How to industry sign banking alabama presentation later
Jeff was mentioning when he was up here that you know the Mises Academy he said you know it's it's like it's like having Bob Murphy over for dinner you know that you really can't tell the difference well I've been to Jeff's house for dinner I can tell the difference that over my computer screen he did really a you can tell a difference the other thing that it's it might just be my personality or where I like to worry about things but it's you know Jeff was up here it's like he just very enthusiastic as Jeff always just talking about how you know when these ideas these things that are free that you know they're immortal you know once you you say this idea it gets out there and you can't pull it back you know and people hundreds of years will know what it was that you wrote down and I'm here thinking I'm kind of afraid to write more articles now you know I mean that's gee-whiz one one other sort of light thing before we really get into the meat of this is in this I'm this is not a joke this really did happen as a few hours ago Jeff was mentioning his daughter I was before the you know the conference started before I had to go get something to eat I came out of the oven hotel and I'm driving down I forget what street that is over here you know come in and I was going to turn right but the tumors put those four corners you know that real busy intersection so I'm in the right lane so from your point I'm in the right lane and on and I'm coming up to the crosswalk and it's a red light so I'm slowing up but you know how kind of you edge forward and then you look and then you turn but there was a big truck that was in the left lane right up on the crosswalk and I'm driving along and I thought you know I'm gonna slow down because it's possible there's a pedestrian that's right in front of that truck that's gonna stop out and so I did and it was fortunate because a young lady did step out and it was Julia Tucker so besides just you know that I would have felt bad if I'd hit somebody I was thinking that probably would be a really awful career move if on the day of the supporters summit I hit Jeff's daughter right before we were both supposed to speak so fortunately let that be a lesson for all of us okay so I'm a little bit squeamish about talking about this topic it's it's very important the problem is that you know when you're teaching a bunch of students they're young people you can say whatever you want because they don't know right whereas I'm always a little hesitant these supporters some ones because a lot of you actually you know first of all you're adults most of you and so that's you know one strike against me if I'm bluffing but also many of you have money so you actually understand how the world works and so I have to be careful if we gonna start talking about banking and accounting and things like that so hopefully if I'd make any mistakes you guys were at least correct me once I'm off-camera so let me see now all right so I have to actually show you some slides now this is actually for those of you who've seen my lectures usually I don't use things I just sort of get up and wing it but just as a token of my appreciation for the donors here I actually did some research before I'm gonna give this talk so I want to show you you should feel special what I'm gonna do is show you a few slides not gonna be too many I want to overwhelm you but the points I want to make its if I just hold you in words you wouldn't really get it I mean some of these graphs are really just shocking so before I get into this let me just set the context there's a little bit that you need to know against some of you in the crowd here probably this is gonna be really elementary to you but again just in dealing with the crisis and so forth and seeing the pundits talk about it it became clear to me that a lot of people they don't understand just real basic accounting things and people that are on CNBC even just spouting stuff they don't even know what they're talking about and it's how can I put it I think you people would be if you really understood how the mainstream economists and the pundits how little they knew what they were talking about you'd be horrified ok now I think you're probably go come on we know those guys but you don't because they use jargon and so you're not really sure what they're saying like you know they're wrong and then their conclusions are stupid but you don't really get what they're talking about right well where's I got a PhD I know what they're saying and I was like this guy has no idea what he is talking about all right so let me just try to get that across to you one one thing again is awesome for people who are watching online and they need to know some of this background let me just very quickly go over the distinction between a firm that takes on more debt versus more equity because that's related to a lot of the discussion of how do we fix the economy largely it happened before the crisis really kicked in in September of 2008 people were talking about a credit crunch before that and so forth but that's when it really came to the fore and the issue was a lot of economists and pundits there said man I can't understand you know the feds been cutting rates they're having all these you know opening up liquidity facilities and so forth and the banks aren't lending what's going on it doesn't make any said it's like we're pushing on a string like you know the Keynesian used to talk what's going on and so a lot of people economists and other analysts who were actually involved in banking that weren't just you know some macro person that did a lot of blackboard diagrams and was asked to comment on this crisis because well gee the person teaches economics at MIT he must know he's talking about