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Don't Blame Wall Street -- The Government Did It!

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I think European banks bought up the securitized mortgages for the same reason everyone else did -- they were all under the impression that the US Government was going to back up the mortgages, as they stated a few times during the boom. In other words, everyone was treating them like some sort of government backed securities -- like government bonds -- and so they thought it was a safe bet. Part of the reason they came to believe this was that as Freddy and Fannie bought up the mortgages and they went toxic, the US government did bail them out, several times before the big crash. And government officials were saying and implying that they would continue to do that; hence everyone began to think it was a safe bet.

Someone earlier had asked me why I thought it was evil to impose a standard onto someone, and especially evil to impose a standard onto businesses. The human mind requires freedom in order to function properly -- that is, rationality requires the operation of free will focused on the facts of reality as the sole criteria. Once one introduces force -- the initiation of force -- the human mind tends to shut down or will no longer focus on anything aside from the gun pointed at his head. This is evil. It is especially evil to do that to those who are willfully providing a service or a product in the market place. The operation of capitalism and the benefits thereof require freedom, not force. As force negates the human mind, so it negates the products of the human mind -- those goods and services that would otherwise have been produced.

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I don't know about fines, what they did was deny regulatory approval for interstate mergers unless you were CRA friendly.
Exactly, and there too you will probably not find any objective rule that says "we won't let you merge unless you have 5% of crap on your books". The beauty of our current system is that the rules are subjective. People speak of the President's so-called "bully pulpit"; but regulators at all levels have similar "bully pulpits". The priest in the bully-pulpits do have a gun under their vestments. The blackmail is very gentlemanly. I have personal experience with one credit card company that had internal quotas for accounts they should open for certain "segments" of the population that would not be targets of their usually algorithms.
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Let me try and advance this discussion by asking a question:

Why did European banks buy up massive quantities of toxic securitized loans originating in the USA?

Essentially because they misjudged the risks.

Exactly. Contrary to the title of this thread, it was the bankers own fault.

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Exactly. Contrary to the title of this thread, it was the bankers own fault.
No, that does not follow. Governmental action is a major source of risk. People have to act with their best guesses of such action.

In the same way, pensioners who put money in fixed-rate deposits were taking on interest-rate risks. Now that the government is keeping rates low, it does not follow that it is the pensioners' own fault.

Governments will try to do all sorts of odd things, and have the muscle to pull much of it off, for extended durations. People who do not get with the party-program are just as likely to be burned as people who buy it completely.

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I think it's fair to say that it was a little from column A and a little from column B.

The CRA/FDIC thing pulled a number of banks to make riskier loans. Then you started seeing some hints that banks, even non-CRA banks, were under threat of being held to "higher standards" for low income loans etc. The 90s was a really bad time for this. This was a push. With the hole market moving towards these riskier portfolios, particularly during a speculation boom, it was hard for a bank to get the kind of profits that were "the norm" without taking on risk.

So, they made the choice to push towards riskier financing, but the housing boom, the shift from the internet speculation, the glass-steagal deregulation, etc etc, made for the perfect cattle run to encourage them to lead themselves into the slaughter house.

Long story short, this is why I use credit unions. Why would anyone put their safe/savings/low risk money into an institution that they have no control of?

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Long story short, this is why I use credit unions. Why would anyone put their safe/savings/low risk money into an institution that they have no control of?
In FDIC-backed banks customers are covered by the government up to a certain amount (I think it used to be $100,000, but it is $250,000 now). Up to that number, keeping money in an FDIC bank is has no more risk than keeping it in a credit-union.
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I agree that the govt is ultimately to blame almost 100%. Every bubble, depression and severe recession is always WITHOUT EXCEPTION due to govt interference in the economy at some level, which is why I agree with Ayn Rand that there should be separation of State and Economy.

The specifics are varied and complex but there are some basics which in my view account for the bulk:

1. Cheap credit from Chinese money courted by govt

2. Artificially low Fed interest rates (in 2000 Greenspan reduced to 1%, less than inflation and Ron Paul predicted the very following year that the bubble would collapse in due course)

3. Monetary mischief from the Fed by printing money due to lack of a gold standard. The Fed should be abolished as Paul says.

