Maybe their natural toadying, the Nancy Pelosi Crowd's, will cause them to fall into line for Obama the way a dog might heel to ANY authoritative voice.

Somehow I doubt it, though. Somehow I know, collectively, that the Nancy Pelosi crowd knows there is only ONE power they heel to...the Bushies. The ones who can anthrax them and then tank the investigation using their criminal Loyal Bushie LEOs at the FBI and elsewhere.

They sure didn't frame Ivins because they're honest.

I hope I am wrong, but if Obama gains the throne in November, I just had a vision. the Congressional democrats will be MORE contentious with him that they were with Bushler. Perhaps MUCH MORE.

Talk about an epiphany! I may have to save this to my journal so I can tell the Blind 2/3rds of DU "I Told You So" for the 51st time. (or will I be up in the 60s by the time this particular prediction comes demonstrably true?)

Yes, it fits. Not only from a "gut" knowing, my own "sense of smell" which, while not perfect these last 8 years, has been closer than I ever thought I could get. No credit to me, though. All the credit goes to the leaden predictability of totalitarianism.

Yes. If Obama gets elected, you watch. The Bushies will show you how an opposition is supposed to work, even if they are dirty, criminal bastards at least they can stand up and FIGHT. And the Democratic Congress will be MUCH more contentious to Obama than they EVER were to Bushler.

After all, Obama isn't going to have is people send them anthrax, or have Raytheon jam the controls on their small airplane right before election. They have little to fear, so what's their motivation to do what he asks?

After 8 years of cowering before a tyrant...NOTHING. You will be amazed at how Congressional Oversight is "restored". I also suspect the Bushies will drive this process from the minority, using their Mighty Wurlitzer to trumpet the Democrats into submission as if THEY were the majority and the Dems the minority...much like it is now.

:rofl:

I hope I am wrong about this. The last eight years show that there is only about a 20% chance of that.

I really appreciate the work you did to help us understand what's happening.

I can see why people who reluctantly voted for the bailout are pissed that the market is still sliding--well, tanking--because the bailout seems not to have helped, but in a time of such huge uncertainty, and before the money is actually injected into the system, it only makes sense that the market wouldn't stabilize immediately. An engine that big can't stop on a dime and there was so much downward momentum. Also, people are lemmings--they were lemmings when they thought the stock market would never quit going up and up and up, so they made stupid decisions, and they're probably being lemmings (to some extent) now, following each other off the cliff. Maybe when a few of them slow down, others will too.

But anyway, the main reason I'm leaving a comment is that I REALLY want to thank you for this post about the positive circumstances compared with 1929. It's encouraging, especially the part about how there will be economic tools available to the next administration that weren't available in 1929. You've helped me realize that--since there's no choice anyway--it's good to be patient.

:thumbsup: and :hug:

I must admit, I'm particularly inclined to listen to advice from somebody whose avatar is a golden retriever. :)

thanks

I have been collecting pencils at work. You know, I might be able to get a penny a piece for them when standing on the street if I can keep those pesky apple sellers away from my corner. I think all of the warning parameters you cite are blinking red for depression right now -- declining employment, frozen commercial paper, declining stock prices. We are at the brink of the precipice. It is January 1931 right now. All depends on the outcome of this weekend's emergency G8 meetings.

significantly lower corp. profits in EVERY SECTOR! That's what's been scaring me for quite a while already. Everywhere I looked the future looked dismal. Car manufacturers have been crying about low sales for a long time! They've been overloaded with large inventories of BIG gas guzzlers, and although they all SAY they're working on new fuel efficient vehicles that the people really WANT, the earliest projection I've heard of any cars rolling off the assembly line is 2010, and that date is still iffy. The retail sales markets have been declining for over a year! Stories of people losing their jobs & having to accept a new one at 1/2 their precious salary have been circulating for several years! There were far too many fools who actually believed the rapid increase in home values would last forever!

I'm usually not such a pessimist, but NOBODY has been able to show me any bright spots on the horizon for quite a while!

If there are any optimists out there, tell me exactly where or what you see improving within the next year?

if you read history, it's more along the lines of the 1873 panic. In fact it almost mirrors it.

but don't listen to me, here's a great link.

The Real Great Depression
The depression of 1929 is the wrong model for the current economic crisis

http://chronicle.com/temp/reprint.php?id=477k3d8mh2wmtpc4b6h07p4hy9z83x18

on edit: when reading this, there will be points where you will get confused, why? because there are such similarities, that you will think the author is talking about current events.