Greenspan: Once in a century financial crisis

[blahblahblah]

Q: If a company needs a loan to make their payroll, isn't that company bust?

[msj]

Q: If a company needs a loan to make their payroll, isn't that company bust?

It depends.

Many businesses rely on lines of credit to help with cash flow.

Cash can be tied up in receivables, inventory, capital assets (where a business foolishly spends cash when it should have financed) etc....

Big projects which require lots of work in progress also can be negative to cash flow until some future event happens.

Then there are the affects of seasonality - some times are slow to bring cash in as compared to other times of the year (or fast to see cash go out the door as compared to other times).

Edited October 8, 2008 by msj

[blahblahblah]

until some future event happens.

If your company didn't make enough money in the last two weeks to pay your employees, pray what 'future event' is going to happen in the next two that will enable you to both pay your employees with your own money AND pay back the money you borrowed to cover your last payroll?

[sharkman]

Obviously blahboy hasn't gained much knowledge on how businesses operate. At any rate, earlier I said the mortgage crisis had the potential to change the landscape in the US. I was wrong. It could change the global landscape.

Do we officially have a recession in the US yet? It no longer matters.

[msj]

If your company didn't make enough money in the last two weeks to pay your employees, pray what 'future event' is going to happen in the next two that will enable you to both pay your employees with your own money AND pay back the money you borrowed to cover your last payroll?

That receivable which is over 120 days old could show up in the mail.

The inventory could sell.

There are many things that happen every day which allow the world to go around.

It is obvious that you have never experienced the real side of business.

If you want to try and arm chair it then I recommend you look at quarterly financial statements for a variety of public companies.

Take a close look at the statement of cash flow, quarter over quarter, to see how money is used in a business.

Oh yeah, and maybe look into something called "accrual accounting."

Edited October 8, 2008 by msj

[msj]

Back to Greenspan.

Looks like the MSM is finally catching up with what the blogs have been saying for years now:

Taking Hard New Look at a Greenspan Legacy

Easy Money Causes Bubble; Easy Money Cures Bust: Caroline Baum

To be fair, Caroline Baum has been critical of Greenspan for quite a while now.

But I think this post sums up Greenie's legacy the best:

Deconstructing Greenspan

Why was Greenie so opposed to any oversight of derivative trading? Former SEC chair Arthur Levitt said it was a fundamental disdain for government.

I guess Greenspan never heard the expression, "An ounce of prevention is worth a pound of cure." His disdain for government has led to the largest government bailout in the history of the planet, and essentially caused the nationalization of the finance sector.

Nice legacy you got there pal . . .

Edited October 9, 2008 by msj

[blahblahblah]

There are some good reasons for a business to borrow money, startups/'big projects' (based on risk assesment and at the discression of the lender - this is venture capital where risks are more or less inherent and understood), expansion (typically asset backed loans - for equipment and the like) where the business is already profitable, and to purchase materials or product . (Good debt)

On the other hand, if a business needs a loan to make its operating expenses (payroll), I got some bad news fer ya; yer business might be in trouble.

[msj]

There are some good reasons for a business to borrow money, startups/'big projects' (based on risk assesment and at the discression of the lender - this is venture capital where risks are more or less inherent and understood), expansion (typically asset backed loans - for equipment and the like) where the business is already profitable, and to purchase materials or product . (Good debt)

On the other hand, if a business needs a loan to make its operating expenses (payroll), I got some bad news fer ya; yer business might be in trouble.

Sure, if a business is borrowing to pay day to day expenses for a long period of time then it is likely in trouble.

Once again, there are many successful businesses that rely on their LOC at certain times of the year and yet they remain in business year-in and year-out.

Seasonality affects many businesses and it doesn't always make sense to lay off staff and rehire them as compared to using a LOC for a few months to get through the slow period.

Nothing personal BBB, but clearly you know nothing about running a business or accrual accounting.

[blahblahblah]

Hey, you're entitled to your opinion, msj, but frankly I personally would be highly sceptical of any company that openly admits that it needs a loan to cover its payroll. Undoubtedly, there are probably exceptional circumstances in otherwise historically healthy companies which warrant further consideration and analysis, but one thing is for sure, I certainly wouldn't be the lender.

But the fact that Bush, Paulson, McCain and Obama all so casually mention '...freeing up credit...so that [amongst other things] companies can make their payroll...' is indicative of a mindset that suggests that access to credit is the answer to practically all financial woes including the economy at large. When in fact, it is exactly that mentality that has created this crisis in the first place.

