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Chaotic Markets

Unclear Outlook

By: Francis Cianfrocca (Diary)  |  October 27th, 2008 at 06:03 AM  | 

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I’ve been trying for days to form a perspective on what’s happening in global markets, without much luck. And I’m not talking to or reading anyone who feels very differently.

Stock markets are plunging again in Europe and Asia, indicating a growing concern with falling economic output and a coming global recession. The dollar and yen continue to strengthen. Oil and gold continue to fall. US Treasury rates are lower across the curve, but not as much as one might expect.

US stocks are participating in the rout overseas at this moment, as they did last Friday morning. But I’ll stop short of predicting this will continue in New York today, because on Friday that turned out to be a bad call.

Markets are essentially in a chaotic state. There is no sustained pressure from economic fundamentals anywhere in the world. I can’t think of any prior period in history to compare this to.


One thing that can be said for certain is that the world is de-leveraging (“ungearing,” as traders say). When we get through this period of turbulence and people start looking at actual investments again, it will be harder and more expensive to do so with borrowed money.

This effect will be felt as a reduced amount of available capital. The financial Ferris wheel will come to rest at a considerably lower level than it reached over the last few years.

I believe that risk-management technology will also be significantly transformed. There will be considerably more “vertical integration” of risk-management practices, if you will. You’re not likely to see people taking on faith investment-grade ratings on asset-securitizations again.

That doesn’t mean that people will stop securitizing assets. There’s just too much benefit and efficiency in that process to give it up altogether. (Unless a misguided Congress tries to outlaw it.)

But it does mean that there will be a reduction in the efficiency and an increase in the cost of credit intermediation. This is part of what will make it feel like there is less capital in the world.

This much is for sure, but it’s also in the future. What remains is to understand the present.

The de-leveraging process is driving a great many investors (many of them hedge funds) to sell off large amounts of high-quality assets. I think there is a lot of people out there anxiously waiting for up-days where there is some positive news, so they can sell.

If that is a correct reading of current market dynamics, then it follows that there is significant risk of major crashes. That’s because a sharp decline on any given day could lead people to believe they shouldn’t wait to get out. And some of them won’t be given a choice, because they’ll face margin calls.

Someone is definitely stepping up to buy US assets. We saw that on Friday, which surprised everyone by being a bad but not catastrophic day in New York, after total disasters in Asia and Europe. What we don’t know is whether those assets are going into strong hands or weak hands.

Is there a value-based case for buying assets like stocks and corporate bonds?

Corporate bonds are so illiquid right now that it’s hard to justify trading them due to the extraordinarily high spreads.

And stocks are only valuable at these levels if you accept two assumptions: first, that there will be enough capital available in the coming de-leveraged world to bid stocks back up; and second, that corporate earnings will not be heavily impacted by a long recession.

The fact that an Obama administration might target corporations for big tax increases makes the outlook for earnings (and stock prices) even more uncertain.

Money and credit markets have been steadily improving in tone since the partially-coordinated moves to nationalize banks around the world that began at mid-month. It remains to be seen whether the improvement will continue.

You can’t do an analysis like this without mentioning volatility. As far as I know, no one has been taking nuclear weapons to large chunks of America’s industrial infrastructure. Farms, factories, logistical facilities, and other capital stock are pretty much in the same shape now that they always have been. So how is it possible that some very large corporations can swing in value by ten percent or more, in a single day, as has frequently happened in the past month? That reinforces the point that markets are being driven by something other than fundamentals.

The distinctive feature of chaos is that you simply have no basis for predicting what will happen next. You can’t reliably trade on any analysis in which a given outcome is more likely than any other.

The upside risk may be very large compared to the downside risk (which is limited by the fact that asset values can’t become negative). I wouldn’t be at all surprised to see US markets rise sharply from here. But I’d be just as unsurprised to see them keep falling.

At some point, everyone who is sitting on losses and has been trading with leverage will have to meet margin calls and get taken out of the market. When that happens, the financial world can start concentrating on finding a bottom. But because of de-leveraging, it will stabilize at lower levels than prevailed before the crisis.

