Midsummer Market Meltdown: Is the End Near?
Last week’s stock market tailspin has many of the big-time money folks worried. They have suddenly discovered risk. It turns out leveraged buyouts are not always successful, and mortgages and other debts sometimes don’t get paid off. Who could have known?
While some of the big rollers who helped propel the housing and debt bubbles of the last five years will lose substantial sums, the fact is most will still end up much richer as a result of their efforts. This is because most of the risk they take is with other people’s money. The biggest risk these folks face is a smaller paycheck.
This is most obviously the case with the standard contract used to pay hedge fund managers. Typically, these contracts give managers a fee equal to 2 percent of the value of the funds being managed, plus 20 percent of earnings in excess of some benchmark. Under such a contract, if a hedge fund controls $4 billion, and manages to get a return that exceeds its benchmark by 5 percentage points, the manager walks away with $120 million. Of this sum, $80 million comes from the 2 percent flat fee and the other $40 million comes from the commission on the excess return.
Now suppose the genius fund manager managed to lose half the value of the fund’s assets by speculating on bonds backed by subprime mortgages. The manager still gets the $80 million in fees, even though he lost the fund $2 billion. Perhaps the fund manager will get fired, but with $80 million in the bank (which gets the special low fund manager tax rate), he will be able to take his time looking for a new job. Many of the people most directly responsible for the subprime meltdown will also be in a similar boat. Some of the big issuers of subprime mortgages have already gone belly-up after they were unable to meet obligations on bad mortgages. While the people who hold the mortgages are out of luck, many of the top executives of these mortgage-lending companies will walk away with millions of dollars in profit.
When you see people making vast fortunes in this economy, it is usually a good start to ask what the government did to allow for their success. In the case of the fund managers, a substantial chunk of their business comes from pension funds. Some of these pensions involve government money in the form of public employee pension funds. Others carry a government guarantee; so, if the fund managers blow the wad, the government picks up the tab. In both cases, it would be a good first step if regulators let the pension fund trustees, who hand billions of dollars to fund managers, know that they will lose their jobs if these investments don’t pay off as promised. Ripping-off the public to make the richest people in the country even richer is not funny, and pension fund trustees must understand this.
As far as the mortgage industry, this is a complete mess. The current regulatory system provides enormous opportunities for sharp operators to pilfer millions, while leaving investors out of luck and homebuyers out on the street. This will be a topic for future columns. But, it is long past time we hold the people who control the investment of public funds or publicly guaranteed funds more accountable. If they want to give the fund managers huge paychecks, then they should do it from their own pockets.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer ( www.conservativenannystate.org). He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues. You can find it at the American Prospect’s web site.
How the stock market is doing is not much of economic indicator (i.e., not much of an indication of how well the economy is doing.) So, unless the market goes way way up or way way down, watching the market doesn’t really tell you much about how well or poorly the economy is doing.
Using adequate campaign spending limits to get America better politicians is the only way to solve America’s problems enough. If you think “clean money” public financing of our campaigns will bring us enough campaign finance reform, you’re sadly mistaken.
The nervousness of the ruling class is why they are funding the front-running Dems. They have apparently come to the collective decision that their investments would be more secure with Clinton or Obama.
I don’t fully understand the housing industry and market, but it seems to me that the over-production is of the suburban/exurban variety. I wonder if the cost of gasoline is a factor in the slump in home sales.
The inner-city housing market is still strong, due at least in part to the high cost of gasoline. We should not rule out the national traffic nightmare for this shift from suburb to inner-city housing preference. It’s unlikely the average american motorist has gained some consciousness about the environmental impact of the car-dependent lifestyle.
If the stock market dip is tied to the slump in housing sales, it is probably temporary, though cyclical. If it is tied instead to a realization that suburban sprawl is economic suicide, expect further collapse of the stock market. Our national economy is tied too much to long-distance travel and transport. Even a doubling of the CAFE mileage standard cannot reduce the costs of maintaining current traffic and growth.
“The stock market has predicted nine of the last five recessions”
(Paul Samuelson, 2nd to recieve the Nobel Prize in economics, the doyen of mid 20th century economists)
The stock market doesn’t reflect what is going on in my neighborhood. Here it is job cuts and benefit cuts. Not a whole lot for celebrating bench marks on wall street. The rich get richer and the poor, well, forget about the poor which now includes a large portion of the old middle class. Everyone I know is struggling with juggling their priorites. We are in for a long hard winter.