4. Govt-driven home ownership promotions

5. As stated by others, govt backing of mortgages and legislation that fosters lower lending standards

One curious fact that the official report on the causes of the 2008 crisis reported was that mortgages that resulted from the CRA accounted for only about 6%. A friend and I argued this point. He said that the laxity that followed from the lowering of standards on the 6% ultimately affected the 94%.

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One curious fact that the official report on the causes of the 2008 crisis reported was that mortgages that resulted from the CRA accounted for only about 6%. A friend and I argued this point. He said that the laxity that followed from the lowering of standards on the 6% ultimately affected the 94%.
I'd say that the major source of causation flowed from regular and prime mortgages toward the sub-prime ones: via the effect on home-prices. When credit booms and flows to an asset-category, the price of those asset goes up. Typically, lower quality assets in that category go up in price as well ("rising tides lift all boats"). Thinking that prices of homes would rise was the single biggest factor inducing loans (including sub-prime loans) and all the more complex financial assets based on those loans.

The notorious Greenspan put and Bernanke's "helicopter drop" reiteration of the put led people to assume that the Fed would try its best to ensure a floor under nominal prices of assets. This turned out to be a valid assumption. However, even the Fed can only do so much. The question then becomes: what type of floor can the government actually support. People who completely buy the government's party-time theme ("use your home as an ATM") are irrational. However, people who don't get with the program and who assume that the government will simply sit by and do nothing, or who act as if we're in a free-market are irrational in their own way. Government involvement in the economy is so high, that guessing correctly about government action is a major criterion for success. (Witness the recent upheavals in the stock market driven by ever changing guesses about what European governments will do about the debts of their "PIGS").

In a free-market, actors who are using other people's money are kept in check by those other people. However, when those other people are being back-stopped by government guarantees, this removes the most important check that a free-market would impose. When the recent crisis was clearly upon us, and Countrywide was clearly in trouble but not yet dissolved, they (Countrywide) tried to raise funds by offering CDs with slightly higher rates. In a free market, they would have had to offer a huge premium to induce people to invest. However, with the FDIC guarantee, putting money into their CDs carried only a small risk of inconvenience and slight delay in return of principal. A small premium of about 0.5% was enough to induce people to buy their CDs. If bad actors are not checked by funds drying up in such bad times how can one expect any checks during good times? [The same principle plays out with food and drugs: with the government being the rule-setter and proactive policeman in those areas, it drives out private-sector options, since people don't see the point.]

Of course if the FDIC and the Fed were to tighten standards, if Glass Steagall were to be brought back, and so on we would reduce risk-taking. We could go all the way and reduce fluctuations to North Korean levels: stagnation and steady decline are the ultimate non-fluctuation.

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To understand this you have to look at it as a dynamic progression, with each player having a role to play in the development...

Yes, CRA played a role in undermining the integrity of gov't-subsidized banks and investment houses. Banks had to meet CRA standards to combine with investment co's and create MBS's. GLBA was passed in 1999, allowing this, but the first banks didn't securitize a mortgage until 2003. By that time, Fan & Fred had already started the snowball rolling...

Understand first the way mortgages used to be made - read the threads on fractional reserve banking. In a system with a reserve fraction of 10%, a bank can loan out $9 for every $1 of currency it holds. That limits the amount of mortgages generated to nine times the amount of currency available to the bank. If demand for mortgages goes up, so too do interest rates, and vice versa.

Fan & Fred were created to securitize mortgages, which means, they bought those loan assets from the banks, which gained currrency reserves in return. The banks were able to vastly increase the amount of loans they made, to an (almost) inexhaustible extent. This flow of money into mortgages, regardless of how carefully F&F were on lending standards, led to a reduction in the cost of loans, which artificially increased demand. The increased demand for mortgages, and the houses they purchased, led to a perception that houses were a money-making investment. The perceived value of houses became disconnected from their fundamentals, and instead was based on the amount of money that could be made from a purchase. The Federal Reserve did nothing to contradict this perception, and in fact Greenspan pronounced several times that bubbles could not be detected and did not truly exist.

