Why Debt Keeps Increasing

If we are going to make sense of the current state of world economic affairs, we must first answer the difficult question of why debt keeps increasing. More and more debt is being accumulated and right now we are in a place where such debt would take decades to repay. Let's go over some reasons:

1. Because of past mistakes we are paying off old loans with new loans. All over the world there is an increasing amount of revolving credit that is not paid off, similar to how a consumer allows credit card balances to remain elevated, only to find they cannot keep up with the payments, so they go get another credit card. However, in the case of consumers credit is not available like it was in the past. Instead of consumers running up debt, it is banks and governments.

2. In order to "protect" banks from failing, governments are lending money through facilities like the fed discount window at a near zero interest rate in hope this will keep banks solvent, and even that banks will improve their balance sheets. Sadly, even at zero percent banks are continuing to increase their leverage.

3. Banks have been increasing their leverage through ever more complex financial products. Terms like Credit Default Swap and Re-hypothecation sound difficult to understand, and there is a reason for that. Banks do not want people to understand them. But to put it in simple terms, it used to be that banks lent out about 5 times more than they had help in deposits. Now they are lending out more like 30 times more than they have in deposits. Why would they do this?

4. Those running banks are paying out record bonuses for short term profits that are extremely damaging to long term fiscal viablity. By continuing to increase leverage (ex. from 5 to 1, to 30 to 1) they are essentially creating money out of thin air, and then finding ways to pay that money to leading stock holders and board members. How can they get away with this?

5. Governments know that if these mega-banks fail it will dismantle a large part of the financial system. In many ways allowing them to fail is worse than continuing to bail them out. So governments keep pumping money into them hoping they can get the banks fixed. The problem is these banks are massively lobbying the very people whose responsibility it is to regulate them.

So that gives a perspective. I'm not offering solutions, but hopefully as more people understand the dynamic, they will work together to solve these difficult problems.

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Inside Job Hosted by Matt Damon

Watch this as it is a great explanation of what happened in the financial crisis, and more importantly, it helps us to understand what is continuing to happen now.

Inside Job, Narrated by Matt Damon (Full Length HD) from jwrock on Vimeo.

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Uncertainty at home and in Europe

One of the Republican talking points over the last year has been that the economy can't get moving again due to "uncertainty". And they are right, except that the uncertainty is probably not the result of government regulation or taxing the rich.

Instead the uncertainty has a lot more to do with people transferring their money to shorter term investments amid record low interest rates. With the difference between investing in a CD and a checking account often being less than 1 percent, billions of dollars have been transferred from CDs to checking and savings accounts. With a lack of long term investment, that creates a lot of uncertainty.

And of course we have Europe. Even if they somehow do manage to prevent the "contagion" where one country defaults leading to the default of others, there is still the problem of Europe being near recession with a projected 2012 growth rate of 0.5%. And that is before the new austerity cost cutting measures in Italy and Greece that will further reduce GDP.

I believe time is going to work some of this through the system, but we have a ways to go still. There is plenty of evidence we will continue to be in a deflationary environment in that areas of home prices, wages, and discretionary spending type items. The only possible area of inflation would be those items links to energy prices like gasoline and food, and should we have that type of inflation it would only increase the chances of deflation in the other areas (wages and home prices).

But on the other side of this we will have more affordable homes and the excess debt will work its way out of the system. Hang in there! 

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Government Job Losses

Though there has been very modest job growth in the private sector, that growth has been tempered by continuing job cuts in the public sector. The only real growth has been in defense, and the biggest drops have been in education. That does fare well for the future as we invest less in education, and certainly the baseline employment would be higher if it weren't for these drops.

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Reason Short Selling Needs to be Banned

If a bank of other business is in trouble the common practice today is to bet on its downfall. It is especially valuable to engage in short selling when you have either insider information or have made a discovery about the company that others don't know about yet. 

One of the last things people would be inclined to do is tell other people about the problem facing the company. If too many people know about it there is less profit to be made. Better still there are often larger investment banks that can manipulate markets in a way that automatically gives them a "type" of insider information. Let's look at a real example...

Investors from an investment banks buy oil contracts on oil that is to be delivered at a given date. They have some methods that can both delay delivery of the oil and/or drive of the price of the contracts before the contract is fullfilled (sold). They can then bet against stocks in the transportation sector for example. On a larger scale they may be lobbying a government for a rule that will give them some advantage, and because not everyone knows about the lobbying effort, they can bet against the losers of the impending legislation. There are so many small changes added to bills before they pass Congress that are the result of these lobbying efforts. And of course, this goes on throughout the world, not just in the United States.

If investors were not so easily able to bet "against" but only "for" companies, there would surely be more stability in the markets.

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