The Liquidity Crises and why a solution is absolutely required - a personal explanation

[grantcart]

cross posted by request


In 1985 I went into the furniture business in S.E. Asia. for an Australian company. In 1987 I started my own company with a few thousand dollars and 4 employees. I had developed a reputation in the area and within a few months I had millions of dollars of orders from American manufacturers and IKEA. We were able to become one of IKEA's largest suppliers in sofa's. We were able to get the business in part because we had very good quality control and because our costing was done on an open book basis - we showed them how we calculated all of our costs. Ingmar Komprad (the owner and I K of IKEA) visited our factory, a very rare occurence.

By 1990 Eastern Europe was transitioning from communism and in 1992 the Soviet Union fell. The costs of absorbing East Germany and the huge economic changes in Europe caused a massive interuption in business and interest rates went through the roof (Denmark set their prime at 21%).

People in Europe stopped buying cars and furniture. We had a long term contract and continued to manufacture and ship. I got a cal from IKEA and they wanted me to come to Sweden and they were willing to pay for the trip. Once in Sweden they took me to one of their massive warehouses. It is the size of a football stadium, all of the material is handled by robots and run by 4-5 guys. Outside of the warehouse stood thousands of containers.

The problem was that all of the product that was not selling (like big sofa sets that we made) were inside the warehouse and all of the things that people were willing to buy were sitting in trailers outside. For them it was a product liquidity crises all of their liquidity (in this case access to warehouse space) was tied up in non performing assets. They had decided to start taking out product and destroying it (If they gave it away it wouldn't do any harm to them but it would depress the market further and force other smaller retailers into bancruptcy and that they would not do.) Even as we continued to ship they had no space for the product. The good assets were sitting there and pretty soon their stores would be empty of the product their customers wanted and filled with the product that no one wanted to buy now. (The point of the trip is probably obvious - it was a nice way to explain why they wouldn't be ordering any more product - that and similar cancellations meant that the factory failed)

This is what our entire economy is facing - all of the liquid capital - the paper that is sold - is tied up in non moving assets that they cannot sell even at a discount.


I was able to raise capital for the factory that paid for the land and the buildings.

In order to function we put the land and building up for collateral and borrowed money for our working capital, equipment, inventories, letter of credit etc. You have to borrow to pay for inventory before you make it and then you have to give your customers time to pay you (accounts receivable). While we were able to make a profit from day one the real major challenge of a company, especially a new one is not profit (except for the dot.com industry) but cash flow. You need to borrow for payroll and raw material and then you pay those loans off and then in a couple of weeks you borrow again. It is a part of the daily regular business.

What is happening is that the bottleneck of cash liquidity has become exactly like the inventory liquidity listed up above. The financial banks do not have the liquidity to offer loans to good businesses because they cannot move the bad assets that they have.

Let me make this clear. If this is being reported accurately and the normal day to day loans that good profitable companies get to make payroll and pay for inventories and buy equipment, etc. are frozen and they cannot get them - even for a very short period of time, then hundreds of thousands of good companies with good jobs will fail.




Letting the liquidity of the banks freeze will cause massive huge dislocations and once started will cause domino effects that could reach that of 1929. Anybody who has run a business knows this simple fact - almost no business has enough capital to operate without borrowing from time to time - it would be like saying no one could buy a home if they couldn't pay the whole price at once. Virtually no one would have a home.




I have no idea if the plan that is being negotiated is a good one or not. I seriously doubt that anyone involved in this likes doing it. It is extremely unfortunate that this is called a "bail out" because that seems to indicate that shareholders will retain their value. I do not believe that is the case. It is also not a bail out of 'Wall Street'. It is providing assistance to the part of Wall Street that buys and sells commercial paper. If it provides that assistance and props up shareholders value then it is a "bail out". If it does not result in shareholders regaining value then those share holders are not being bailed out.


If it is done correctly then not one cent of taxpayer's money will be at risk - if the assets do not result in a return of investment then the government can add a recovery tax on the banking industry to make them pay.


I understand that some will be against anything that looks like it is assisting businesses.

