The last opportunity for effective action before disaster strikes
Summary: The Paulson Plan is already irrelevant. New and larger measures are needed immediately. This is the second post in a series describing their size and scope. We are only weeks away from disaster. Fortunately, I am certain that Secretary Paulson and Chairman Bernanke know this. Bernanke, as an expert on the Great Depression, certainly understands the need for fast and effective action.
The end of the post-WWII debt supercycle started with the collapse of the mortgage brokers in December 2006. Since then the government has made aprox 15 initiatives to stop the deterioration of our financial system. The super SIV, 3.25% in cuts to the federal funds rate, FHA Secure, Hope Now, a $120 billion tax rebate, massive expansion of access to the Fed’s discount “window”, TAF auction, TSLF, PDCF, the Bear Stearns bailout, the nationalization of the GSE’s and AIG … and now the TARP (aka the Paulson Plan). Don’t bother looking up the acronyms, they will all soon be forgotten.
All too small, too late. Incremental and reactive, responding to critical problems of last month — irrelevant to the current situation. This is a recipe for disaster. Like in the US 1929-1933 and Japan 1989-1996 — delaying the necessary large-scale response until the problem was no longer manageable.
Now the US financial system is seizing up. The machinery remains, but the gears no longer turn. Most of you have no idea to what I am referring, but you will learn over the next few weeks. To use a bad medical analogy, the financial system has had a cardiac arrest. Rather than describe the problem, this post describes solutions.
What must be done now
Recommendations from A solution to our financial crisis, 25 September 2008:
- Stabilize the financial system.
- Stabilize the economy.
- Arrange long-term financing for steps #1 and #2 with our foreign creditors.
This post discusses step #1 — how to stabilize the financial system.
Restarting the necessary flows through the business credit system must be done immediately, and will require drastic measures. The following indicate the broad scope and scale of the necessary action, not the specifics.
(A) Broad guarantees of the securities for the financial sector. Not just banks and brokers, but also leasing companies and lenders of every flavor. Confidence in these securities must be restored now.
The Paulson Plan is only a small first step in this direction. More is needed, fast. The Fed is pumping vast sums into the financial system (“Wall Street”), but the money is not reaching “Main Street.” Disintermediation is necessary.
(B) Direct lending to business. For example,
(1) Direct loans to corporations by the Fed (e.g., Fed purchases of commercial paper from companies). Update: the Fed has begun doing this, per this announcement.
(2) Fast loans from the Small Business Administration on simple security (personal guarantees and net assets of the business). As were made to families after Katrina.
The full effects of the recession will hit in the next few quarters, and the current financial crisis has exacerbated it. We should prepare for something longer and deeper than 1973-75 or 1980-82 (the worst since the 1930′s). Let’s not wait to begin mitigation efforts. Anyone asking “Dude, where’s my recession” should be banned from the Internet for life.
(C) Massive fiscal stimulus. Government spending on valuable infrastructure. Expanded education programs. Fast cash disbursements to local social service agencies. Avoid the usual chaotic rush — begin setting them up now, as their lead times are long. The alternative is dropping money from helicopters later. This is essential, but logically part of recommendation #2: stabilize the economy.
This is triage. Immediate aid to those who can survive. Fairness and equity are now irrelevant luxuries. Punishment of the innocent and rewards to the guilty can wait until the immediate crisis has passed.
This is just first aid. The recession is coming. None of these measure will speed its end or lay a foundation for an economic expansion afterwards. Such measures must wait for the new Administration. The timing of the crisis, in the midst of a critical national election, could not be worse. Let’s hope our leaders can put aside their partisan differences to take the necessary steps. Let’s promise electoral death to those who cannot manage to do so.
I doubt we can take these measures without prior agreement of our creditors. The additional — and larger — measures necessary next year will certainly require their money, so let’s consult them now — rather than arouse anger by assuming their cooperation. For years they have provided vendor financing — loaning us the money to buy their goods. Now we ask them for much larger loans to mitigate the results of our past imprudence. Without their aid we cannot simultaneously obtain the necessary funds, keep interest rates low, and avoid a collapse of the US dollar.
This is one of the major inflection points of American history. The outcome will be shaped to a large degree by the skill and values of the new Administration. Please do all you can to help America make that decision. Donate your time and money. Get involved in discussions. Write and talk about it with everybody you know.
What should we do next, after applying First Aid?
That is a complex question. For a simple answer see the following (you will not like the answers):
- A solution to our financial crisis.
- America has changed. Why do so many foreigners see this, but so few Americans?