And then we can start talking about how long it will take for the real-world economy to come back.

-Francis Cianfrocca

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COMMENTS

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  • markol

    Here’s an interesting article: Europe on the brink of currency crisis meltdown. I have no idea if this accounts for any of the weakness in world markets, but it’s an interesting (frightening) read.

  • streetwise

    The market players seem to be more introspective as they spend more time analyzing what’s actually in their portfolios. I think we will see less momentum and “theme” investing for a while.

    I have been seeing more prospectus requests and questions on collateral.

  • liberalrepublican

    “Be fearful when others are greedy, and be greedy when others are fearful.”

  • izoneguy

    I think the reason the European & Asian markets are tanking is that they fear the Obama socialist onslaught. Yet at the same time you would think they would want Obama because of all the new jobs he will be sending overseas. Or maybe the European & Asian markets are fearful of McCain who will lead a new American economic resurgence? But the idea that Obama would be best to fix the economy is like the arsonist who shows up at the fire he started and wants to put it out.

    • blackhedd

      I’m assuming you’re being greedy while the rest of us are fearful.

  • Marcus_Traianus

    There is much uncertainty in the markets already and I believe this election magnifies its fears. When industry people combine their past experiences with Democrats (say, Fannie, Freddie, FHA and CRA) then start to think about a potential future with Democrat super majorities and a Democrat President, they vomit. Combine that with Obama?s desire to raise corporate income taxes, redistribute our wealth, increase overall taxes almost a trillion dollars, increase heavy handed regulation, impose a windfall profits tax, create another mandatory government entitlement, stop free trade, intimidate people to join unions that already kill our competitiveness, ignore an increase in drilling for our own economic security and God knows what else; people start to convulse.

    I have never heard so many companies talk about investigating various tax shelters and potentially shifting to foreign subsidiaries as the engine for future production. We have small businesses, this countries job growth engine, talking about ?going to the mattresses?, that is, going to an all cash operation in order to avoid the grotesque governmental financial burden; illegal yes, but necessary for their survival under an Obama/Democratic Congress world. Combine that states which have Democrat majorities who are losing tax revenue in this economy and see corporations as the piggy bank. Does the long term picture look bad? You bet it does and the market is under no illusions where this is going.

    The one thing Bernanke and Paulson can not control are these political aspects which ultimately affect confidence and legislative economic policy. They can provide all the funding possible to banks and corporations, however if Congress is intent on taking from productive people and giving it to the unproductive, taxing corporate success and increasing the reach of government into our economy and lives, get ready. We are in for a long ride and currently far from bottom.

    I already have my bumper sticker printed in event the unspeakable happens. It reads ?Don?t blame me, I voted for McCain-Palin.

    • blackhedd

      They’re not. For the most part, they’re responding to economics. What you’re seeing unfold in the emerging world is very much like the crisis of 1997. No one wants to take any risk, so they pull resources out of the high-growth economies. And the people who lent long-term in those economies will get crushed.

      Shipping jobs overseas: that strategy only makes sense if US consumers don’t decide that saving money is better than spending it. Otherwise, there won’t be any jobs to ship overseas in the first place.

  • MSU_Charles

    Francis,

    As always, very nice analysis.

    In my opinion, market participants are still discounting the mountains of poorly performing debt. Until the vast majority of this debt unravels, we can’t begin a full recovery. And as we know, unravelling debt is always painful. But when the entire economy is built upon this debt, the process is magnified.

    In addition, I believe we are observing a deep discounting of capital assets in anticipation of higher taxes and the subsequently decrease in productivity that will ultimately follow.

    Best Regards,

    Charles

  • kingfish

    The market still doesn’t know the amount of credit default swaps that are still out there so are not trusting balance sheets. This is contributing alot to the uncertainty. This guy has been right for the most part all year, http://market-ticker.denninger.net/.

    Until we do something about these unknown CDO’s sitting out there waiting to explode another balance sheet, expect more of the same.

  • StudentOfLincoln

    How did we get into this mess?