Americans (and Canadians for that matter) don't need any more credit (debt). What they (we) do need is jobs that pay sufficient wages (at companies that can actually make their payroll without borrowing) so that they can pay for their non-asset necessities (living expenses) with their own money. What they (we) also need to learn (and probably will - the hard way) is the differance between a necessity and a luxury, and that we simply cannot buy stuff that we don't really need on credit. Debt, whether personal, corporate or government, is not just a number on paper and will not just disappear by shifting the numbers around. Debt is based on the real world and will eventually have to be paid in one form or another. 10 trillion? Ouch, it's gonna hurt.

Edited October 12, 2008 by blahblahblah

[sharkman]

Making payroll by borrowing short term is common practice. Companies involved in construction often get revenue payouts according to WIP completion levels. It may take 6 weeks to go from one completion level to the next one to receive the next payment from the owner of the project. But they need to pay their employees 3 times in that 6 week period any may need to borrow.

It doesn't mean they are in financial trouble, but if no credit is available because the credit market has dried up and the banks they deal with can't loan them anything, then they are in trouble through no fault of their own.

[msj]

Hey, you're entitled to your opinion, msj, but frankly I personally would be highly sceptical of any company that openly admits that it needs a loan to cover its payroll. Undoubtedly, there are probably exceptional circumstances in otherwise historically healthy companies which warrant further consideration and analysis, but one thing is for sure, I certainly wouldn't be the lender.

But the fact that Bush, Paulson, McCain and Obama all so casually mention '...freeing up credit...so that [amongst other things] companies can make their payroll...' is indicative of a mindset that suggests that access to credit is the answer to practically all financial woes including the economy at large. When in fact, it is exactly that mentality that has created this crisis in the first place.

Americans (and Canadians for that matter) don't need any more credit (debt). What they (we) do need is jobs that pay sufficient wages (at companies that can actually make their payroll without borrowing) so that they can pay for their non-asset necessities (living expenses) with their own money. What they (we) also need to learn (and probably will - the hard way) is the differance between a necessity and a luxury, and that we simply cannot buy stuff that we don't really need on credit. Debt, whether personal, corporate or government, is not just a number on paper and will not just disappear by shifting the numbers around. Debt is based on the real world and will eventually have to be paid in one form or another. 10 trillion? Ouch, it's gonna to hurt.

Sharkman has already provided an excellent example.

There are many industries where there are up front cash costs for which financing is required.

By the time the project is finished there is a positive cash flow (assuming a normal business environment).

Of course you wouldn't be the lender to these types of companies for obvious reasons....

[blahblahblah]

Sharkman, you're talking about construction loans (which are specifically catagorized as such) and don't quite fit the profile of what I've been talking about.

Also, I don't think you know exactly how things work in the construction industry. It goes something like this; the developer ('owner') typically borrows to buy the lot/site (he gets a mortgage just like everyone else). This is an asset-backed loan. Worst case, he defaults, the bank liquidates the property. Otherwise, he then applies for a construction loan. The bank assess the risks (based on a number of criteria and also uses any equity the developer may have in the property (over the amount he already owes - the money he had to put down - usually upwards of 25% - plus any market gains) as collateral. Still nothing to do with payroll. The developer enters into contractual agreements with the individual trades contractors (excavation, services, framing, drywall, ...). These contractors request/require a specific payment plan from the developer (based on completion levels -like you mentioned) which are quite standard in the industry. These payment schedules usually require a substantial upfornt payment which everyone understands and accepts as normal business practice. Yeah, we all know that the contractor needs to purchase materials and pay his employees to get the job started. Still, not exactly what I would call 'a loan to make payroll'.

I understand full well that there are plenty of business that often need and use 'operating lines of credit' due to the nature of their business.

[sharkman]

Actually I am presently involved in a project (The Canada Line) and the sub-trades involved are numerous, but it's not a typical construction industry project. I think we still disagree in principal that corporations can need credit to make payroll and still be on sound financial footing, but I'm not going to lose sleep over it.

[bush_cheney2004]

Making payroll by borrowing short term is common practice....

...It doesn't mean they are in financial trouble, but if no credit is available because the credit market has dried up and the banks they deal with can't loan them anything, then they are in trouble through no fault of their own.

Right you are.....without such credit, many businesses (and entire sectors) would grind to a halt. Terms for purchase orders and contracts of 30, 60, 90 days (or even longer) make the credit markets and commercial paper essential. Were there no credit, the lack of "debt" would be the least of our problems.

[msj]

There is no point trying to teach accrual accounting in a forum so let's get back to how this crisis is having an impact on the "real" world [btw, I like to put "real" in quotes since it is absurd to think that a crisis in the financial sector is not part of the real world].

Anyway, from John Mauldin:

Letters of Credit: Going, Going Gone?

[sharkman]

At any rate, I think this world crisis is something that is still emerging and we are only seeing the tip of the iceburg. Maybe a year from now we'll know how bad it's going to get. One economist I heard said when the full impact of the mortgage failures hits the US, the Dow will stop rallying.