Mark to market accounting principles, dictated by the gov't and blamed during the collapse for the sudden insolvency of institutions, led ratings agencies to rate all mortgages as safe, because, even if a borrower failed in payments, he could sell the house for a profit, or the bank could, in a foreclosure. In fact, no-money down became the rule for lenders because housing prices rose quickly enough to (seemingly) guarantee that a loan would soon be less than 80% of the value of the house. In the absence of a strong argument that houses were overvaluing, there was no good reason for ratings agencies to downgrade MBS's. In fact there was a very good reason for them NOT to downgrade those MBS's: The gov't dictated that only those agencies that had a large market share would be accepted as raters for MBS's. If Fitch's had decided to downgrade, and lost bank customers because of it, they would have been sidelined by the gov't. (See Reckless Endangerment)

Read the chart referenced above very carefully, It shows share of mortgages in percent, and the GSE's are shown losing market share from a high of 50% in 2002, to a little under 40% by 2007. But the key is not what they did in the final run to collapse, but what they did to start the bubble. Here's a chart of household credit market debt, a pretty good surrogate for mortgages outstanding:

CMDEBT_Max_630_378.png

Note that between 2000 and 2003, (mortgage) debt rose by over $2T - that's mostly attributable to the influx of cash into the mortgage industry by F&F's MBS's.

Okay, so now it's 2003, and F&F start losing their market share to private banks. Enter stage left, the Federal Reserve, which, for a period of over one year, and while GDP was experiencing a growth rate of just under 4%, inexplicably held the fed funds rate at 1%, providing a mortgage-Fed spread that averaged 5% over the period, the highest in over 30 years of records. By the time the Fed started raising rates, the Case-Shiller index had risen from it's historical average of 100 in 2000, to 181 in mid 2004, with a >20% increase just the previous year. Pretty good return, huh?

The rest of what happened is simple bubble dynamics, as people rushed in to make huge gains on real estate, flipping houses, refi-ing for huge cash lumps, and trying just to get a house while they could still afford one. When the flow of money slowed, as it must inevitably do, the value of houses, based on the annual increase of home values, began to crater quickly. The use of MBS's as money in the global markets let to a sudden devaluation of assets worldwide. Gov't's tried to inject cash with TARP, etc., but that just slowed down the inevitable unwinding of the financial imbalance.

Banks and Wall Street had their roles in this disaster, but they were supporting roles influenced by gov't policies, the main of which was something called "affordable housing."

BTW, look to 1934 to see the gov't only option for cleaning up a bubble. The huge debt of WWI led to use of Liberty bonds and T-bills as money during the 1920's. When it became clear that the gov't couldn't repay all that debt, the deleveraging of those securities in the market culminated in the 1929 crash. It wasn't until 1934, when FDR defaulted on more than $20B in WWI debt, by reneging on gold convertibility and devaluing the dollar by more than 40%, that the markets became properly leveraged again and growth started. Unfortunately, the rest of FDR's meddling caused growth to stall again in '37.

The only answer to the present malaise is to devalue the dollar so to increase the dollar price of houses above their mortgage amounts. The longer the government waits, the less drastic that action will have to be, but the longer we all have to wait to get on with our lives.

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I strongly disagree that the only way out of the Financial Crises via bad mortgages is to devalue the dollar so that the nominal price for houses goes up above the current valuations. The only way out of the crises is to let the mortgage bubble collapse entirely -- let the market adjust downwards -- and then the market can take care of the devaluations. Devaluing the dollar would hurt the entire economy and the Federal Reserve had better not do that with the ensuing inflation or hyper-inflation. The only real solution is freedom in the market place. One does not help the bubble by continuing it. Let housing prices fall to the bottom so the market can take care of the rest of the problem. In short, capitalism is the solution, not further market manipulations by the government.

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"The only way out of the crises is to let the mortgage bubble collapse entirely -- let the market adjust downwards -- and then the market can take care of the devaluations."

I agree, though I am not confident that the government will let this happen as it should.

Another factor in all of this, though it's seldom mentioned, is a declining birth rate: the bulk of Boomers are beginning to retire, and their peak producing/consuming years are behind them. They did not have many children -- 1 or 2, maybe 3 -- in contrast to the larger families they themselves came from. I read an interesting article by a David Goldman which asserted that sectors of the housing market would never recover because of this: the Boomers bought big luxurious houses way out in the 'burbs, but when it comes time to retire and move to smaller, multi-unit condos and townhomes nearer to hospitals, grocery stores, etc., they will sell these big homes to....who, exactly? To each other?