    Easy. Right-wing ideologues held that free markets were robustly good … left-wing ideologues held that honest investment was robustly good … and neither right-wing nor left-wing ideologues were curious to inquire further.

    But the incurious ideologues of the right and of the left were dead wrong: the global market found a way to melt-down that flatly contradicted the ideologies of the right and of the left.

    To understand how this can happen, suppose we ask “In a free market with honest traders, what limit exists to the complexity of financial trading?”

    The answer is … there is no free-market limit to market complexity.

    And in consequence, the global market in leveraged derivatives became so complex, that it outstripped the ability of any human, or any nation, to understand its complexity.

    The market in financial derivatives was technically “free” and its players were technically “honest” … and the result was global calamity.

    The bottom line … we need less ideology … and more curiosity … as to whether left-wing or right-wing ideologies really work.

    • kyle8

      For one thing it does no good being fearful of higher taxes when you are in a tailspin. You have to actually make profits before you can be taxed on them.

      Taxes certainly don’t help, but it is also premature to assume that the democrats would raise taxes by a large percentage during a financial crises. They might, but I doubt it.

      Personally I think de-leveraging is a good thing in the long run. There was entirely too much debt used for speculation and not expansion.

      • kyle8

        You have a kernel of truth, extremes of any type are usually wrong. But we have experienced neither extreme “left or right” ideologies in recent years.

        The market is in this condition for easy to understand reasons.

        (1) a speculative bubble in real estate (bubbles happen, always have, always will)

        (2) Too much debt

        (3) Government (Democratic party) meddling in the housing markets that caused a lapse in sound lending practices.(not for ideological reasons, but simply as a payoff to their constituencies.)

        (4) Overuse of derivatives and swaps, relatively new creations.

        (5) Similar things happening in other nations which in a global economy causes ripples around the world.

        I see no evidence that any ideologies either right or left played much of a roll in it.

        • Skanderbeg

          I’m afraid that I can’t quite agree with that statement, blackie. For more than a quarter century, political risk has been stunningly reduced (with regard to finance and economics) and we’ve gotten spoiled.

          Now, it’s coming back – not by direct intent, but because many of the uglier realities of “politics” are re-asserting themselves.

          I got a concentrated dose of that in Ukraine last week. Despite all the obvious economic progress in Kharkov, that’s a part of Ukraine where you have to regularly remind yourself that you’re NOT in Russia. I got several reminders on this visit that Ukraine is riven by a division (orange-blue) that is as deep and regionalized as our “red-blue” division. Basically, they are still fighting WWII; the economic growth has held that in check for years, but with the faltering of prosperity things like that tend to become more “important.”

          And the big question in the general region is, is Russia going to get a chance to re-assert itself in a new political environment. I had a long dinner chat last Thursday with one of my Polish-professor friends who was also in Kharkov. Like many in “new Europe,” he is terrified of Russia getting handed a chance to re-assert control over its “historic” “sphere of influence.” I’ve heard this fear during my stops all around eastern Europe during the past month – that a suddenly self-pussified US would be green light for all sorts of bad actors to run amok.

          Bad actors run amok for political reasons, but the consequences to economics are horrific as well.

          The outcome of this election could be disastrous for us (US), but much of the world is terrified (justifiably) that it will be catastrophic for them. It’s just amazing how strongly many people in eastern Europe are literally praying for a McCain win. For them it’s a matter of survival.

          • kingfish

            Oh please. The time bomb began ticking when the SEC removed the leverage limits in 2004. 20,30, & 40 to 1 ratios were just plain nuts. That had nothing to do with ideology but just plain common sense. Its no surprise Paulson did nothing about it as in 2000 he was lobbying for these changes, calling them “more efficient uses of capital”. These instruments weren’t so complex that some good old-fashioned common sense on leverage, exposure, and risk would have prevented most of this meltdown from occurring.

          • blackhedd

            I also don’t expect any of that to happen early in the Obama Administration, but farther out is a different question. Barney Frank is already setting expectations for higher taxes once the economy stabilizes.

            You know, I occasionally have conversations with far Lefties. You can pretty much avoid them if you work in business, but you can’t avoid them at family gatherings and holidays.