[msj]

At any rate, I think this world crisis is something that is still emerging and we are only seeing the tip of the iceburg. Maybe a year from now we'll know how bad it's going to get. One economist I heard said when the full impact of the mortgage failures hits the US, the Dow will stop rallying.

This is a credit crisis. That means that your ear is closer to the ground when you are looking at the debt markets.

The best way to do this for us lay people is probably through Calculated Risk's look at certain progress indicators.

This is not to say that the stock markets aren't effected - obviously they have been and will continue to be.

But the progress indicators have more meaning to the extent the "real" world has been and will be effected than what the Dow Jones has been doing/will be doing.

[jdobbin]

Here is what Greenspan said today:

http://oversight.house.gov/documents/20081023100438.pdf

http://www.politico.com/blogs/thecrypt/100...is.html?showall

Greenspan, in his testimony did make one significant shift, admitting that more regulation is now needed in financial markets, an abrupt reversal from his years as Fed chairman advocating a lighter regulatory approach.

http://money.cnn.com/2008/10/23/news/econo...sion=2008102311

Greenspan said he made a mistake in presuming that lenders themselves were more capable than regulators of protecting their finances. He said he was "shocked" when that system "broke down."

[Wilber]

If your company didn't make enough money in the last two weeks to pay your employees, pray what 'future event' is going to happen in the next two that will enable you to both pay your employees with your own money AND pay back the money you borrowed to cover your last payroll?

There are a lot of businesses that are only profitable at certain times of the year yet make money on a yearly business. One big quarter can make their year.

[msj]

You blame Greenspan, but I would blame Bernanke.

Take a look at the two in their prime: Alan Greenspan and Ben Bernanke.

Now frankly, which one is an average Joe going to trust.

Now, I think Bernanke was an atrocious choice for Fed Chairman. He's like Dion. However intelligent he is, whatever he says, it doesn't get through. Greenspan would have gone before Congress, given a speech and everyone would have had confidence. Even Arthur Burns could have done it with a few puffs on his pipe. Bernanke doesn't have it.

I read something from Gregg Easterbrook today that reminded me of this Greenspan "Maestro" worship:

French President Expresses "Shocked Disbelief" at Reports of Malaise in Paris Cafes

"Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief," Alan Greenspan told Congress last week. Greenspan devoted much of his career as Fed chair to fighting the very regulations that might have prevented the 2008 financial meltdown and saved taxpayers $1 trillion; few high-and-mighty persons have ever been discredited more thoroughly. TMQ proposes that in slang, "greenspanning" should mean "putting a pompous dupe in charge of something" while "a greenspan" will mean "a colossal screw-up" and "to greenspan" will mean "to say in full seriousness such utter nonsense you should giggle." Comparisons to Captain Renault being "shocked, shocked" to discover gambling in the casino in Casablanca are not apt, because Renault knew exactly what he was doing. Greenspan, we now learn, had no idea what he was doing. In 2003 Greenspan fought to prevent regulation of credit derivatives, which in 2008 caused the collapse of AIG; in 2004 he fought attempts to impose stricter credit monitoring rules on commercial banks, investment banks and mortgage brokers, saying "the financial system as a whole has become [so] resilient" that a meltdown was impossible. Despite these vastly wrong views, Greenspan was treated reverentially by Congress, the White House and the media as a super-ultra-genius.

Greenspan's excuse to Congress last week was that he believed executives of banking and Wall Street firms would not take crazy risks with debt because market forces would pressure them to protect their shareholders. There's a small problem and a big problem with this flimsy excuse. The small problem was that in 1998, Greenspan arranged a bailout of Long Term Capital Management, a hedge fund that took crazy risks in order to run up bonuses for its executives. Market systems respond to incentives, and Greenspan's message to top executives of the financial markets via the LTCM bailout was -- no matter how poorly you perform, there will never be any consequences. Now Greenspan is "shocked" to discover the result was that financial executives took more crazy risks to enrich themselves, confident they personally would never face any consequences. Which, so far, they have not.

The big problem is that Greenspan, the uber-guru of market economics, seems to have little grasp of what actually happens in many modern businesses.... [you will have to follow the link to read the remaining parts]

A couple of reasons why this is funny:

1) Even a football columnist (well, okay, he does write books) gets it when it comes to Greenspan.

2) Greenspan supposedly has "real world experience" (well, for an economist ) and yet Easterbrook summarizes quite nicely how Greenspan's theory didn't/doesn't work in the real world.

3) I know that this doesn't fully address August's argument.

I don't really know how to argue with someone over how one person looks versus another.