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I'd say that the major source of causation flowed from regular and prime mortgages toward the sub-prime ones: via the effect on home-prices. When credit booms and flows to an asset-category, the price of those asset goes up. Typically, lower quality assets in that category go up in price as well ("rising tides lift all boats"). Thinking that prices of homes would rise was the single biggest factor inducing loans (including sub-prime loans) and all the more complex financial assets based on those loans.

The notorious Greenspan put and Bernanke's "helicopter drop" reiteration of the put led people to assume that the Fed would try its best to ensure a floor under nominal prices of assets. This turned out to be a valid assumption. However, even the Fed can only do so much. The question then becomes: what type of floor can the government actually support. People who completely buy the government's party-time theme ("use your home as an ATM") are irrational. However, people who don't get with the program and who assume that the government will simply sit by and do nothing, or who act as if we're in a free-market are irrational in their own way. Government involvement in the economy is so high, that guessing correctly about government action is a major criterion for success. (Witness the recent upheavals in the stock market driven by ever changing guesses about what European governments will do about the debts of their "PIGS").

In a free-market, actors who are using other people's money are kept in check by those other people. However, when those other people are being back-stopped by government guarantees, this removes the most important check that a free-market would impose. When the recent crisis was clearly upon us, and Countrywide was clearly in trouble but not yet dissolved, they (Countrywide) tried to raise funds by offering CDs with slightly higher rates. In a free market, they would have had to offer a huge premium to induce people to invest. However, with the FDIC guarantee, putting money into their CDs carried only a small risk of inconvenience and slight delay in return of principal. A small premium of about 0.5% was enough to induce people to buy their CDs. If bad actors are not checked by funds drying up in such bad times how can one expect any checks during good times? [The same principle plays out with food and drugs: with the government being the rule-setter and proactive policeman in those areas, it drives out private-sector options, since people don't see the point.]

Of course if the FDIC and the Fed were to tighten standards, if Glass Steagall were to be brought back, and so on we would reduce risk-taking. We could go all the way and reduce fluctuations to North Korean levels: stagnation and steady decline are the ultimate non-fluctuation.

Interesting analysis but I have a few issues.

First, the government has to intervene in the market to some extent, for example in setting nominal interest rates. Wouldn't you rather have a system where investors are guessing what rational central bankers are going to do, rather than having a fixed stock of money that always and everywhere produces deflation. Wages are sticky to the upside so persistent deflation would be an utter nightmare for any economy.

Second, in your last paragraph you set a continuum of regulation from laissez faire to North Korea. The key for policy makers is to find a balance; to reduce reckless risk taking while still allowing people to risk their capital on ventures. The fact that regulators failed in this and actually exacerbated reckless risk taking doesn't change the goal of successful policy making. It was done successfully in Canada which didn't experience as much of a boom and bust because of minimum loan-to-value regulations. (I realise that Canada's real estate is looking frothy at the moment but lets see if the BoC will raise rates.)

I strongly disagree that the only way out of the Financial Crises via bad mortgages is to devalue the dollar so that the nominal price for houses goes up above the current valuations. The only way out of the crises is to let the mortgage bubble collapse entirely -- let the market adjust downwards -- and then the market can take care of the devaluations. Devaluing the dollar would hurt the entire economy and the Federal Reserve had better not do that with the ensuing inflation or hyper-inflation. The only real solution is freedom in the market place. One does not help the bubble by continuing it. Let housing prices fall to the bottom so the market can take care of the rest of the problem. In short, capitalism is the solution, not further market manipulations by the government.

This is a liquidationist argument which is basically what turned a recession into the great depression.

EDIT:

Andrew Mellon, Secretary of the Treasury from March 4, 1921 until February 12, 1932:

liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.

I wonder how that one worked out lol.

Edited by IceFive
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I don't think letting free markets work will cause a depression. Yes,housing prices would come down and a few people would be underwater on their mortgages, but without the free market operating and letting housing prices come down due to supply and demand things will only get worse, with the bubble further collapsing at some unpredictable date in the future. The government caused the bubble and the more they try to support it by manipulating the market the worse it will become. I say keep the government out of it altogether, and let's have a free market in housing, including keeping the government out of interest rate determinations. Capitalism is the only way to go to correct the malfeasance of the government.

