The state of our economy

By Contributor Archive

Filed Under General, Race for White House 2008 on Sep 18 

As you’ve all heard by now, John McCain said, “The fundamentals of this economy are strong.”  He said it months ago, he said it again recently, and he’s said it many times between.  Well, he was right, until today when he reversed, and rightly so, his opinion that the economy is now in crisis. When McCain made this statement, he was referring to classic economic indicators.

Unemployment is at 6.5%, which is the text book number for a healthy level of unemployment.   The farther you get away from that number, higher or lower, the worse it is for the economy.  There was a 3% growth in the economy last quarter.  Yes, it’s an indication that the economy has slow, but it’s a heck of a lot better than negative growth. I keep hearing people talk about how we’re in a recession.  By definition, a recession is a decline in economic growth for 2 consecutive quarters.  A 3% growth is not a recession.  The market was well over 14,000.  Just 3 years ago everyone was talking about how it would be impossible for the Dow to hit 12,000.  That’s a 40% increase in 3 years.  Given that lifetime average growth is about 8% per year, I’d say that’s pretty impressive.

Today aside (I’ll get to that later), there are obviously some issues with the economy, specifically oil prices and the credit crisis.  The high oil prices are due to speculators in the market.  In July, the price per barrel was around $140 and the estimated impact of speculators was between 40 – 60% of the price.  President Bush lifted the executive ban on off shore drilling and today oil prices closed at $97.  Even after OPEC recently announced that they are cutting supply, the price per barrel has decreased about 30% in a little over 2 months.  By President Bush lifting the ban, he told the world that we’re serious about decreasing our dependence on foreign oil and drove some speculators out of the market.  If Congress would quit sitting on their hands and actually do what’s good for this country by lifting the congressional ban on off shore drilling, it would drive the majority of the remaining speculators out of the market and the price per barrel would fall to somewhere between $60 and $70 per barrel.  In other words, we’d be back to about $2 per gallon as the gas tank.   Please don’t start pointing fingers and saying that we should have been putting more money into research and development of alternative fuel sources.  I think we can all agree that should have been done all along and it’s EVERYONE’S fault.  The blame doesn’t fall to one party, it falls to everyone in Washington.

As for the credit crisis, the primary blame falls to greedy companies who loaned people money who they knew wouldn’t be able to repay them and to individuals who try to live above their means.  The secondary blame falls on Congress, the SEC, and the Treasury for not regulating sub-prime loans.  Unfortunately, without businesses and individuals being financially responsible and regulators not stepping in to control the situation, the credit crisis would have happened no matter who was in the White House.

The Fed bailed out Bear Sterns because it was the first of the IBanks (investment banks) to fail as a result of the credit crisis.  They had to bail Freddie and Fannie because they are government sponsored enterprises.  The Fed gave a warning to the rest of Wall Street when they bailed out Bear and that’s why they didn’t bail out Lehman Brothers or Merrill Lynch this week.  Lehman, Merrill, Morgan Stanley, Goldman Sachs and others had 7 months to correct themselves and they continued to use paper as hedge funds to cover their loans.   It’s a shame that Lehman went under, but it wasn’t a well run organization and this is a cyclical event that happens about once a decade.  It always feels like a crisis in the short term, but if you look at history and how we survived the fall of other major companies like Salomon Smith Barney and E.F. Hutton, the market will bounce back.   AIG was too large of an insurance company to allow to fail, but at least the Fed didn’t outright bail them out.  They gave AIG an $85 billion loan.

We really saw the impact of the credit crisis in the market today, again due to speculators.  Speculators hammered Lehman with short sells, making their stock price plummet.  Their 52 week high was $67.73; it’s now trading after hours for $0.128.  A lot of people lost money, speculators made a lot of money, and other IBanks are now getting beat up because they were essentially offering themselves as leverage and the market is operating in fear and distrust of all financial institutions.  In addition, The Reserve Money Market Fund closed at $0.97 yesterday because they held so much of Lehman’s paper.  For those of you who don’t know money markets, they’re a short term investment that’s viewed as cash because they’re such a safe investment.  They are expected to have a daily price of $1 and pay a small yield.  This particular Money Market was very popular because it has a higher yield (it’s riskier than most; more risk = more reward).  Other than this one, there was only 1 other money market in 1994 that ‘broke the buck’.  This has caused serious doubt in the market place and we’re going to continue to see the market decline over the next week or so.  Most likely until we see what happens with Morgan Stanley and Goldman Sachs.

Not only was McCain correct for previously saying that the fundamentals of the economy were strong, but he was also correct for changing his stance and saying the economy is in a crisis.  This is the kind of President I want, one who recognizes the strengths and weaknesses of our economy.

Comments

  • Alaina

    As for the speculators in the oil market, take a look at the trend lines over the last year. The price per barrel about doubled in a couple of months. That’s a huge increase in such a short timeframe to occur without some event that threatened the supply of oil. As a someone who has a solid understanding of economics, I agree that supply and demand is a factor. Its actually more of a factor now due to the increased usage of developing countries than it used to be a few years ago. However, I stand by my statement that speculators caused a 40 – 60% increase in the price of oil. I was going to provide a trend line, but thanks to Hurricane Ike, I don’t have Internet service at home and I’m left with my Blackberry to communicate with the outside world. Anyway, take a look at the trendline on Yahoo Finance. It will show what I’m talking about and look up the news around the time when prices spiked.