It can be understood as simply giving a blood transfusion to the liquidity of the economy. If our elected representatives ensure that there are built in recovery measures then it can be done without risk and like similar type of loan guarantees to Mexico and Chrysler the government can actually gain back revenue. If it was the right thing to do for Mexico, in a similar situation, then why not our own system - if payback guarantees are established.


If a true liquidity crises occurs and the banking system for businesses freezes the result will be massive collapse of businesses and massive unemployment. Having said that I feel completely incompetent to comment on the value of one plan against another and trust Obama and the advisers he has to make sure the best deal for the taxpayers is made key to the plan.

[melody]

1. What scale would the unemployment be do you think? n/t

[Gman]

12. I think maybe 20 - 30%

hard to really say. It would shoot up to 10 - 15% in a couple of weeks to a month after a crash as companies failed to meet payroll because no money was flowing. Long term, 6 months, 20-30%. Maybe more. A year later, who knows what the world would look like.

[melody]

14. During the Great Depression, unemployment was around 30%

So if the choice is do the bailout or not and we'll still have Great Depression-like conditions if we do (to say nothing of
deflation or hyperinflation and all the other booglies we've been hearing about), I'm not clear on what clear benefit we would derive from a bail-out. I'm smart enough to know how little I know about many things and leave those matters up to those who do know, so I favor a modified bail-out because so many others do, but I'm cloudy on that point.

[rzemanfl]

2. The key words in your post are "If this is being reported

accurately." We've been lied to so often no one believes our government about anything.

[grantcart]

7. You are correct - I don't know if it is true

But it could be true. NPR had reports yesterday from small business owners in various states stating that they could not get their normal loans to make payroll.


Here is why I think that the concern is true.


The reason for the failure of Washington Mutual was not widely broadcast.


It was a bank run. The largest bank run in world history.


Over the last two weeks some huge amount - $18 billion I think was withdrawn. WaMu did not fail because of bad debts - although it had them and might have failed anyway but because we had a bank run.


All of the shareholders lost all of their money - that tells me something serious is happening.

[rzemanfl]

9. I am seriously thinking about making a visit to the bank on

Monday.

[grantcart]

10. and with that single simple reply you have proved my argument in all three forums

if you think that then what happens when everyone across the country thinks that.


Remember Jimmy Stewart? The banks don't have our deposits they are loaned out. We are creeping closer to a panic.


If local businesses don't get loans for their payroll then there will be a run on the banks --- massive collapse 1929.


It could happen if the system loses liquidity.

[rzemanfl]

18. If people are yelling "fire" in a crowded theatre, you don't stand

around to sniff for smoke, but it doesn't necessarily mean there is a fire. I don't know if we are creeping closer to a panic or being egged on.

[unblock]

13. naturally they are overstating things in order to sell the bailout, but it is essentially true

the mention of the word "depression" is hyperbolic and irresponsible, especially because proper economists don't even use that term (they prefer "contraction", as in "the great contraction, 1929-1933").

however, the problems in the financial system are severe and can indeed lead to a deep and lengthy recession if something is not done soon. "soon" is also something they've been playing with. the markets might not like it if there's no deal by sunday night, but that's hardly the end of the universe. there's nothing magical about monday. the markets would like the certainty of knowing a deal is there, but if it takes a month or two to get the money flowing, that's hardly likely to make a difference.

what i can say is that my business helps find money for companies, and right now, business is booming. they're lining up at our door for funding. normally, we only handle "complicated" deals, because the simple ones just go straight to the investment banks or even the regular banks. nowadays, we're seeing deals that used to be "simple", yet they can't get funding through the normal routes, because that normal routes are shut down. so we have to go far afield to get them funding.

this is not all of a sudden, either. it's been like this essentially since last august, which is one of the reasons i'm not buying the "deal by sunday or depression" argument.

all this is great for the company i work for, but not good at all for the economy as a whole.

[Gman]

16. Do you mean August, last month, or August last year

when you say "it's been like this essentially since last August"? Are you saying you've been seeing this for over a year now or only since last month?