but the people actually involved in the financial sector we're saying well no this isn't a liquidity crisis it's a it's a capital crisis you know the banks are not liquidity constrained there have facing capital constraints and so it's just to give people a little hint as to that distinction what are we talking about just imagine you're somebody you have a $5,000 in cash let's say that you've saved up and you see this investment opportunity you see some asset out there that cost ten thousand dollars and you think if I buy that I bet you that thing's gonna go way up in price over the next 12 months I really want to buy that thing I only have five thousand it costs ten thousand so there's two things you can do you can go borrow $5,000 from somebody so you're going into debt to buy that thing and so that what happens there well you buy it if it does go up in price and then you sell it you actually you know then you can obviously pay the debt off and in a sense you've doubled your return the rate of return as opposed to if you had that ten thousand yourself and bought it right because you only put up five thousand of your own money so in terms of the ultimate jump and asset price paired to your smaller investment the rate of return is higher but the downside of doing that of course is that if you're wrong you borrow 5,000 you buy this thing and it goes down well then that in a sense you know doubles your loss right because you have to pay that person off according to the terms of the of the loan and so in a sense it like magnifies how much that loss hits you okay and so in contrast you could say instead of borrowing the money you could go find someone and say hey do you want to be my partner on this so we'll go in 5050 you chip in your 5,000 I'll chip in my 5,000 we'll buy this thing that cost 10 and if it goes up $1,000 you know then we sell it and you and I see each split and we each get $500 profit all right so what happens there is you're diluting your ownership in that asset okay and you in a sense you're spreading out the risk that you're now if it goes up you only keep half of the game but the positive the the pro of doing that is that if the thing goes down then you're only eating half the loss okay because you're sharing with your business partner all right so again this is really basic stuff to most of you in here but that's why if the banking system you know if you have a bank that's in trouble and it's the mere fact that the Federal Reserve for example is standing in the sidelines saying hey I'll lend to you basically at 0 is you know so here you go and that bank still might say no I don't I don't want to even if there's something out there that looks like it might be a good investment you know that it would have a rate of a positive rate of return if the bank is on the verge of bankruptcy already then it might be you just afraid to borrow and do that all right so that's why if you think back when tarp was originally proposed that again what was the was that acronym it was the Troubled Asset Relief Program so originally when Henry Paulson who was Bush's Treasury secretary when he proposed that the idea was he needed seven hundred billion dollars and he was going to just directly buy those assets off of the the banks okay that people were making jokes back then saying the idea was the you know cuz you say well why would why is that a good deal for the Treasury why would they pay more for these mortgage-backed securities that the investment banks and other institutions are holding then the market wants to pay for them isn't the taxpayer just eatin the loss and the Treasury's official position was no no no see it's not that these things are really that awful it's just there's this systemic panic going on everybody you know there's fire sale prices it's by us coming in and buying up these things will restore confidence and it'll be a self-fulfilling prophecy and then you know they ask that's what we do and so a lot of bloggers were making the joke saying that Paulson's position was that there was no such thing as a bad asset just a misunderstood one so but of course that's not what happened right it's not that the US Treasury acquired 700 billion dollars of mortgage-backed securities instead what happened is Paulson if you remember this was what was it late September of 2008 and then I think that's when the first vote went and it didn't go through because the people in Congress were literally getting calls I heard various estimates but nine to one against if not more their constituents calling and saying no you do not take 700 billion dollars in bailout investment bankers that's crazy right and so being as we do live in a representative democracy at first they it took like three days for Congress to ignore the constituents so I mean it's uh thank goodness we don't live under saddam hussein or some you know crazy autocrat so that so that's what happened and then but the moment it was I don't know the exact timing but it was like within a week I think of when he got the authorization he said you know actually I talked with my advisers and what we just said that would be stupid if we bought these assets because how would we know how much to pay for him if we didn't pay enough that wouldn't be helping the bank's right because they're all insolvent right now with these assets on their books at current market prices so if if they're right now if like a hedge fund would be willing to offer them 15 cents on the dollar and that would make them in solvent that's the problem if we come along and offer them 16 cents on the dollar that doesn't really help but to really help them if we give them 95 96 cents on the dollar well then obviously the taxpayer might take a huge hit and that's bad too so ii thought that's a dumb but since you already gave