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Archive for the month “September, 2013”

If the global financial system is based on the US having a AAA bond rating, and the US is downgraded to AA+, will this play out the same …

Answer by Jake Kaldenbaugh:

There are two sides to the coin. One perspective is that AA+ will just become the new AAA. Given that there is surplus capital in the market and no comparably large, safe places to invest globally on a relative basis as the U.S., the market may ignore the nominal change in rating and maintain a relative economic pricing of risk.
The other side of the debate focuses on the broad effects that an increase in the general risk-free rate would have across the entire market.
For instance, one area where it could have a major impact is in forcing the entire real estate market to devalue by a substantial percentage. Consider that most mortgage loans are based on evaluating the monthly payment versus a person's monthly income. An increase in interest rates means that more of that payment would go to interest rather than principal. Rates are at extreme lows and any substantial systemic increase in rates of more than a couple percent would mean that for a given monthly payment, the amount available to pay principal (the purchase price) would be substantially less. So, if the downgrade caused even a relatively minor increase in rates of three percent, that would almost double the typical prime mortgage rate. The only way the math works assuming that incomes stay the same is that purchase prices would have to fall substantially.
Additionally, given our substantial national debt, any substantial increase in interest rates would divert a large and growing amount of our tax dollars away from needed public and government spending programs (I know the "needed" part can be debated) towards addressing pure interest obligations. This could have a substantial impact on near-term GDP as multiplier gets adjusted from government spending to risk-adverse savers.

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Who is to blame for the current mess in the global economic/financial system, circa November 2011?

Greece and Italy on the brink of becoming collapsed state, the US in a mess, China in a desperate death-hug with America. Let's figure out whom to blame, this Blamesgiving. Nominate your top candidates (preferably individual people, living, rather than institutions or dead people).

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On January 13, 2010 the Federal Reserve escalated its campaign to stabilize the economy, saying it would flood the financial system with …

Answer by Ryan Cantin:

Peter is right. Also, Washington has provided ZERO assistance with fiscal policy, essentially leaving everything up to the Fed. Bernanke has stated his displeasure with fiscal policy many times, leaving the Federal Reserve the only game in town.

In truth we will not be able to truly examine the benefits and consequences of 0 percent interest rates and QE until it is unwound. The very mention of the beginning of this process has led treasury rates up 100 basis points, potentially derailing one of the stronger aspects of this economy, Real Estate.

Hang on

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What would you do if our global financial system or fiat currency system collapsed?

Answer by Erik Fair:

Wait it out someplace near a large body of potable water and arable land – it will be temporary because Money and Trade are fundamental to human existence – we have always engaged in trade, and have always invented money to facilitate trade. We will again in future if the existing Monetary System ceases to function from lack of Confidence and Trust.

See my answer to Economic History: When, where and through what stages, does the sort of "marketplace" that Adam Smith addressed evolve, from an occasional, interpersonal, subsistence-transaction into a requisite, social-institution, where transactions commonly generate wealth more efficiently than subsistence?

The only thing that screws up trust and trade and money (time and time again) is the Lies that Politicians tell people (e.g. "I can give you everything you need or want and you don't have to work for it" – Socialism and variations thereof), and the laws that politicians write which forestall or prevent competition and trade (e.g. Price Controls, Protectionism); Economic Collapse comes from too many people believing those lies and acting on them as if they were true.


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How systemic risk spreads through a financial system?

Answer by Scott Hoover:

I'm not sure that "spreads" is the most accurate description of how systematic risk affects the market. It is more about simultaneous impact than it is about something that gets propagates through the market. Consider the risk associated with higher inflation and suppose that the Chairman of the U.S. Federal Reserve makes public comments suggesting that higher inflation is imminent. Higher inflation triggers higher interest rates, which in turn are bad for most stocks. Because of this, the Chairman's comments cause investors to be less likely to buy stocks and more likely to buy other investments that are less negatively impacted by higher inflation. The result is net selling in the stock market and net buying in some other markets. Thus, the stock market would tend to drop in the aftermath of the Chairman's comments.

One interesting aspect of systematic risk is that it affects different assets in different ways. News of higher inflation would be good news for companies that benefit from higher interest rates, so stock in those companies might increase value. This basic idea that different assets have different sensitivities to market risk is at the core of the well-known Capital Asset Pricing Model (CAPM). Although the applicability of the CAPM to real-world situations is a matter of debate, the intuition behind it is sound. Those interested in learning more about systematic risk should begin by exploring the CAPM.

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Is it economically possible for the U.S. financial system to collapse?

Answer by J.C. Hewitt:

That's entirely up to how much pain dollar-holders are willing to endure and how much foreigners love America.

If the former two variables are infinitely large, then the US financial system – which is the global financial system, it goes beyond our borders – will never collapse.

If the pain becomes too much, corporate leaders and the members of the media will feel extreme pressure to not provide the crucial propaganda support that the system requires to function smoothly.

It really depends on what you mean by collapse, though.

As long as the banks have electricity, you'll be able to access your money. The Fed can produce money in infinite amounts. Transactions are still going to go through, no matter what the quantities involved are.

Even if Goldman Sachs goes bankrupt seven times before Thursday, you can rest assured that they will be bailed out every time. It would be embarrassing, but after all, it's all just paper with president pictures on it.

Right now, there are no real competitors to the US system, in large part because competing systems are forcibly suppressed. As long as the leaders have the will to power, the US financial system will remain crucial to international trade.

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Is there a really big problem with USA financial system?

Answer by David Gomes:

By simply asking the question, you have answered it yourself. Why did you ask it is what I am more interested in?

Were you expecting an answer you don't already know in your own heart.

This is why there is so much suffering in the material world. We ask questions we know the answers to already.

Kind thanks for allowing me to express my thoughts….


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Is there a really big problem with USA financial system?

Answer by Yael Tamar:

Yes, there seems to be a problem with the setup of the US financial system that made the US economy so vulnerable to shocks as witnessed by the recent crisis.

The financial crisis was caused by a variety of factors, but most of all, I see the problem with lack of regulation with respect to the interconnection between the banking system and capital markets

First of all, this connection makes banks less liable about making bad decisions (the government has to bail the banks to save the economy)

Second, this connection resulted in further absurdities due to the built-in incentives. Firms that received bailout money had incentives to continue to pay dividends to show that they were strong, which in turn made them much weaker by depleating their funds.

Having said that, the system is in much better shape because of the measures taken since the crisis.

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