[unblock]

19. over a year.

most were in denial at first, but go back to when the fed finally started slashing rates. they had already waited too long, and then assumed that simply cutting rates would do the trick. but they misdiagnosed the problem. the illiquidity has not been because capital isn't there or is too expensive. it's the lack of trust, and cutting rates doesn't address that.

[Gman]

25. The first significant rate cut after the rising rates was September last year

it corresponds. Rates were cut, IIRC (and I don't have my spreadsheets with me) like 3 times from September - January of this year.

[unblock]

26. but they started out with puny 25 bp cuts.

only in january did they get real. they cut 125 bps in about a week. THAT was needed back in august.

[Gman]

15. I've been hearing the same anecdotal stories here and there

about suddenly increased interest rates on credit cards (which many businesses use for liquidity).

I do consulting work for a small land development company building a new upper end shopping center. We submitted the first construction draw ($250K) to the bank for the construction loan about 10 days ago. It was funded, but the bank officer sounded very unusually nervous when I talked to him. He's a really nice, friendly guy. But he had called to ask for another copy of tax returns from the previous year and said if he needed anything else, he'd call back. The whole thing seemed very unusual. He didn't call back and there was no problem. I wondered out loud why he was asking for more stuff when the $6 million construction loan was approved 3 or 4 months ago. Everything was in order at the time.

We're going to do another draw against the loan next week for about $360K. They usually fund the draws in less than 24 hours after the 3rd party construction company retained by us and the bank certifies the work was done and done correctly. I have a sneaking feeling that it may take several days to get the draw funded. If the bank in any way balks or hesitates, to me, that's the first real sign of a huge problem.

[yellerpup]

3. This should be mandatory reading on DU!

You should take this story and your experience on the road, by which I mean, get yourself on TV and explain the "bailout" just like this. Incredible work, grantcart. Thank you for your insights. This is the most valuable post I've read today. :dem: :kick: :dem:

[mckara]

4. Thanks, For Your Explanation...

It's difficult for us to trust our CEO president and his advisors. Especially after we found out that they chose $750 billion because it was a "big number." Help!

[JDPriestly]

5. The problem is that the American people will be paying for

this bail-out for generations to come. My husband and I did not contribute to this mess. To the contrary, we scrimped to put a little money into retirement 401(K)s. We are too old to get the scarce jobs available today. This bail-out will not help us. It will just cost us and our children who have worked very hard to start careers.

In exchange for help to the illiquid in Wall Street, we want much, much more than is currently being bargained for.

First and foremost, we want an admission from those who have sold the Americans the bill of goods that the free market is God and that regulation and government are the devil that in fact the free market is hell and regulation and government are good. We want to put an end once and for all to the Friedman school of economics. It has failed the taste test. It is putrid.

Second, we want the Wall Street wealthy to be the first to put their fortunes into any bail-out pot. Take their homes in the Hamptons and turn them over to the many, many homeless people in the U.S. Let the Wall Street wizards sleep in shelters for a while. Those Wall Street guys ruined everything for everyone with their greed. They need to learn a lesson in humility -- especially Greenspan, Bernanke and Paulson. They need to be brought down to a level where they know what it is to have nothing.

Third, reinstate the taxes on capital gains for the very rich.

Fourth, stop the war, and cut back on military spending. We need a strong military, but we can have just as strong a military with far less spending if we get a government mechanism to oversee the contracts and the spending and performance. I worked in a nonprofit for a number of years. Part of my job was obtaining government grants and reporting on performance on them. Trust me, the government is perfectly capable of insuring that those who receive grants perform as they promise. They can do the same on military contracts.

Fifth, enforce the anti-trust laws.

Sixth, prosecute those who lied to get mortgages.

There's lots more, but that is for starts.

If we don't get what I am asking for, we'll be back in this same place in 20 years. We've been here before. It's time to stop repeating this cycle. We need to take strong action this time.

[grantcart]

8. I will not get into any details of what the "liquidity fix" should be but

there is no reason for the tax payers to be lose any money.



First they should be able to get good value for the purchase of the bad debt. There are other ways like getting equity positions or like Warren Buffet get some kind of privledged warrants.


