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Oct 06

The Explainer: A frozen world economy

 

Warren Buffett:

Yeah.  When 40 billion of treasury bills are sold like they were last week, seven day treasury bills, at a yield of 1/20th of one percent, that means the whole country is basically at the point virtually, or a lot of the country is at the point of putting the money under the mattress.  One twentieth of one percent away from where it’s betting to put it under the mattress.  You don’t want 300 million Americans putting their money under the mattress.  This economy doesn’t work well without the lubrication of credit and trust.  And that’s been lost.  It’s a huge problem.  What you have is you have the major institutions of the world all wanting to deleverage.  They want to take down their assets and liabilities.  What seemed so easy to borrow against a year ago now looks like rat poison to them.  So they’re trying to deleverage.  There is only one institution in the world that can leverage up in a way that’s all a countervailing force to that, and that’s the United States Treasury.

 

You put your money in the bank, the bank pays you interest. In turn, the bank lends out money to other people –including you, for your car or housing or business loans- and profits from interest on their loans.

 

Let’s look at AIG and insurance. According to Bloomberg, banks have to

The nervous banks, having to increase their capital, have to sell assets –but when everyone’s selling assets, you won’t get what it’s worth

 

That was the legendary investor Warren Buffet, recently interviewed on PBS by Charlie Rose. Two weeks ago we looked back at the Great Depression to figure out why it happened and by so doing, appreciate why it continues to haunt governments and economists to this day.

Tonight, we’re going to look at what’s happening in the global economy, not in terms of the specific failures of big banks and corporations, but rather, to get a grip on the big words being thrown about by the pundits and news anchors. The news will change from day to day, but the key concepts will remain.

It’s financial vocabulary night on The Explainer! I’m Manolo Quezon.

 

I:  Economic Word Power

 

For the past few weeks, fear and awe have gripped all kinds of people, from filthy rich financiers to ordinary blue collar workers, because of how the American Economy, in the words of Warren Buffet, has ended up like a world-class athlete suddenly struck down by a heart attack.

Tonight we’re going to do things a little differently around here. We’ve been riveted by the news, but everytime you see a talking head on TV or read their statements in the papers, there are certain words and concepts that keep cropping up.

When the US House of Representatives http://www.politico.com/news/stories/1008/14252.html passed a bailout package last week, it came after a week of furious debate and agonizing on the part of American politicians.

As they tried to decide what to do, their phones rang like crazy, emails flooded in, and that was just from their voters.

For the rest of us, we were riveted by the sight of stock markets seesawing based on raw emotion, it seemed, swinging widely from relief to despair depending on how the American congressional wind seemed to be blowing.

Key terms- they are:

Derivatives

Risk

Leverage

Liquidity

And a pretty basic word,

Trust.

Let’s start with the last, because it’s something Warren Buffet talked about in the clip with which we started the show. Without further ado, let’s have our guest join us.

You know, in a past episode we tackled the SubPrime Crisis in the States, but for tonight I’d like to ask you to help us understand the concept of derivatives.

What are they?

How do they work?

And how did they end up so toxic, economically?

 

When we return, more from Warren Buffet and the continuation of our vocabulary-building exercise.

 

II: Risk and Leverage

 

Charlie Rose:

And so when you look at where we are going, there seems to be two issues that are apparent to me at least, risk and leverage.  We just lost sight of risk and leverage of what was appropriate?

 

Warren Buffett:

Yeah.  Again, because it pays off for a while.  You know, you can lose leverage, and it’s the only way a smart guy can go broke.  If you owe money, you can’t pay them out.  You just pay for everything, you do smart things, you eventually get very rich.  If you do smart things and use leverage and do one wrong thing along the way, it could wipe you out, because anything times zero is zero.  But it’s reinforcing when the people around you are doing it successfully, you’re doing it successfully, and it’s a lot like Cinderella at the ball.  I mean you know at midnight everything is going to turn to pumpkins and mice; right?  But if the evening goes along, I mean, you know, the guys look better all the time, the music sounds better, it’s more and more fun, you think why the hell should I leave at quarter of 12.  I’ll leave at two minutes to 12.  But the trouble is, there are no clocks on the wall.  And everybody thinks they’re going to leave at two minutes to 12.

 

Charlie Rose:

And you’re having a good time.

 

Warren Buffett:

Yeah, sure.

 

Charlie Rose:

So if this plan — you hope it will do what?  It will loosen credit.  It will stop the slide and the panic.  People will have more confidence 

 

In the clip you just saw, with Warren Buffet talking to Charlie Rose on PBS, Warren Buffet brought up the concepts of Risk and Leverage.

I’d like to ask our guest to walk us through these words. We explored in part one of our show tonight, what Derivatives are. Let’s use that concept to figure out how they whetted the appetite of investors, bankers, and big companies to take on Risk and how they intended to use these instruments –the concept of leveraging.

 

When we return, the biggest word of all.

 

III. Liquidity

 

Warren Buffett:

Confidence is key.  Confidence is key.  You’re not going to leave your money with me unless you’re confident I’m going to give it back to you.  And at this point, when treasury bills, seven day treasury bills at 1/20th of one percent, it’s not because people want to earn 1/20th of one percent, it’s because they trust the fact the treasury will give it back to them next week.  And I’m sitting with six and a half billion dollars we’re going to use to close the Mars-Wrigley deal on October 6.  I’ve got to hand over that six and a half billion on October 6.  Now, I have to be very careful about who I leave it in between now and then, because they’re expecting that he show up.  But I lose confidence in other people, all kinds of institutions.  And there are plenty of them that I’ve lost confidence in.  Then they get — their funds aren’t available.  They don’t have it for the next — I mean the whole economy just comes to a grinding halt.  Competence in markets and in institutions, it’s a lot like oxygen.  When you have it, you don’t even think about it.  Indispensable.  You can go years without thinking about it.  When it’s gone for five minutes, it’s the only thing you think about.  And the oxygen has been sucked out of the credit markets, and confidence, and there has to be — it’

And that’s what this.

 

And finally, this brings us to perhaps the word you’ve been hearing most often.

Liquidity. We often say we’re liquid when we have cash on hand to meet our day-to-day needs, or even cash on reserve when an opportunity or emergency arises.

So let’s have our guest walk us through the concept of liquidity, why it matters, and why its absence has so thoroughly paralyzed the global economy…

 

IV. My view

 

If you’d like to see the Charlie Rose interview of Warren Buffet in its entirety, do visit our blog, www.the-explainer.com. We’ll have it there.

The experts like to use the words we explored tonight, because they not only mean precisely what they want to say, but because they also act as a kind of code among themselves even when they’re talking to us.

But what’s clear to them, to bankers, financiers, politicians and businessmen may not be so clear to others. And when that happens, the mystery deepens and our sense of helplessness increases.

But it only takes a little time and study, to get a clearer idea of what the experts are saying. Knowledge, as they say, is power, and as the experts make momentous decisions concerning you and me, involving the tax money you and I pay, it’s always a good thing to be a little less powerless today, than you were yesterday.

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