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What do we know about the financial crisis? What are the key questions?

20 September 2008

Amidst all the blather about the financial crisis, I believe two things are clear.

  1. We — everybody — have more questions than answers.
  2. We, the American people, are fools.  These events should spark thought about our fitness for self-government.

This post discusses the questions, the details about the crisis.  As usual for this site, let us take this by the numbers.  First, what do we know?

1.  This down cycle has much more to go, still in its earliest stages.

2.  The de-leveraging of US households has just began.  Purging of excess mortgage debt is the first step; credit card and auto loans are next to go.

3.  The full force of the US recession has not yet hit, nor the effects of the global slowdown (perhaps to become a global recession).

4.  Most important, the global rebalancing process has barely started.  It will end when the US dollar has declined so that US goods and services are again competitive on world markets, our trade deficit is positive, and we can pay interest and even some principle on our foreign debt (there are other possible outcomes, but this is the good one).

The US government has changed course, from microeconomic tinkering (band-aids on individual firms) to broad macroeconomic intervention.  Nobody — including our leaders — knows what this will mean.  All we can do are list the questions.  Here are mine.

5.  How far will the government go in socializing the excess debt, moving it from private balance sheets onto the national credit card?

6.  Neither the US government nor the US economy has the funds to fuel this process.  Will our creditors lend us the money?  If so on what terms?

7.  Will our markets recover from the extensive manipulation by the US government?  Midnight rule changes, authorizing falsification of financial statements, it is a long list of efforts to prop up prices.  Participants have not realized this yet, lost amidst the chaos, but this corruption of our market machinery (analogous to a government debasing its coinage) eventually will be recognized and have long-term impacts.  See this for a brief look at these issues.

8.  How will the government use the financial sector, after its nationalization?

#8 is the key question for the long-term health of the US economy and survival of our political regime.  So far we are living in Oz, looking at the city through our emerald sunglasses.  How wonderful is this rescue, how few the long-term ill effects!

Taking off the green lens reveals a few questions.  The financial sector is one of the commanding heights of a modern economy, a key node in the flow of power.

9.  How much of the US financial sector — the banking and financial firms that comprise its machinery — will the US government control when this is over?

10.  How long will it retain ownership?  A short-term fix followed by a quick return to private ownership.  Or long-term ownership?

11.  Control is as important as ownership.  The industry will inevitably be far more regulated.  How much more?  At some point regulation becomes control.

12.  How much wealth will be transferred from the taxpayers to insiders by this process?  The Resolution Trust Company and the Iraq War proved that vast sums can be looted by insiders without public protest.  Those sums might be pocket lint compared to what happens in the next few years.

Please share your comments by posting below.  Please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

Key Treasury Department documents

We cannot plead the “we didn’t know the details in the fine print” excuse. The important details about this massive nationalization have been clearly spelled out for us.  See this page for a current list of Treasury Department documents.

Some FM posts about the current crisis

For a full listing see the FM reference page about the Financial crisis – what’s happening? how will this end?.

A few of the most important posts warning about this crisis

This crisis has long been forecast by many, including in articles on this site.  Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results.  Here are some of those posts.

  1. A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
  2. The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  3. We have been warned. Death of the post-WWII geopolitical regime, Chapter II, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
  4. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  5. Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end?  With re-balancing of the global economy, so that the US goods and services are again competitive.  No more trade deficit, and we can pay out debts.
  6. A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
  7. What will America look like after this recession?, 18 March 208  — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
  8. The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
  9. The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.

To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime.

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8 Comments leave one →
  1. plato's cave permalink
    21 September 2008 12:04 am

    Historically, regulation in America has not been imposed on, but sought by capital for its own protection (see Gabriel Kolko’s interpretation of the “progressive era” in “The Triumph of Conservatism”). AFter the current shakeout in the banking and brokerage industry, the remainig mega-firms will be happy to live with the new regulations, which could easily have the effect of raising the bar for future competitors.

    But is this the same as government taking ownership? Hardly! The best that government can do, and we can hope for, is to redefine the conditions of doing business in the United States. A good place to start would be the principle of “corporate personhood”, and the many other ways that corporations are allowed to operate without any responsibility to the public good.
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    Fabius Maximus replies:

    “But is this the same as government taking ownership?”

    Perhaps you dispaly a lack of imagine in this, and assuming that the future regulatory regime will resemble that of the post-WWII era. That may not be the case.

    “The best that government can do, and we can hope for, is to redefine the conditions of doing business in the United States.

    Agreed. The question is to what degree. Just as the measures of the past month are greater than most folks assumed possible, it is possible that the financial regime will change more than they expect.

    Like

  2. c. smith permalink
    21 September 2008 1:18 am

    At what point does the centralization become such that the country is effectively The United /State/ of America, and the Constitution a mere historical notion? Has this Rubicon already been crossed?
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    Fabius Maximus replies: I have discussed this in several posts, the two most recent being:
    * Treasury Secretary Paulson leads us across the Rubicon
    * Another step away from our Constitutional system, with applause

    Like

  3. pluto permalink
    21 September 2008 2:10 am

    Excellent questions. I can add a few of my own.