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First, the government has to intervene in the market to some extent, for example in setting nominal interest rates. Wouldn't you rather have a system where investors are guessing what rational central bankers are going to do, rather than having a fixed stock of money that always and everywhere produces deflation... The key for policy makers is to find a balance; to reduce reckless risk taking while still allowing people to risk their capital on ventures. The fact that regulators failed in this and actually exacerbated reckless risk taking doesn't change the goal of successful policy making.

Govt intervention in the economy is ALWAYS a very bad idea as history endlessly shows. Professor Walter Block in his book "Defending the Undefendable" in Chapter 21 put it eloquently.

"... all government involvement in the economy has been marked by inefficiency, venality, and corruption, and the evidence suggests that this is not merely accidental.... A government “enterprise” can be expected to be inefficient because it is immune to the selective process of the marketplace.... This continual process of the selection of the fittest ensures the efficiency of entrepreneurs. Since the government is immune to it, it fails to regulate governmental economic activity.

The venality and corruption of the government is... even easier to see. What is difficult... is to realize that corruption is a necessary part of governmental operation of business.... We readily concede that people enter business in order to gain money, prestige, or power.... But when it comes to government, we lose contact with this basic insight. We feel that those who enter government service are “above the fray.” They are “neutral” and “objective.” We may acknowledge that some government officials are venal, corrupt, and profit seeking, but these are considered exceptions to the rule. The basic motive of those in government is, we insist, selfless service to others.

It is time to challenge this erroneous concept. Individuals who enter government are no different from any other group. They are heir to all the temptations that flesh is heir to. We know we can assume self-seeking on the part of businessmen, unionists, and others. It can be assumed just as clearly to be operative in government officials. Not in some of them, but in all of them."

-- Walter Block

In a free-market, actors who are using other people's money are kept in check by those other people. However, when those other people are being back-stopped by government guarantees, this removes the most important check that a free-market would impose... Of course if the FDIC and the Fed were to tighten standards, if Glass Steagall were to be brought back, and so on we would reduce risk-taking.

I agree with the first part. The second part is based on the wrong assumption that governments are better at regulating markets than private businessmen. Only the free market can do it, not regulations from politicians that can easily be bought and lobbied.

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Houses are not tulip bulbs and they're not dot-coms. When most bubbles collapse the assets behind the bubble disappear rather quickly as people rush to avoid further losses on cratering assets. The difference with houses is that selling the house (or walking away from it)) leaves the owner in a worse situation than holding on to it, even if the value is expected to continue to fall. With assets wiped out, no money for a dp (you need at least 25% these days) and a default on their record, they have no way of getting another loan and face a foreseeable future of renting. Since rents are often now considerably higher than mortgage payments on the same place, the owners are better off staying put and ignoring the continuing loss of value of their home. The back pressure against selling homes only gets worse as their values fall.

The economy is in a slow death spiral now, with the slow decline in housing prices further depressing the economy, which throws people out of work, which forces them into foreclosure, which drives prices down, which makes it even harder for those who didn't sell to sell. Worker mobility is close to zero, and businesses are waiting for the next "great idea" to come out of Washington. If they're lucky, it won't be as great as Obamacare or Dodd-Frank.

There have been a lot of suggestions for "solving" this. Most involve reducing the principal of loans below the homes' market values, but what happens when people see daylight and rush to get out of their homes? A further devaluation. So the plans are modified so that those who get their principal lowered have to stay put. If they leave, the gov't can go after other assets, etc. Another is to subsidize the purchase of empty homes to rent them out. That drives down rent prices and will force current rental property owner to sell. Every "answer" has unintended, negating consequences.

Left alone, it will take a combination of defaults (bank losses) and the gradual paydown of mortgages to below the home value. On average, a house bought in 2006 or 2007 with a fixed 30yr and no DP will not get its principal below today's value until 2022. Even buyers who put down 20% are just at breakeven, which means they lose their entire DP investment if they sell now.