            I’ve found that one of the core beliefs of the far-left point of view is that profits are unnecessary. These folks figure that everything from gasoline to healthcare would be half as expensive if it weren’t for the “fat cats getting rich off the rest of us.”

            And you get nowhere explaining that without a profit motive, they’d be growing their own food, riding their horses up and down their family farms, worrying about bad harvests, and burning wood to keep warm.

            Now we have no idea whether Barack Obama feels this way. (In all candor, we don’t really know how he honestly feels about anything.)

            But Nancy Pelosi, Henry Waxman, Harry Reid? Don’t bet on them having any understanding of economic reality.

          • StudentOfLincoln

            Kyle, how do we rein-in “overuse of derivatives and swaps” (in your terms) without compromising free-market principles?

            After all, these derivatives are freely- and fully-specified legal contracts, that are entered into by honest traders with eyes open.

            Both political parties are severely at-fault (IMHO) for failing to confront this key issue.

          • pinkonaut

            ..with escalation of debt during Bush years from about 5 to 9 trillion.

            How is that conservative?

          • mikefisk

            For one thing it does no good being fearful of higher taxes when you are in a tailspin. You have to actually make profits before you can be taxed on them.

            Profits can be made in a down economy… but if they aren’t to the levels that have been enjoyed in the past, it sends a pretty powerful signal going forward that the company is overvalued, and it will bleed market cap just as if it were losing money (perhaps not as much, but still)… what a higher corporate tax rate is likely to do is to apply this logic across the market.

  • SeaShort

    I have been taught the market crash of 1929 was the result of short selling. The uptick rule was put in place by the SEC in the 1930′s to regulate this short selling. On July 6, 2007 the uptick rule was put aside by the SEC. Since then the market has again crashed, and not by accident. I think it is a result of uncontrolled/unregulated short selling that had previously been kept in check by the uptick rule.

    • kyle8

      I was merely pointing out that their overuse was what happened. Markets always have periods of overreach. I am not a big believer in over regulating markets because you cannot stop bubbles from happening.

      You can, however put in place a few things that would help to moderate, like for instance. If instead of pushing bad loans the government would have instead insisted upon sound lending practices.

  • Shaggy_Dog

    I actually expect the market will get a bit of a short term spike with an Obama win.

    The media will be so heavily invested in conveying the glorious new era that we would be entering with an Obama win, that the public will have somewhat of a positive psycological pop as the MSM repeatedly floods the airwaves with how wonderful life in America now is with basking in the eternal glory of Pres. Obama.

    Will the MSM life-is-wonderful-with-President O propoganda be enough to offset fundamental economic problems and widescale deleveraging? I’m not saying I would bet on that.

    But I do believe that market performance is driven not just by economic fundamentals but to some degree by whether the public has a positive outlook or negative one. After 8 years of being hammered with how horrible CHENEY/bush’s America is, there probably will be some positive psychological shift with the public when the MSM flips the propaganda in reverse and proclaims that life is great in Obama’s America. And I think that will benefit market performance.

    I may not like that politically, but as an investor, I welcome any positive impact I can get.

  • ElliotE5

    Dear Blackhedd,

    Thank you for the diary posted here.

    In it, you say, ?I’ve been trying for days to form a perspective on what’s happening in global markets, without much luck. And I?m not talking to or reading anyone who feels very differently.?

    While prices of shares and debt in the US and most nations of the world have been heading downward, I doubt that there is truly a shortage of folks who can ?form a perspective on what?s happening in global markets.? The problem is not in grasping what has happened, or why.

    The problem is in deciding what to do about it for a) our own financial benefits; b)the safety and improvement of the country; and c) the delivery of a message which explains why folks should choose a Red State philosophy.

    Actually, you know and have described much of what has been happening.

    1. For a number of reasons, American monetary authorities held interest rates at levels which were too low. This helped the economy expand, but it caused distortions.

    2. With Democrats leading the charge, Fannie Mae and Freddie Mac were allowed to grow too large. Too large meant buying mortgages for their portfolios holding only about two percent back as reserves for credit losses. The portfolios included not only outright purchases but insurance on the performance of mortgages held by others.