To me, both look like idiots - Greenspan for being a large part in the creation of this mess and Bernanke for foolishly volunteering for the cleanup job.

Anyway, the entire article is an entertaining read.

Edited October 28, 2008 by msj

[August1991]

I don't really know how to argue with someone over how one person looks versus another.

Yet this is basically the issue.

Our financial system is based on trust, or the credible perception of trust. As Keynes said, it's not a beauty contest but who people think the judges will choose.

msj, when you look at numbers on your PC screen, you (and many others) believe that you are wealthier or poorer. Have you read Friedman's article about Stone Money? We believe we are wealthy because the paper tells us so. It is based on perception.

I simply feel that Greenspan inspires trust and while he was governor, ordinary people got up in the morning and worked and produced goods and services. Bernanke is an egghead with a beard who does not inspire trust.

----

OMG. Now I sound like Roubini.

[msj]

August, you keep trying to tell me that I feel wealthier because of this or that.

You know nothing about me to make such idiotic statements.

Such idiotic statements have no relevance to the facts and arguments derived from facts that I have put forward.

The problem with you feeling trust in Greenspan is that your feelings are wrong.

Greenspan will go down as the biggest screw up in the Fed's history (so far) because so many people foolishly placed too much trust in this one man (talk about Cult of Personality!).

Greenspan inspired so much trust that the markets "felt" the effect of his "put" which helped increase moral hazard to absurd levels.

Greenspan bragged about reading economic reports while taking baths and yet he never could figure out things like bubbles or the need for the Fed to do its duty to regulate the slightly flawed free-market (as Greenspan has admitted).

Greenspan's "shock" over his failed theory becoming practice is most telling about the shape of his head.

What's that expression? In theory, theory and practice are the same thing, but in practice, they ain't.

Edit: Ok, maybe Greenspan was just too deep into the groupthink.

Edited November 1, 2008 by msj

[msj]

I simply feel that Greenspan inspires trust and while he was governor, ordinary people got up in the morning and worked and produced goods and services. Bernanke is an egghead with a beard who does not inspire trust.

This begs the question: have you never seen a charismatic leader before?

Sure, Greenspan had a great stage presence but, as they say, the American right doesn't think - it feels.

It is typical of charismatic leaders that ordinary critical reasoning gets left by the wayside. I find Greenspan's rhetoric empty and glib. (Paul Volcker's speeches, in comparison, were never hackneyed.)

As to the reference to a Maestro, he and his own supporters who have created this image. Greenspan will cure the sick banks, feed the hungry creditors, house the foreclosed.

Of course, lots of people are beginning to question how he would do this but it is often the case that the crowd soon turns on charismatic, messianic leaders when reality intrudes and the lenders of last resort cannot deliver inflation.

[Note - the above is generously twisted from August's post in another thread regarding Obama being a "Messiah." The intention is to be mildly humorous - or perhaps to be a touch on the satirical side]

[August1991]

This begs the question: have you never seen a charismatic leader before?

Sure, Greenspan had a great stage presence but, as they say, the American right doesn't think - it feels.

I don't think anyone sane would consider Greenspan as having charisma or being messianic. Most would agree that watching a golf game or paint dry is more exciting than listening to Greenspan.

----

My point above was that our financial system is based on trust. We believe we are wealthy because we trust numbers on screens or bits of paper in our pockets - other people seem to accept our claims on their real assets. If you take away this element of trust, even a little, then you often get one wholly mess.

Greenspan, whatever his merits, inspired trust. I was appalled when Bernanke had to give a joint conference with the President because he couldn't inspire trust alone. The Fed should be an independent institution like the Supreme Court.

[msj]

I don't think anyone sane would consider Greenspan as having charisma or being messianic. Most would agree that watching a golf game or paint dry is more exciting than listening to Greenspan.

----

My point above was that our financial system is based on trust. We believe we are wealthy because we trust numbers on screens or bits of paper in our pockets - other people seem to accept our claims on their real assets. If you take away this element of trust, even a little, then you often get one wholly mess.

Oh? So he was charismatic enough to inspire just enough trust to keep the economy going without increasing moral hazard. Right.

People didn't hang onto his every word, he didn't get paid 6 figures for speaking and he wasn't called "Maestro" because he didn't have some kind of charisma?

He has enough charisma to fool you so he has enough to fool any average Joe.

Greenspan, whatever his merits, inspired trust. I was appalled when Bernanke had to give a joint conference with the President because he couldn't inspire trust alone. The Fed should be an independent institution like the Supreme Court.

As for Bernanke using Bush to inspire trust - you have it backwards. Bernanke was being used to inspire trust in a President who can't be trusted given that he blew his credibility with a war called Iraq.

Edited November 4, 2008 by msj