me the 700 billion here's what I'm gonna do we're gonna buy ownership claims and a lot of these banks alright and so that and that's what he did but they still kept calling a tarp even though it was no longer the Troubled Asset Relief Program it was that socialized the financial sector program right but that wouldn't make a nice acronym so so that's so that's what he did but some part of that I mean that it was true that the objection to the original tarp plan as it was originally conceived was was perfectly valid so that's part of what was going on there and there were a lot of people that were saying it all along and not just you know free-market people but even to his credit but people like Paul Krugman were saying this plan is stupid what you need to do is recapitalize the banks that's the only way you're gonna fix this just by swapping some of their assets around that's not gonna fix the problem that they are you know their capital has been eroded and that they're not gonna lend okay so that was the the alleged purpose of tarp was to recapitalize the banks so that they'd be willing to lend again I mean I I think we can all remember all the rationals they people say yes yes you know we can't stand the fact that we have to bail out the biggest contributors to our campaigns it just causes this physical pain we don't like helping big corporations any more than you guys do but we have to do this we have to hold our nose and bail them out because the financial system is the lifeblood of our economy and it kept talking about small businesses small businesses can't get loans they can't make their payroll and at the time I was suspicious I would go around and ask small business people and say do you have to borrow money to make your monthly payroll and there was like no I'd be in trouble if I had to do that be crazy right so anyway it's I almost thought that maybe the people in the government were lying but I don't want to go that far so all right so he's so he's doing this stuff and so that was the rationale right that and remember even up until then the whole mantra was that we had this credit crunch that was the deal and now of course if you just was in mid-september when the head of the tarp program was stepping down and Timothy Geithner was like in the going-away party or whatever was congratulating this guy and like to the team and and the speech is actually really funny that yet you can get the text of it at the Treasury website about Geithner basically you know like hey guys you know no one appreciates what you do but I do and that kind of stuff and in there I mean he his words were very carefully chosen because he didn't say we actually restored lending to small businesses and things like that or that businesses now we get all he said was things like you know credit spreads have shrunk and interest rates of you know businesses can now borrow on better terms so he was referring to interest rates and things like that he didn't actually talk about the volume of loans because the actual data is the exact opposite of what you would think so if you just listened to the news commentators you watch CNBC you would think that loans from the commercial banking system to businesses had been falling pretty precipitously up until tarp kicked in and then you would think it turned around but let me just show you the actual chart it's not okay I'll read the top it says commercial industrial commercial and industrial loans that call commercial banks so you can see it went up up up up and it peaked and then came down now you know what month of peaked in October of 2008 that was the month that tarp started okay so just to put it in words commercial and industrial loans from commercial banks were at an all-time high in US history right when tarp kicked in and then they fell off a cliff now I have brought that up to people of the one time I was on a Larry Kudlow show and I brought this up and everyone else was just laughing at me like I was an idiot and they said well they said counterfactual and they moved on and what they meant was it would have fallen off even more steeply had tarp not kicked in right which maybe it would have maybe it wouldn't it we don't know but my point is just you would have no idea that that's what the chart looked like and the people are patting themselves on the back saying it's a good thing we invested 700 billion right at the peak of that otherwise loans to businesses might have falling off the cliff all right just so he something else it's kind of funny to the extent that anything from the st. Louis Fed can be funny this chart shows consumer individual loans that all commercial banks so the top one was just showing loan
to businesses this is commercial bank loans to individuals and you might say oh well that's interesting so it also noticed starts falling it looks like a few months after tarp kicked in right and in late 2008 but then in early 2010 it zooms way up you know wow that's weird what's going on there like that must be the banks all the sudden made a bunch of loans no what happened there was there was a rule change and they had to include I think it was like all credit card debt which previously hadn't been these numbers okay so just a one thing that coincidentally made it look like now the banks were lending more so if you see like once you adjust for that shift upward that to you know it still is trickling down okay so again whether you're looking at loans to businesses or individuals basically once tarp kicked in they've been steadily declining so why is that well it goes back to what I was talking about before and Doug's talk he listed a bunch of facts to that there were the banks have been suffering huge losses on their other loans okay so in terms of accounting you know you've got your liabilities on one side and