    3. Each time one group or another tried to speak up about the over-large positions at Fannie and Freddie, they were met by members of Congress who were on the take. Chris Dodd, Barnie Frank, Barack Obama.

    4. But we want to expand homeownership even to people who are poor and of color, those and their friends insisted. Even the Administration at times bragged of the growing rates of homeownership. Ignoring that many of those homes were owned by very marginal buyers.

    5. In the background, the securities business had been changing, in large part because of the Internet. Commissions all but disappeared. Spreads on municipal bond underwritings kept falling. Commissions on common stocks, only a few cents a share now, fell even more. Even more than that, sites such as www.investinginbonds.com made it possible for anyone to see both sides of bond trades in small and large size.

    6. Brokerage firms responded in several ways. One was to buy up pools of assets, say $500 million at a time, segregating these pools into sections which would be paid first, second, third and so on. Whatever the benefit to the investor of buying into such a pool, it made it possible for $500 million of mortgages to be worth several percent more than that the very first day the pool was assembled. That?s because it would be hard to follow what the markup was as it was spread into so many new instruments.

    7. Along the same vein, brokerage firms began to sharply expand their own levels of leverage. As long as Goldman, Bear, Lehman et al could borrow in short term money markets at low levels, carry large inventories of bonds generating higher yields, the spread would make them more money than commissions.

    8. The ratings agencies participated in this sharade as well. How could it be that the AAA portion of so many pools would amount to 85 or 90% of the total? Yet this is what their forecasting models suggested. And the fees to the ratings agencies were temptingly large.

    9. It was only a matter of time it seems that the process would be expanded in a big way to securitizing subprime mortgages, those written to folks who had either minimal downpayments or a lack of income to cover the debts. But there was so much money to be made that all parties went along. And Fannie and Freddie began buying subprime MBS as well.

    10. Whether this happened because house prices were rising, or whether house prices rose as a result of increasingly easy credit doesn?t matter. Yet each was connected to the other; lenders always figured they could foreclose and sell, recovering a large part of the moneys lend. Until they all tried to foreclose and sell.

    11. The collapse in value of mortgages and their derivatives, mortgaged backed bonds, meant the investment banks involved in them might be facing true death. A bank levered 33 times its capital is insolvent with only a 3 percent move.

    12. Because of the extreme leverage, it became possible for this industry to attract many of the best and brightest of the nation?s young talent. Why go to work designing spark plugs when there was so much more to be made designing the B1A tranche of an MBS deal?

    13. Similarly, there was so much to be made running a prime brokerage arm of an investment bank, that most of them did. This involved lending, both funds and securities, to a long and increasing list of hedge funds and similar creations.

    14. When the end approached, however, the hedge fund clients began to realize they might not be able to get funds out of, say, Bear Stearns, and tried all at once to get out the door of a barn which might be burning.

    15. The mortgage/brokerage/banking panic meant that leverage had to go down all over: at investment banks, hedge funds, companies. It triggered massive amounts of sells.

    16. Some funds were more levered than they even knew, as investors had borrowed money via funds of funds to finance their investments. Redemptions triggered withdrawals triggered sales triggered more redemptions.

    17. At the same time, the monetary authorities had been keeping interest rates as low as possible. This helped the economy grow but it put serious strains on the pension world. The lower returns were on bonds and money markets, the more plan sponsors felt they had to invest in such things as hedge funds to meet the actuarial obligations to the participants. Thus large pension funds began investing in higher and higher risk assets with portions of their funds.

    18. But the monetary policy issue was even more complicated. Say interest rates are seven percent. Then a billion dollar fund can easily cover $70 million due its retirees from bonds and t bills. Change rates to two percent, or less, and it means the amounts needed to cover those retirement bills have more than doubled. The lower rates went the higher actuarial needs went, the more incentive to buy into hedge funds.

    19. Until it all started to come unhinged.

    20. There is now a challenge, which McCain has missed, to explain this all, showing how best to get through it.

    • StudentOfLincoln

      Kyle, when you say “the government should have insisted upon sound lending practices”, that sure sounds exactly like government regulation of markets.