If all of that fails then simply institute a tax on the banking system to repay.


My point is very very narrow - fixing the liquidity is not only necessary it is an act of justice. Good companies and their employees should not be penalized by the acts of bad companies.


Please start a thread on what you think should be in the plan - it is beyond my limited background. thank you for your comments.

[JDPriestly]

24. I have already started threads on this.

I think the government, i.e., we should refinance the bad loans for longer terms up to 99 years, depending on each borrower's capacity to pay back the loan. In the process, the current holders of the loan would be paid off in the principal amounts of the loan. We would be fine because we would, over time, be repaid every cent by the borrowers who took out the sub-prime loans in the first place. The disruption in the economy would be less than under other solutions especially on Main Street. That is because my plan would save the borrowers, the lenders, the neighborhoods and most important the families who are facing foreclosure and their children.

[phrigndumass]

6. This is an important read, highly recommended

A similar thing is already happening in the non-profit industry. Fund raising has dropped by 30% to 40% in the last few years and liquidity for administrative operations has become extremely sparse. We've had to dip into Capital to make ends meet on more than one occasion, or literally borrowing from ourselves and our future revenues to pay the current bills. To offset our drain on Capital we sold a few long-held properties, one at a major loss.

Our country is also borrowing from the future. We can't keep this up forever, and sooner or later the country could go bankrupt as well. Our product is the dollar, and it's not worth much lately. The dollar is becoming an inventory we can't move, much like your furnishings held in inventory in Sweden.

[Gman]

11. Excellent explanation. Thanks

DU needs more posts like this to educate people who don't understand what's at stake. The point of the so-called "bailout" is not to prop up Wall Street bankers fatcats that got carried away although that they, along with the government's failure to regulate are the reasons we're in this mess. They can be dealt with later. The point now is, as you say, to ensure an adequate cash flow through each business and the economy.

This is exactly the reason I cringed and said, "WHAT??" when Palin made her snide comment in the Charlie Gibson interview about "OPM" or Other People's Money. That idiot clearly has no clue that it is precisely OPM that makes not only this economy, but the entire global economy work.

Bush really is a high functioning moron. Palin is a garden variety idiot.

[TreasonousBastard]

17. You are absolutely right here, and...

the worst thing imaginable is a full-blown liquidity crisis like the one we had in the 30s. Trillions normally move every day beween banks and it has become a trivial pursuit, like turning the lights and heat on.

But, right now banks can't move much money around and this is something so fundamental to all commerce worldwide that everyone is terrified of it getting any worse. If it does get worse, checks can't be cleared, bills can't be paid, and everything pretty much stops dead in its tracks.

Back in the 30s, macroeconomics really wasn't understood very well, and the Fed refused to expand the money supply-- adding to the pain and bank failures. Now, perhaps we understand it all too well and take too much for granted, but there is an absolute necessity to get money moving around again.

A "bailout" is necessary and it should happen soon, but it is not bailing out Wall Street, it is fixing the wheels of commerce that have fallen off the tracks.

First, we get the banks to where they can get back into business. Then we figure out exactly what went wrong and fix it.

(Some new regulations, some better enforcement of old ones, and maybe a perp walk or two to keep the masses happy.)

[leftofthedial]

20. yes. when capitalism is finally allowed to kill itself, capitalism-based

"businesses" will fail.

It's sad.

It does not explain why capitalism should be saved.

[lostnotforgotten]

21. Naomi Klein "The Shock Doctrine"

eom

[lostnotforgotten]

22. NT

eom

[lostnotforgotten]

23. And My Reply To Your Same Comment Earlier

I Got It - I Have An MBA - My Anger At Our Institutions Is So Profound

For what I had to endure that I believe a Cleansing catharsis is the only way forward.

I realize that you will not agree - so be it.

I lived through hell and I am prepared to live through hell again to make these SOB fat cat Republicans and Democrats pay with their economic and possibly corporeal lives.

My anger knows no bounds when it come to this topic.

I am seething with disgust with what the politicians and a placid citizenry have allowed this country to become.

For me this bailout is my Boston Tea Party.

Let the house burn down!