your assets and your equity on the other so if you're writing down the value of your assets because you're sitting on a mortgage or mortgage-backed security and the homeowners are defaulting then obviously you know you got to write down the value of your assets that erodes your your equity you know the amount of capital you have and so just because you have the Fed willing to lend you money at 0% or what have you it doesn't mean you're eager to go out and left so the banks are basically just hunker down waiting for these write downs to stop and just to give you an idea of the magnitude again Doug read you some statistics but this chart might make it for you so what this is those in the back you can't can't see the text it says net loan loss is divided by the average of total loans okay and so you can see there so that it goes back the chart starts in 1985 or maybe 84 and you could see that in terms of the percentage of their total portfolio and then the losses they're taking that it's much higher this time around then you know in the earlier crises as well I don't know if had gone back to 81 and 82 what that percentage would have been but you can see how this isn't just oh yeah we hit a recession I mean this this is huge so that's again partly explain why the banks are not eager to make more loans when their their balance sheets are getting rapped by these writedowns don't worry I've just got one more chart after this one and then we'll go back to the funny jokes about hitting people with cars so this this is a there's two things going on here so the I want you to first focus on this what that is US government securities at all commercial banks okay so that's showing the market value of track I think it's includes Treasuries you know bonds issued by Uncle Sam as well as bonds issued by the GSEs government-sponsored entities Fannie and Freddie because now that's classified in this thing as government debt because the government's backing it up all right so what you see here is that was pretty much constant throughout the hutt of the main housing bubble years and then about when all these rescue actions kicked in you see it goes up by about what about 400 and so billion dollars meaning the commercial banks added to their balance sheets 400 plus billion dollars of debt either from Uncle Sam or the GSEs which is implicitly the same thing now because the government is guaranteeing all that stuff okay so it's it's not actually and just in the other line here just showing what happens to interest rates okay that so you see once interest rates come down that's when this happened so to try to understand what's going on there part of it is that when the Fed pushes down interest rates so you can't earn interest anywhere else what are the banks do they go by what they're very safe assets right they lend money to the government basically okay so in terms of the this overall story that we're telling here it fits in that they're not going to lend to somebody in the private sector because there is some risk there whereas the government's the treasurer is probably not going to default I mean they might just have the Fed print up more money because they can't meet their bills but they're probably not just gonna default on their bonds and so those are considered to be fairly safe assets so it's actually let me just show you one more and then we'll correct a common misunderstanding so this is the last chart will show this is excess reserves of depository institution now it's almost hard for you to see it because it hugs the zero line for most of history and then boom jumps up by eleven eleven hundred billion dollars at one point one trillion okay so this this refers to the fact that the Fed came in in late 2008 especially better than also a little bit afterwards and just its balance she more than doubled its balance he just started buying assets like crazy mortgage-backed securities in particular bailing out the banks okay and that's partly why tarp made money is because the US government bought shares and banks and then the Federal Reserve came in created a trillion dollars out of thin air and bought a bunch of the assets that those banks held so that's a nice way to make up money if you if you can do that you know insider trading is one thing having a printing press is another so you know it's a neat trick but so you see those excess reserves are singer the banks are not lending them out and so that that's partly why you haven't seen gasoline prices go up in milk prices go up and so forth even though you would think well gee if the Fed creates a trillion dollars shouldn't that cause a bunch of price inflation so that's partly what's going on but the the thing I want to Dress here is this a lot of commentators and I was doing this too we were we're saying oh that that money's all bottled up the banks aren't lending and technically that's not quite right they are lending in a sense that they're buying bonds from the Treasury and Fannie and Freddie and so forth so they're buying government backed bonds so that in a sense they're lending it to the government on new rock will calm a few weeks ago there was a good article by Gonzales Lehrer called stealth monetization and what his point was is that the the Federal Reserve is basically buying all the debt the Uncle Sam is is creating okay but if you ask the regular financial pundit he said no no they're not doing that the markets would freak out if they're doing that you Bernanke is very responsible you said no it's yes the Fed has bought some of it through their quantitative easing back in 2009 but most of this new debt is being picked up in people in the private sector because they're just rushing to safety but is this chart or the previous chart shown this was what Liras point was what what has happened it's not