      • WillWong

        Compassionate conservative-that is your clue. He did give us two very good supreme court justices and a bunch of federal judges. He did take the fight to the terrorists. Other than that, he governed pretty much like a democrat. Who would have guessed that he will expand the prescription drug bill by $450 billion and who would have guess that he will invite Ted Kennedy to sponsor the $68 billion No Child Left Behind Act.

        By the way, I resent the word compassionate conservative-it implies that conservatives are not compassionate.

        • QueenOfCups

          Especially ones that sell mood elevators and anti-psychotropic drugs. Mental health facilities would be good, too.

          I have a feeling there is going to be a whole lot of demand after Nov 5.

          If McCain wins, the left is going into full fledged psychosis. We will see derangement like we have never seen.

          • Common_Cents

            Where are the opportunities in the current market?

          • The_Gadfly

            so much as it isn’t possible to roll even the explanation of how we got here into a 2 minute sound bite, let alone how to get out of it after you explain it.

            Your explanation is pretty good, but I think it leaves out the future looking part vis-a-vie politics. Let’s assume McCain manages to win the White House, which right now I’m actually pessimistic about. Let’s further assume that although a few seats switch hands, Republicans don’t lose in the overall count. Given this situation, Grandma Comrade and Grandpa Comrade are still going to be pushing socialist solutions to the current problems, especially with Representative Tax-em-all in charge of the revenue committee. At best McCain can veto them and the bad things from Congress won’t happen. But the corrective actions that Congress needs to take also won’t happen. We won’t get proper oversight of Fannie and Freddie. We won’t get an extension of the Bush tax cuts and the rates will start to spiral up of their own accord. We won’t get the even more appropriate solution of reducing capital gains taxes to spur economic innovation and job growth. As Congress and the MSM continue to beat up on McCain, at some point he will yield to “common sense proposals” to extend welfare benefits for the unemployed, which either forces up borrowing or taxing now, and taxing at some point in the future because the borrow can only be paid back from tax revenues. All in all, not a good outlook.

            If Obama gets in, we may not even have our 401(k) plans so we can cry about how much of a haircut we’ve taken on them in the last 4 weeks. Taxes will go up. Oh, they won’t be income taxes. Those he’ll put through just the way he promised, because those will “spread the wealth around” in the manner he deems appropriate. But the taxes on businesses will go up to at least cover those costs. And businesses will do what they always do when costs go up (and as every Joe Six Pack knows, businesses treat taxes as just another cost for profit purposes): they either raise their prices to cover them or declare bankruptcy, layoff their workers, and maybe wind up unemployed themselves. (There is of course the variation where they fob the live grenade off on somebody else and retire, but what ever poor sucker catches the grenade still has the same two choices.) This is an even worse outlook.

            So no matter how you look at it, it is going to be a rough two years ahead of us before there is any glimmer of real hope. Oh, there might be a brief period of euphoria in which the markets temporarily go up after Obama wins, but when it become plain how badly he and his comrades have undermined the fundamentals of the economy, that crash is going to make our current difficulties look positively Lilliputian.

  • streetwise

    Perhaps the less depressed state of the US markets is signaling the recognition of the increase in spending power that comes with a big decrease in gasoline prices:

    Some good news for JMac, I think, inthis map

    • Old_Crow

      has more to due with us sucking less than the European or Asian bourses (at least for today)..

      A choppy decline over the next 6 months or so will cause far more destruction than a short, sharp drop. (Financial) death by slow bleeding is not fun.

      • ElliotE5

        Sorry but I was at a meeting. Here is what I would have John McCain say. It is rough but a thought

        My friends, my name is John McCain and I seek your vote as the next President of the United States.

        My opponent has been giving speeches pointing out that house prices, retirement plan values, the number of jobs and consumer confidence have been falling. They are and they have been.

        His conclusion is this is all the fault of my party, my President and would be continued by my Presidency. His plan to repair things is focused on raising income and estate taxes on those at the upper ends of success and wealth, and handing those funds to those at the bottom ends.

