James Kenney (Fort Lauderdale, FL) wrote on our facebook "Investing for the Long Term" forum:
I'm sure it is all very confusing so that the middle class can taken yet again by the very-rcih and their political lackeys. As far as I can understand it things will spiral down as long as real estate prices continue to decline. The toxic assets include the collateralized debt obligations (CDOs) which the Wall Street geniuses put together. Many CDOs are loaded with lot's of mortgages for properties that have negative equity. Since large numbers of people with negative equity and/or decreased ability to pay due to job loss and a slowing economy are no longer paying their mortgages the banks/investors are geting shafted. Even worse, these geniuses sold thinly disguised "insurance" (credit default swaps - CDS) to investors/financial institutions around the world. These CDS were often highly leveraged to get big returns. Problem is that when the underlying assets (CDOs mostly) started to default this leverage is magnifying the losses as financial institutions have to make good on their "insurance". Of course, thanks to the Democrats and Republicans and their lobbyists buddies these "insurance" derivatives were not regulated as if they were insurance so the "insurers" didn't have sufficient assets to cover their bad bets. Now they want taxpayers to bail them out and that is what they are trying in DC now.
Because banks are required to have some "reserves" (money/liquid assets) as a modest percentage of their loans as real estate continues to tumble down they have less and less reserves despite all the money the FED and US Treasury are giving them. Until their reserves are adequate they are not supposed to lend out (the leveraged) money they don't technically have. If/when real estate prices bottom then the downward spiral stops because banks will have sufficient money to lend out again (liquidity). In the interim lot's of businesses are forced to cut back growth becausethey cannot get money to grow. Indeed, as growth has turned to shrinkage and consumers are now spending less demand for goods and services is falling and with it corporate income.
The big question is is this downward spiral going to continue to the point where we are in a Depression or will it turn around before the economy sinks that low. I saw a chart showing that corporate earnings are now lower (in inflation adjusted dollars) than they were back in the mid-1960s. Unless investors believe this decline is transient and will soon reverse I think we will likely see continued downward pressure on most stock prices.