    As for speculators and Lehman, I wasn’t suggesting that they caused Lehman’s fall from grace, just the sharp decline in their stock price since so many of them were shorting.

    The next week, especially this weekend will be interesting. Regulators globally have agreed to crack down on speculators. London’s exchange has actually put stop orders on new redemptions (shorts) and many countries are starting to probe speculators. That’s why the market jumped over 400 points at the end of the day today. That and The Fed is dicussing putting a Trust in place similar to their reaction to the savings and loans collapse in the late 80s. More to come on that. ‘The Street’ is going to be an interesting place over the next few weeks.

  • kristen

    Great points; and I also agree with Shawn’s argument. Supply and demand is the real heart of the economy; speculators do just that: speculate.

    And I love what was pointed out in a comment from another post: The president doesn’t have that much control over the economy. I’m sick of people blaming Bush for everything. Believe it or not, we still live in a capitalist society where the free market reigns (or is supposed to). If we could just deregulate it a bit, all the better.

    The loan situation is out of control because credit and loans are handed out like candy. It’s ridiculous. But you are right on–it’s not a catastrophic event. Companies crash and burn, and we suffer in the short-run, but the market works itself out.

  • Red State Eddio

    Alaina’s doing my taxes next April. I called dibs.

    • Alaina

      Ha, as long as you’re doing the EZ form and I can do it on Turbo Tax. ;-)

      I’ll respond to the rest of you later… Thursdays are travel days for me.

  • Shawn Naegle

    Alaina,

    I agree with a lot of what you wrote, but I have to disagree with you on the cause of high oil prices. It’s always been about supply and demand – not speculation. Speculators can only have a temporary effect on the market based on their perception of what the current state of supply and demand is. If they think supply will be short and demand high, prices will go up – as they should in a capitalist market. But if they are wrong, prices will crash – again, as they should in a capitalist market. What you haven’t addressed about the oil market is that at the end of the day, someone has to take delivery of the actual oil. And the price that it is delivered at is the issue, not the previous speculative price, but the actual hard cash per barrel price. If there is too much oil on the market and all of it can’t be delivered, then the price falls until someone wants the contract – regardless of speculation. The guy sitting in his living room going long or short on oil isn’t going to take delivery of a thousand barrels of oil at his house. He has to sell that contract to a company that actually wants the oil to make any money. If there is a glut of oil and no one wants the contract, the speculator is stuck with a worthless contract, unless they actually want to pony up the money and take delivery of the oil. Good luck with explaining the oil truck in the driveway to the neighbors. By lifting the ban on oil, Bush didn’t drive the speculators out of oil. Instead those same speculators are now shorting oil and the price is going down.

    Speculators loose as often as they win. How many people bought that $140 a barrel contract only to see it drop to $97? You should be thanking the speculators that are shorting oil futures and causing the price of oil to go down. But, make no mistake, if those speculators are wrong, and there ends up being a shortage of oil, the price is going to go back up, with or without the speculators. Companies and countries competing for a limited supply of oil will cause the price to increase. Those oil contracts are going to go up or down based on demand, not speculation.

    You also can’t blame the speculators for Lehman’s demise. You can only win shorting a stock if the company is in trouble. If Lehman had been on solid ground it would have survived the storm and the speculators shorting their stock would have lost big. As you correctly pointed out Lehman is to blame for their problems. They bought bad mortgages from subprime lenders. They bundled a lot of bad paper into CDOs thinking that the bad paper would refinance out of the pool and off their books into new mortgages somewhere else. That worked for a few years as home prices went up. But when the bubble burst, and the mortgage holders couldn’t refinance and started to default, they were over exposed. Lehman was foolish and greedy. Are the speculators to blame for Lehman’s stupidity? No. Speculators ultimately keep the market honest.

  • Fabs

    You really nailed this one right on the head. It’s been almost sickening to listen to how people talk about the economy. “This is the next Great Depression.” “I’ve never seen things so bad.” And so on. Things have certainly been much worse without huge fallout, even within the past few decades. All this dramatic hype is certainly not going to benefit anyone thanks to the self-fulfilling prophecy aspects of the economy based of of perception.

    I also totally agree about the completely unnecessary blame game going on. While there are fingers pointing all over the place, if I hear the Obama campaign say it’s all due to a Republican administration one more time I’m going to hurl (since that’s the “blame” I’ve heard most often)!!! It’s a natural business cycle and if people are going to do the stupid things in the market like you explained, then there are going to be consequences. But if we have to blame someone, it’s the fault of everyone (businesses, consumers, etc.) for not being more responsible, realistic, and less ignorant.

    • Fabs

      A quote I found on yahoo finance that I like for summing up the cause of our economic turmoil is:

      “The root of the problem is a cocktail of debt with a chaser of pathological optimism, and many Americans got drunk on both.”

  • east-of=eden

    Another great post Alaina, I understood more of what you have said than all the talking heads on all the TV stations over the last few days…..

    Thanks for also stating that this is not the fault of one party or the other. I’ve been shaking my head as I see the politcal people trying to blame it on each other. Personally, I’d like the regulatory laws we have to be enforced better, some heads to roll, ala Enron style, and people to start taking responsibility for what they’ve done. I think we might be able to see the first two, the last one, is a dream…

  • Patrick Keegan

    Good post, thanks Alaina.

    There are somethings I disagree with, but I think speculation and greed have played a major role in the current situation.

    Gotta do real work, so I’ll try to respond in-depth later on.