like these banks just on their own are buying a bunch of Treasuries it's that they had their other assets picked up by the Fed and then they replaced them with Treasuries okay so it's it's an indirect monetization or he called it a stealth monetization that for all intents and purposes the Fed is the one who's the largest buyer of all this debt so it's it sort of solves the mystery of why is it that long-term yields on US debt US government debt are relatively low even though Obama's spending money like crazy and borrowing money like crazy and why do we see gold prices hitting all-time highs it seems that you people talk about the bond market being schizophrenic but not if it's really the Fed is the one buying all this stuff right so it's not surprising that you can keep down yields at least temporarily if you just keep creating money and buying those things those bonds right whereas every other area you see asset prices zooming up alright so anyway that I'm just trying to tie together all these these threads showing you that this is partly what's happened the feds creating money allowing the banks to buy Treasuries earn the interest on it and that's how they're slowly recapitalizing now let me just take a few more minutes and I'll let you go here the what about decapitating the economy why is that bad well it's so it's helping the bank's there or at least the bigger banks they're earning that income in the overtime they're willing to sit there for years just slowly earning income and working off those bad loans that they made but it's bad for the economy for several reasons just a few of them those low interest rates well that's this is the exact strategy that Greenspan did when the.com bubble burst right back then back when people call him the maestro you might remember he lowered interest rates so to give the US economy a soft landing after the.com bubble burst and people called him the maestro because man home prices didn't fall during that recession they kept rising that's great good job Allen and now of course not just Austrians but regular economists are saying maybe that wasn't such a good idea maybe all he did was postpone the crisis and set the stage up for even worse calamity that hit you know 2006 7 2008 and yet those same people are saying but now of course it would just be too awful if we face this thing full on and so a good thing Bernanke brought interest rates down to zero right so what Bernanke has just outdone what Greenspan did and I don't say this to be flippant or you know pessimistic but I I think people need to prepare themselves for the idea that in two thousand eleven or twelve we're gonna look back at this and say all wouldn't have been great if we just had gone through the crunch you know the crunch in 2008 instead of Bernanke lowering interest rates to zero the same way in 2008 people were saying man if Greenspan had just let us suffer the dot-com bust at the time that would have been a piece of cake compared to what happened now I'd so I think that's what we need to prepare for uh one other just general point is it's there were real mistakes made during the housing bubble years get real resources were misallocated there's too much went into housing Americans over consumed they they spent too much money they were you know borrowing they weren't saving either their paycheck because their stock portfolio was going up and there the price of their home was going up so they didn't save enough out of their current income thinking that they didn't need to because their overall wealth was going up right so you can't undo those mistakes just by having the Fed create a trillion dollars or create ever more trillions according to what the pundits want all right so that something has to give and that this notion is ridiculed in the blogosphere you know people talk about call this like a puritanical thing that all there needs to be suffering to atone for our sins well you can call it that if you want but it has to do with the fact that no there's more to an economy than just dollar bills floating around there's actual real resources and you can't undo those mistakes just by magically creating trillions of dollars in paper money all right so it's it's shocking that we've we've come to that now there's the open just what I would think would be just obviously recognized as monetary cranks are now the ones gaining currency no pun intended in the in the the pundit reclass and what's funny is that the way they know this is what I'll leave you with the reason they know that the Fed hasn't done enough yet even though if you look at you know something like this chart there are people saying the Fed obviously hasn't done enough because look you see the fit you know they should go up hired and what's their prove that the Fed hasn't done enough is we're still in this thing right if the Fed had done enough we would be out of this and we'd be in full recovery so clearly the Fed has not printed up enough money that's that is truly their argument that's how they prove it that the Fed has not been even easy enough is that we're still stuck in this thing so you know you want to just say well okay but suppose for the sake of argument that printing up money is not the way to get a recovery then what you're saying would just be ten times worse wouldn't it and it was well you sure but that's that's what they suggest but they do they think no it's printing up money is the solution so it's I wish I could give you some you know diagnosis or explain these real highfalutin theories but I mean it really just it's that naive and basic that they think printing up money is the way to prosperity and so what more can you do besides saying well it hasn't worked so far and it just doesn't make any sense even in theory so with that happy note thanks a lot you
