What the &^$*&# is happening in the financial markets? And how should it be solved?

I hate to agree here, but you are spot on. If you read the Japan saga, you will notice that we are following in their footsteps none the wiser. Bail out after bailout, and whats quite sad is that the new president is no different than the old one in terms of economic sense!
Companies must fail, we must go through serious pain for 2 years before we can start recovery, however if we keep throwing money at this thing (and creating inflation in the process) then this indeed will be a painful decade long recovery very much like Japan.

 

One major difference between our current situation and the Japanese situation is that the Japanese banks wouldn't write off the trillions of dollars in non-performing loans. That isn't the case here, as mark-to-market accounting rules are causing the blood to run in the streets.

 

Also, the average Japanese had a nest egg, in savings, whereas the average American has a savings of zero dollars.

 

Well, you sure have memorized your talking points, but damn is it clear you have no idea what any of it means.

We have transparency? The whole crisis is due to the LACK of transparency in the credit default swap market. Banks had all these totally unregulated, secret bets with each other, and they had no idea what kind of bets anyone else had. That's how they ended up with $60 trillion worth of swaps based on only $5 trillion worth of bonds. In other words, it's exactly the opposite of everything you're saying.

 

Who needs savings when you have credit cards?

 

You're confusing recessions (which happen every 10 years or so on average) with depressions (of which there's only been one).

Also the current recession is a strong one! This is not normal like what happened in 2001-2002.

Needless to say that's easier said than done. You cannot predict when the bust will happen. Also, you cannot say for sure that the stock market has hit a bottom right now. Some thought it hit bottom back in July when the Dow Jones was down 20% for the year. But obviously we weren't even close to the bottom then.

If you think it can't get any worse than right now, think again. On Apr 1, 1929 the DJI stood at 333 points. Three years after that it was on 42 points, down almost 90%!!!

So now is definitely not the time to dive head-first into the market. I think the best approach now is to invest very small amounts each month (or not at all) and put your money into exchange traded funds (I'd recommend something conservative like VTI or if you're feeling a bit more rebellious VDE or MOO - its inevitable that agriculture rebounds strongly).

Once the DJI hits its 65-day moving average you can start investing at a slightly greater rate. When the DJI hits its 200-day moving average, invest as you normally did in 2007 or even at a greater rate (if you can afford it). That way, when the market is on the upswing - whenever that is - your portofolio will be heavier than when it was on the downswing, therefore wiping out your 2008 losses even before the market reaches its Jan 1 2008 levels.

 

The only company that has, thus far, fallen foul of the CDS market has been AIG. That's it. All the other banks/institutions have gotten themselves in trouble the old fashioned way. Lack of liquidity and bad assets.

I don't agree with SgtSchultz's points (letting the market decide everying is dumb), but credit default swaps aren't the reason for this, nor is the lack of transparency.

 

Given that we're about to drive interest rates down to 0%, that's not actually a big deal.

 

The stupidity of Ben is beyond me, I sure hope he leaves office soon. Yes, I think lowering rates is a stupid idea. Again, very Japan like, they had it at 0 for like a decade if I recall correctly.

 

But Japan didn't suffer stagnation because of that. I think nearly all economists agree that lowering interest rates right now is good; a bit of inflation isn't such a bad thing. Increasing interest rates right now would create even more problems for the credit markets because borrowing would be so expensive, and they're likely to seize up even more.
Being "fiscally conservative" is exactly what Hoover tried to get us out of the Depression, after all.

 

It was low interest rates that got us in this mess in the first place. Greenspan even admitted to his 'mistake'. You cant possibly believe the government numbers, be it its ridiculously flawed unemployment numbers or that of inflation. Inflation is more likely to be at 7-9 percent currently. Besides, with interest rates dropping like a rock, it hasnt caused any ease in lending, what will another point or two do? I think we are handling this wrong, increasing rates will cause short term pain but at least we know that we are heading in the right direction.

 

I agree that it was low interest rates that got us into trouble. But the game has changed - we're not seeking to deflate a bubble, we're trying to stave off a Depression. I agree, unemployment numbers are poor, but disagree on inflation. And causing short term pain is one thing, but when that short term pain causes a complete cluster********, its hardly the sign that all's getting better.
Mellon's advice in 29 was to balance the budget and get all the "fat" out of the system immediately. That shot of fiscal austerity got the Depression ball rolling.

 

But the lack of liquidity is tied the the frozen worldwide credit market and dead commercial paper. Which is due (mostly, at least) to the fear inspired by the CDS "market." Of course the problem is that it isn't a market, and lendors are freaked out by how little they know about how exposed the huge banks are.

 

Agree with you about what got the depression rolling...
There is forced liquidation right now, which is leading to deflation, this tide shall turn in 2009 though, thanks to the amount of money we are printing, and I think that inflation will yet again be a huge factor (I could be wrong of course since all we can do at this point is speculate). We are bound to overshoot this regulation thing and that's never a good thing.

 

That's fundamentally false. The first real tremor in the credit crisis was the collapse of the CP market last August, long before CDS became an issue. That was a simple credit issue - lenders were no longer comfortable that conduits and SIVs would be able to repay their CP as it came due because of the quality of their assets. This is not relevant to the CDS market or the fears of exposure, which have been badly overstated, as can be seen by the drastically lower Lehman results. Also, nearly all companies issue CP. Why does CDS matter if a receivables conduit or, say, IBM are trying to sell CP?
Your argument that banks won't lend because of CDS concerns isn't correct; banks aren't lending to ANYONE because they're concerned about their own balance sheets. Citi is desperate to dump its "legacy" assets and is hoarding cash because of that. And, your CDS argument only applies to banks lending to other banks - why would Citibank not lend to non-financial companies? They're not swap counterparties.
Also, why isn't the CDS market a "market"? Of course it is. Spreads are determined by the market, there are indeces, etc. It may be a somewhat opaque market, but that's hardly the same thing.

The bogeyman of CDS is grossly overstated in this situation. It has had far less to do with the current crisis than the assets that people now consider toxic, primarily sub-prime RMBS.

 

But there's no huge forced liquidation. There's deleveraging, but the problem that TARP is exposing is that no one actually wants to sell these things, because the market isn't sure what its really worth. It would be better if there was a huge forced liquidation - it'd get the markets going again since cash would have to come in to buy the liquidated assets.
I agree that in the future inflation may become a problem, but we can raise rates once that happens. Better to stave off depression first.
As for regulation - lets see what's proposed first. One of the real ironies of this crisis is that no one seems to have put together a comprehensive system of reforms that would have, in theory, prevented this crisis. And no, the people vainly yelling about the repeal of Glass-Steagal don't count; GLB had nothing to do with this.