Other sources saying similar, if milder, things
- “From central bank to central planning?“, Prof Delong (Economic, Berkeley), BusinessDay, 29 September 2008
- “UC Berkeley economists think through the crisis“, San Francisco Chronicle, 2 October 2008
- “Edge of the Abyss“, Paul Krugman, op-ed in the New York Times, 2 October 2008
- “Transcript of Charlie Rose’s interview of Warren Buffett“, Bloomberg, 2 October 2008
- “Financial and Corporate System is in Cardiac Arrest: The Risk of the Mother of All Bank Runs“, by Nouriel Roubini, RGE Monitor, 3 October 2008
Krugman and Roubini are among America’s top economists; Buffett is one of our top businessmen. Their warnings deserve close attention. Esp note Buffett’s comments:
We have a terrific economy. It’s like a great athlete that’s had a cardiac arrest. And it’s flat on the floor, and paramedics have arrived. And they shouldn’t argue about whether they put the resuscitation equipment a quarter of an inch this way or a quarter of an inch that way. Or they shouldn’t start criticizing the patient because he didn’t have blood pressure tests or something like that.
They should do what’s needed right now and I think they will. I think the Congress will do the right thing. I think that they’ve gotten into certain arguments and then they start worry about assessing blame and there’s a little demagoguery. But in the end, something this important, they’ll do the right thing. This is really an economic Pearl Harbor. That sounds melodramatic, but I’ve never used that phrase before, and this really is one.
Esp note this: “Libor Rises, Commercial Paper Slumps as Credit Freeze Deepens“, Bloomberg, 2 October 2008 — Except:
The crisis deepened after the worst month for corporate credit on record. Leveraged loan prices plunged to all-time lows, short-term debt markets seized up and even the safest company bonds suffered the worst losses in at least two decades as investors flocked to Treasuries. Credit markets have frozen and money-market rates keep rising even after central banks pumped an unprecedented $1 trillion into the financial system.
“The credit window is closed,” Jim Press, president of Chrysler LLC, the third-largest U.S. automaker, said today at the Paris Motor Show. … “It’s going to get much, much worse,” said Gregory Peters, head of credit strategy at Morgan Stanley in New York. “The credit markets are effectively shut, the CP market, which there’s not enough focus on, is under complete duress. That can’t be sustained, as that’s the lifeblood of corporations funding themselves.”
Commercial banks and bond dealers borrowed $348.2 billion from the Fed as of yesterday, an increase of 60 percent from the prior week amid the worsening credit freeze.
The market for commercial paper plummeted $94.9 billion to $1.6 trillion for the week ended Oct. 1 as banks and insurers were unable to find buyers for the short-term debt amid the worst U.S. financial crisis since the Great Depression. Financial paper accounted for most of the decline, plunging $64.9 billion, or 8.7 percent, to a two-year low.
…”The purge is broad and is impacting issuers with far more predictable cash flows — regular run-of-the-mill companies in need of working capital,” Crescenzi wrote today in a note to clients. “The declines add to the urgency for fixes to the credit crisis and bolster the case for a Fed rate cut.”
The U.S. market for short-term debt backed by assets including mortgages and car loans fell $29.1 billion, or 3.9 percent, this week to a seasonally adjusted $724.7 billion, according to the Fed.
If you are new to this site, please glance at the archives below. You may find answers to your questions in these, such as the causes of the present crisis. I have been writing about these events for several years; since November 2007 on this site. As you will see explained in these posts, the magnitude of the events now happening is beyond what most Americans have — or can — imagine.
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).
Some FM posts about the current crisis
Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008
Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
Another voice warning about the nationalization of AIG, 18 September 2008
A vital but widely misunderstood aspect of our financial crisis, 18 September 2008
A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
Another step away from our Constitutional system, with applause, 19 September 2008
What do we know about the financial crisis? What are the key questions?, 20 September 2008
Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
America appoints a Magister Populi to deal with the financial crisis, 21 September 2008
Legal experts discuss if the Paulson Plan is legal, 21 September 2008
Essential steps to surviving the current crisis, 23 September 2008
How should we respond to the crisis?, 24 September 2008
A solution to our financial crisis, 25 September 2008
Is the US economy in good shape, or in terrible shape?, 27 September 2008
A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
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. To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime. Here are some of those posts.
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.
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.
We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
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.
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.
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- 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.
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.
The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
“The changing balance of global financial power”, by Brad Setser, 22 August 2008
“The Coming US Consumption Bust”, by Nouriel Roubini, 6 September 2008