    13) Have much money will the US government need to borrow to fix (or nationalize) the financial industry? Admittedly since the government hasn’t figured out what exactly they are going to do this is a difficult question to answer, but I consider the question to be of supreme importance.

    I’ve seen estimates of $500 billion to $1 trillion. But since I suspect that the US government is not going to be able to hold the line at just bad mortgage debt, I suspect the final number is going to be in the neighborhood of $2 trillion.

    14) The rest of the world has lost a lot of money investing in US financial institutions in the last year, under what terms are they going to be willing to loan us the money we require?

    A few rough back-of-the-envelope calculations suggest we are looking at an 8-12% annual return on Treasuries. That in turn suggests that business loans (which are naturally viewed as riskier because they are issued by corporations rather than governments) will be in the neighborhood of 9-15%. Won’t those high interest rates constrict businesses almost as much as a credit crisis at lower interest rates?
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    Fabius Maximus replies: It is absurdly speculative to give such numbers. We have not the slightest ability to forecast yields at this point, as there are far too many variables. Two of the big ones, amidst many other signficant variables, being …

    (1) our choice between an inflationary or deflationary path (we are on the former, but it is still early days,

    (2) decisions of our foreign creditors (who have a wide range of timing and actions).

    Like

  4. 21 September 2008 3:10 am

    Pluto, you’re pretty close to the mark. Treasury yields of 8-12% may be seen as pretty conservative in a couple of years. You’re right about business loans costing even more. The net effect will be to degrade the ability of small businesses to prosper (forcing them to sell out to larger corporations) and deter the middle class from even starting businesses in the first place (keeping them dependent on large corporations for a living). Banks will balk at granting business loans to anyone who is not already a multimillionaire. Perhaps bringing about a neo-feudal society is part of the elite class’s intent.

    If you can’t beat ‘em, join ‘em!

    Like

  5. Duncan Kinder permalink
    21 September 2008 4:46 am

    It will end when the US dollar has declined so that US goods and services are again competitive on world markets, our trade deficit is positive, and we can pay interest and even some principle on our foreign debt (there are other possible outcomes, but this is the good one).

    One thing we could do would be to legalize drugs and to export narcotics.

    Like

  6. Yours Truly permalink
    21 September 2008 8:51 am

    dckinder : is prostitution legalized in the US? I know of many sonsofab!@#$%s ’round the world who’d like to have American mistresses… Hell, I’d like to have a Southern gal myself!

    Like

  7. Samer permalink
    21 September 2008 2:24 pm

    “It will end when the US dollar has declined so that US goods and services are again competitive on world markets, our trade deficit is positive, and we can pay interest and even some principle on our foreign debt”

    you can’t expect the US economy to regain a positive trade deficit without structural changes, the US economy is a now a services-based economy and its industrial base is decaying. And also, a lower US dollar would increase fuel prices and inflation.
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    Fabius Maximus replies: I do expect that, on the basis of a large body of prior history. Brad Setser (economist at the CFR, expert on global capital flows) has often written about this — how changes in relative currency values produce massive changes in trade flows, inevitable but always astonishing.

    It’s not a theory. US exports are skyrocketing, from the relatively minor US dollar devaluations to date. The trade-weighted US dollar is still in its post-1971 range; when it breaks to new lows we will see exports zoon.

    A lower US dollar is not a panacea. It means less US income and wealth, experienced as higher costs for foreign goods. Including oil. This is an inflationary force, but not inflation (inflation is a monetary event, one possible choice in response to higher prices).

    ” the US economy is a now a services-based economy and its industrial base is decaying.”

    Why do you say this? Note graph #2 in this post, showing that exports as % of gdp have been rising since 1987.

    Like

  8. Raz permalink
    23 September 2008 1:17 am

    With regards to #9, the financial sector controls the US government and not the government controlling the financial sector as you suggest. You are also backwards on #8 the government is not nationalizing the financial sector, quite the contrary, the financial sector is privatizing the US treasury. You need to be clear on what is really happening here.
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    Fabius Maximus replies: Like the blind men touching the elephant, there are many perspectives on these events. All have some validity. As a general audience site, I stick to the consensus way of viewing these things, as just the points I wish to communicate are difficult enought to convey (and I am usually unsuccessful).

    While I understand what you are saying, and agree that there are elements of truth in them, this is not my perspective. I do not see the “government” as a distinct or seperate element in our society. Powerful elements in our ruling elites are getting bailed out by the government, and will probably be further enriched by the bailout process. On the other hand, there is a cost for this aid. Elements for whom the government is their chief source of power gain greater influence over the financial sector.

    When this is over the financial sector will be far smaller (at best half the size of today) and far less powerful, less influential. Less leverage, less freedom, more highly regulated. Everything comes with at a price.

    Like

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