Great Depression 2.0

Update: I just found out they now have 3x ETF funds, or funds that match 3x a particular index...they can't be serious.
http://finance.yahoo.com/q?s=bgu
So last night I was reading this book "The Great Crash: 1929" for the second time. The similarities with the fundamental issues (high leverage in bubble assets) in today's economy are scary similar.

1.
THEN: Back then the Fed was lending out cheap money (similar to past 5 years).
NOW: The Fed over the past 5 or 6 years lent out very cheap money.
(This is GOVERNMENT INTERVENTION for the record--damn you Greenspan for giving the Senate baffoons a soundbyte that FREE markets failed...the markets never were free!!!!!!!!!).

2.
THEN: Individuals and businesses started thinking that stocks were the asset that could not drop in value
NOW: Housing would never go down because population was growing, land is fixed, blah blah blah.

3.
THEN: People borrowed more and more money from the banks to leverage up their position in stocks. The banks, who could borrow from the fed for 2-3%, were happy to turn around and lend it out to stock speculators for 6 or 7% because the loans were essentially risk free. The banks reasoned that margin loans were risk free (almost) because they could always liquidate the stock position to cover their loan.

NOW: This time around the banks thought mortgages were relatively risk free, because there was a home backing up the loan and they could always rely on the collateral to save their ass.


4.
THEN: Some people realized that the FED's policy of low interest rates was causing a huge bubble in stocks because they witnessed the bankers clamour to borrow cheap and lend high. The minute politicians or regulators tried to do the right thing, they were berated for treason (a serious threat back then!) or trying to 'kill' the American economic engine.

NOW: Plenty of people warned of the bubble in the housing market and other assets and suggested raising FED rates, but again, people bitched because it would 'kill' the economic engine.

SIDENOTE: Notice how in both cases it was a GOVERNMENT intervention that caused a market failure? If banks were forced to compete for funds and the FED wasn't there to lend them infinity at any rate it would have naturally curbed lending practices because as more people wanted to borrow, the rate would go up and curb demand...but alas, we want to blame the 'market' for screwing this up...stupid...


3.
THEN: Wall Street came up with the concept of the investment trusts, which would pool a basket of stocks (basically a closed end fund). They would then sell this package to investors as a low-risk way (high diversification lowered the risk according to the rhetoric of the day) to invest in stocks, which 'always' went up.

NOW: This time around Wall Street packaged mortgages into pooled products and told everyone that they are low risk because the underlying assets are diversified and uncorrelated.

4.
THEN: Wall street used leverage within the investment trusts to buy stocks, levered investment trusts were then bout by speculators who used leverage to buy the investment trusts. What you ended up with was levered, levered stocks.

NOW: This is similar to the CDO squared, derivatives, Credit default swaps, hedge funds, private equity buyouts, and other insane levered products we have today. Easy money, brings easy leverage.

5.
THEN: Eventually, stock prices were sustaining a ponzi scheme that Wall Street was proud to accomodate. For every product they could sell, and for every margin loan they could lend--they were making dough. It was a perpetual money machine as long as the FED kept rates low and the cost of borrowing from the government stayed put no matter how much you borrowed (supply/demand principles don't apply).

NOW: For every mortgage product Wall street could sell, and every mortgage transaction mortgage brokers could transact, more money was greasing the system. The housing ponzi scheme grew and grew.

6.
THEN: The bubble in stocks eventually burst, and the fallout in leverage created the massive shockwaves that annihalated the economic system.

NOW: This time around the housing bubble burst (worldwide and almost simultaneously) and the leverage that was used has created a massive shockwave that is annihalating the system.


Differences:

THEN: The 'solutions' the government implemented were poorly executed and did not fix the problem.

NOW: People say we are smarter and more sophisticated this time around...fine, for arguments sake I'll agree with that statement even though it is probably not true.

2.
THEN: Leverage was pretty insane, but it was focused on stocks.

NOW: Leverage is stratospheric, in every asset class, and global! This time it is homes, hedge funds, private equity, corproate lending, consumer credit cards, commercial real estate, etc. The total leverage in the system this time is probably multiples of what it was back then.

3.
THEN: The common reason cited for the Great Depression was the lack of initial government intervention and lack of liquidity in the system that allowed firesales and the house of cards to come crashing down in dramatic fashion.

NOW: Now, instead of letting market prices move to their pathetically low value, we are throwing TONS of money at the problem and letting the government intervene to try and save the world. Okay, so this may not let asset prices fall as much, but it will increase real rates long term (if they just issue debt) or it will end up in insane inflation (if they print money). Higher long term rates and/or inflation are not good alternatives.

Conclusion:

If history is any guide, we are likely entering the second Great Depression. That is a scary thing to contemplate, but I think it's a lot more likely then people realize. The "government can save the day" philosophy that is overtaking America is only worsening the problem. Every day a new constituency is claiming they are vital to America and they need more money and a handout. And it looks like we are actually giving these people/industries a seat at the table. This is a sure way to waste taxpayer money, prolong a recession, and warp market prices and incentives.


...but not all is lost...

Solution:

I see two possible solutions to this problem (this is actually the 'Seager/Gray' plan, which is VERY preliminary).

1. Invite anyone in the world with a Ph.D. or M.A in science or math a free pass into America and a tax credit, or similar incentive, if they put 20% down on a home. This will increase demand for housing, soak up supply, fundamentally rectify the root of our problems, and will flood America with productive, GDP generating individuals. We should also allow GM type companies to fail, sell the assets to non-unionized, efficient producers like Honda. Honda can give jobs to former GM/ford employees, but they will not have the high wages, healthcare, and sweet pensions that bankrupt GM in the first place. Union workers can either take market wage or go to Mexico--their choice.

2. Another solution is more drastic, but actually pretty good. We need to dig, dive, search--whatever the hell it takes--to use our natural resources, which are bountiful in America. We are blessed to have some of the greatest resources in the world and this is a huge source of wealth we could use to shore up our national balance sheet. We could save this for a rainy day, but its pouring at the moment and it's time to use it. At the same time we need to create some sort of chaos in Iran or Saudi Arabia so their supplies are restricted (0therwise, we won't make much money since selling resources in a recession isn't a profitable idea). This sounds drastic, but it would be the only method of ensuring resources prices stay high. We would essentially become the new OPEC and put a lid on Middle East Oil. It would also be poetic justice. After being beholden to the Arabs for all these years, who gouge us and control supply, we will control their supply, and sell our own resources to the world. We'll get rich and raise capital to save our asses, and they will no longer have influence. Awesome.

Anyway, I hope all of this is overblown, but I'm worried that history may repeat itself. Who knows...as Robert Shiller says, "forecasting humbles everyone."