        Before I address what I would do about the very real problems we have, let?s talk for a few minutes about the implications of following his plans.
        Mr. Obama may have been trained as a lawyer, but he apparently skipped economics classes on his way through two colleges and a law school.

        Nor has he studied much history.

        This is what he had to say about our Constitution
        ?the Constitution is a charter of negative liberties. It says what the states can?t do to you, it says what the federal government can?t do to you, but it doesn?t say what the federal government or the state government must do on your behalf.?

        Is there any secret, my friends, why in the two and a quarter centuries since this nation was founded and that Constitution was accepted, we became not only the largest, strongest, safest nation this planet has ever known? No.

        What our constitution gave each of us was the freedom to live where we want, to try whatever challenge we wanted, to make of ourselves whatever we could with the God given abilities, the ambition and drive we have.

        Why is it that in the Soviet Union, in Cuba, in China before it began to change, that their people were by and large poor? That their natural resources lay under developed? That where there wasn?t any reward for succeeding, people by and large didn?t.

        That where there wasn?t any reward for starting companies, people by and large didn?t. Is there any real secret why there was never going to be an Apple started in a Russian garage, why the smartest, most talented and driven people made their way here to start out?

        One after another, they have said for years and years: it is only possible in America.

        Now my opponent wants to change that.

        He wants to make over America in the image of older, weaker, poorer nations.

        What is it that we have that they don?t?
        Incentives.

        How many of you have kids who are in high school? Ever see what happens when you offer a ten dollar bill for an A on that test?

        Tickets to High School Musical for a completed term paper?

        Now imagine what happens when you take the top students in the class and tell them that credit for their papers is going to be spread among the weaker students.

        Now imagine two high schools, one on either side of town. At one, they get prizes and incentives for top performance. At the other, they take credit from the top students, giving it to the weaker ones. Why?

        My opponent told Public Radio in Chicago the following: He want to be ? able to put together the actual coalitions of power through which you bring about redistributed change.?

        Now, just imagine that there are two sides to this state. On one side, the folks who write computer software, who argue legal cases, who do brain surgery, who fix car engines, who write books, who edit newspapers, are to be nicely rewarded for their work.

        On the other side of the state, the same kind of software engineers, lawyers, mechanics, authors, reporters, are going to be told: you can?t keep as much of what you make. At some point they either wont work. Or they move.

        Now, let?s take just a minute before I leave, and address what it is that got us to such a terrible state.

        It?s that we cant have everything we want without a price.

        If we cut interest rates again and again and again, it does help the expansion of business. But it has costs, too.

        Everybody wants the Fed to do a rate cut; it makes mortgage rates fall, houses more affordable. Inventories easier to finance.

        But it also makes it harder and harder for your aunt or your mother to live on the savings she has carefully put aside over the years. Seven percent of a couple hundred thousand is 14. Two percent is four. Fourteen is a lot easier to live on than four.

        For pension funds, for retirement accounts, for everyone who wanted returns on money, it got harder and harder with low rates to eke out the returns they needed. To cover the incomes owed to pensioners. For a hundred different things.

        The superlow rates caused all sorts of folks to stretch to get the returns they felt they needed. Banks took on too many loans and investments, given the reserves they had.

        Probably the worst example of this was Fannie Mae and Freddie Mac. They only had about a two percent margin of error.

        Now, you should be asking my opponent why it is that in the four brief years he served in the Senate, Mr. Obama got the second largest amount of campaign contributions they had made in the past 20 years.

        You should ask him why it was that his friends at Acorn kept pressing on Fannie, Freddie and the nation?s banks to make loans to folks who were disadvantaged. Who didn?t have the down payments and income to cover service on the moneys they were borrowing.

        It was the folks from Acorn who marched into bank meetings, thugs who insisted loans be made to folks who couldn?t pay them.

        It?s the folks from Acorn who registered Mickey Mouse to vote in battleground states such as this.

        And it?s the folks at Acorn who have endorsed my opponent for your next President.

        And, guess what, it?s the folks at Acorn who want the government to take your money, and give it to them.