Devaluation of the currency to pay the federal debt is an inevitability. So why wait and prolong the pain to the economy? Imagine the worst case: gov't lets mortgages unwind slowly as our economy slowly dies, then when revenues drop below a certain point, it becomes crystal clear that gov't default is the only recourse. They print a shipload of money to pay off debt because no one is renewing prices rocket uncontrolled and the housing problem is finally solved, amidst the ruins of a once great economy. If they devalue now, let people know why they're devaluing, put in place safeguards against future bubbles (like, oh, I don't know... a full-reserve, audited gold standard?), then everyone takes their lumps and we rebuild what is still a vital, intact economy.

I'm as against gov't intervention as the next guy, but when gov't intervention causes a bubble, gov't de-intervention may be required to re-balance the system. At least in this case, where the bubble dynamics of people's homes prevents a quick orderly correction.

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Unfortunately, this graph isn't adjusted for price-inflation or population growth

The Fed site (search FRED Database) allows graphs to be customized in various ways. By combining a couple of graphs there, you should be able to get a feel for what you want.

For current, excellent-quality graphs of key economic measures, the best place I've found is the Calculated Risk Graphs Galleries. (By quality, I mean objective and not driven by the need to push some political viewpoint.)

On mortgages, CRE has one that shows Mortgages as a percentage of GDP. That's one decent way of normalizing the measure over time.

post-1227-0-99715100-1319228137_thumb.jp

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I think it is very important that as Objectivists or as fans of Ayn Rand that we always push for a free market solution, regardless of some thoughts that the government can engineer a "soft landing". Government manipulation always entails further government regulations and these cause more and more distortions in the market, and we should stand against that on principle. If the government got out of housing altogether and let the market go where it goes, we would have a few rough years, for those just buying a house, but it would be over with fairly quickly. With more government interference, it will just stretch on and on with the next crises bringing even more regulations for "a soft landing." I am completely against this line of thinking.

Regarding the gold standard, the gold standard did not cause further problems for the Great Depression. If we don't have sound money (gold or silver, at least gold or silver backed money), then all sorts of problems caused by the Federal Reserve will crop up, including having to have dealt with inflation all these years since the Federal Reserve took over. The gold standard does not put a dampening on the economy, but having fiat money and inflation always spurs booms and then busts, because ultimately, you cannot fake a good economy. The gold standard or better yet gold as money is the only way to go to insure the government is not manipulating our currency.

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Here is a free market solution to there being too many houses on the market first proposed by Yaron Brook and currently being debated in Congress: If you are an immigrant and buy a house, then you get American citizenship. Of course, Congress couldn't make it that simple, they proposed it has to be a $500k house, which would be a really big house in most markets. And, of course, the Conservatives are against the idea of "buying citizenship" and who knows what those Mexicans might introduce to America...maybe tacos or something as horrible as that :)

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Here is a scary economic story that may lead to much further devaluations of the dollar, if the government goes for it. Bank of America has transferred all of its toxic assets to a branch that is covered by the FDIC -- The Federal Deposit Insurance Corporation. If the government permits this to go through, then the taxpayer will be saddled with additional debt as the FDIC pays out the claims. This could lead to further "quantitative easing" on the part of the government, leading to hyper-inflation, something that many people are predicting anyhow to pay off the national debt.

http://wrightlawaz.com/?p=303&utm_source=rss&utm_medium=rss&utm_campaign=bank-of-america-transfers-derivatives-risk-to-us-taxpayers-2

But, again, if this goes through, it is the fault of the government for setting up the FDIC, rather than the fault of the banks for trying to take advantage of it.

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*** Mod's note: Moved posts - sN ***

If they devalue now, let people know why they're devaluing, put in place safeguards against future bubbles (like, oh, I don't know... a full-reserve, audited gold standard?), then everyone takes their lumps and we rebuild what is still a vital, intact economy.
For the follow up posts on the Gold standard, and also some on fractional-reserve banking, please continue here.
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Occupy Wall Street: "To Hell With Steve Jobs" http://industrialpro...ith-steve-jobs/

Steve Jobs had a lot of good ideas but the wealth he accumulated was produced by others. Steve Jobs took in the wealth that others produced…Somebody else would have invented the things…I think Steve Jobs and all the other Steve Jobs’s in the world, like most researchers, most R&D, can be salaried employees of the majority…I don’t believe that there’s any need for individuals like Steve Jobs in this system to flourish based on their particular talents or their particular genius…
A "physical labor" theory of value in the 21st century. The guy cannot be this ignorant.
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