“The inner-city housing market is still strong, due at least in part to the high cost of gasoline. We should not rule out the national traffic nightmare for this shift from suburb to inner-city housing preference.”
When I take the four-hour trip from my Pittsbugh neighborhood, where one can do fine without a car at all except the occasional out of town trip, to the DC suburbs, I am stunned at how many spend a large porton of their waking hours behind the wheel of a car just to get to their jobs and essential errands - spending more of their income on gasoline than anything else except the mortgage. Yet, most seem to have no idea that another way of life is possible. They still consider the automobile an enhancer rather than a detractor of their living standard and many still harbor the same unresonable racist fears of getting mugged by black men if they move to the city
So, i suspect that the declining suburban house prices is just the bursting of a speculative bubble, and most of the hot urban housing market in cities like DC is just snob-appeal driven gentrification by urban “professionals”.
Given the track record of this so called government are we really ready to believe the Securities Exchange Commission is responsible for oversight? In all liklihood, they manipulate markets to raise prices in prelude to a wholesale share dump on the part of the wealty. After prices have fallen as a result of high volume sell offs the insiders reacquire the same stocks at lower prices. As usual leaving the poor unsuspecting, non-insiders to take the losses. As these tactics eliminate more and more small gamblers in the market, the rich will inevitably begin to prey on one another and we’ll see just how unsustainable this charade really is.
Withhold your money from the elite! Buy local, pay cash. This country already belongs to them and they do what they damned well please with YOUR resources. If you want back rule of law, Habeus Corpus, the Geneva Conventions, or the Constitution, stop funding this madness!
Marctileston: One of the best suggestions yet.
The system works best for those who designed it and for those who have the means to control it. It is not “conspiracy theory” to point this out.
An economic system that continually functions to enrich the wealthy at the expense of societal well-being, stable government, and even individual freedom is not sustainable. The system cannot function the way it does in a “democracy” without willing administrators, a complicit media, and a pacified populace.
The current US administration, the Bilderberg Group, the Trilateral Commission, the Council on Foreign Relations, et al are comprised of individuals who make conscious decisions. They should be held accountable for the society’s costs of their economic decisions.
For example, the oil companies who take control of Iraq’s oil infrastructure and crude reserves should have to pay the costs of the invasion and occupation of the country. Legitimate contracts had previously been signed by French, Russian and Chinese companies to operate in Iraq’s oil industry. The new contracts to Western firms only occurred with a complicit puppet government after the US invasion and occupation. So let’s call the “war” what it is: a subsidy.
End corporate subsidies. Make ‘em pay! Make the oil industry pay for the war in Iraq.
And the great white father wants us to change the social security system to the stock market.
These hedge funds betting others’ futures against government guarantees got plenty of practice time in with the S & L debacle which used similar tactics. So long as persons who worship Mammon and hold the least moral scruples gravitate to occupations of this nature, we will see major parabolic effects on collective monetary interests.
Corporations are persons, per 1886 Supreme Court decision.
Corporations are owned by shareholders.
Corporations are therefore slaves.
Slavery is unConstitutional.
Free the slaves.
Take the corporations away from their owners.
If I may add to “dave lines” line of thought (no pun intended)…a friend got me thinking about the real cost of gasoline. Essentially, his argument is that the prize of gas is subsidized by the Industrial-Military-Congressional-Complex and therefore does not reflect it’s true “market” price. Instead of using BS propaganda about “war on terror” and “spreading democracy to the Middle East” and taxing gasoline the amount to fund the costs to get the oil, then we may finally have a real debate about our foreign policy. For example, instead of $3 per gallon gasoline, let’s say gas costs $10 per gallon. How many Hummers and similarly stupid SUV’s, would be cruising the roads?
dave lines,
I agree with much of what you say, but I fear that the overall level of wealth and comfort enjoyed by the great majority means that they may tolerate for some time a small well-connected predator class taking the lion’s share of the wealth, dishonestly and unjustifiably to be sure, because that will not make that great majority uncomfortable enough to break the inertia of their habits and lifestyles, unless they lose their jobs and homes. And that small predator class is very aware of this and works to keep the unemployment level from rising too much.
Siouxrose,
It seems to be that a fundamental flaw with capitalist systems is that those with the fewest moral scruples have a significant advantage and as a consequence achieve great financial success and the opportunity to rule the government and the society.