The comments on the FM site contribute much of its value. Some I lift into posts, as they capture important perspectives in the debate about current affairs. This comment by Tom Grey was posted in reply to my 26 September post A picture of the post-WWII debt supercycle. As it represents a widely held view, I reprint his comment here and reply.
For more of Tom Grey’s writing, see his blog Liberty Dad – a World Without Dictators.
Fab says: “The US financial system is burning.”
And your evidence?
- overpriced homes have a higher foreclosure rate, after
- no-money down poor speculators (liar loan users) stopped paying, causing
- rocket science ‘financial instruments’ used by ‘top banks’ to meltdown?
Sorry, I don’t think so. Conservative local banks have lots of cash for good local loans. Depositors, and borrowers, DO have lots of options on where to go. As shown in “Smaller Banks Thrive Out of the Fray of Crisis“, Washington Post, 26 September 2008 — “People Shift Money From Wall Street. to Main Street”. The primary ‘Main Street’ purposes don’t need the Wall Street overpriced bankers. The gov’t maybe made a mistake with AIG, and certainly did with Bear Stearns — should have allowed failure.
I was wrongly in favor at the time, thinking it would be enough for stability. Your great Financial Debt graph above shows the huge need to rapidly reduce that debt. Best long term would be debt to equity swaps, between different financial institutions that were imprudent, but even more chapter 11 bankruptcies would be OK.
There are FAR TOO many ‘top bankers’. The bailout keeps too many of them. The non-financial economy doesn’t need so many of them in financial institutions — and as Lehman Bros. look for work, big companies wanting to put out bonds directly will be an increasing possibility.
Investment bankers were always just intermediaries — with special contacts more than special knowledge. Now both are easier and cheaper to come by for those with real products.
We should accept far more banking failures than we’re likely to see. With low Fed interest rates, banking failures today will NOT spill over nearly as much to the production economy. Depositors are insured, somebody will try to enforce the borrower’s promise to repay.
Where is the ‘rush’? What loans haven’t been made? The rush is to save the multi-millionaire top bankers, not the real economy.
This illustrates one reason we are so unprepared. Years of “happy talk” by our leaders — attempting to maintain consumption and investment, avoiding panic — has resulting in most Americans being uninformed about our problems and unprepared for the inevitable correction.
We see this in the debates on this site. I have warned about this for several years (along with many others, both eminent experts and important institutions), and am now advocating severe measures beyond anything contemplated in the general media, while you question the existence of a major crisis! Quite a contrast.
Tom’s 3-point summary of my evidence had no resemblance to what I said in my post, but is a widely held view of the crisis. It is easily disproved. I gave strong evidence refuting this theory in this post (showing the massive overbuilding of homes). To understand the underlying causes of our crisis I suggest looking at the four graphs in A picture of the post-WWII debt supercycle. They show why the crisis affects the US broad economy, not just mortgages of “no-money down poor speculators”.
An timeline of the crisis
The debt default process started 22 months ago, in December 2006.
- The mortgage brokers began to go bust.
- Then the asset-based commercial paper (ABCP) market vaporized, an important financing tool for corporations (from $1,200 billion in August 2007 to $750 B now, per the Fed).
- Foreclosures rates have risen to post-Depression highs. The aggregate value of equity in homes with mortgages is probably near zero (per Fed flow of funds statement).
- Default rates on auto and credit card rates our rising.
- We have had several large bank failures and near-failures (including two of the largest in our history, Countrywide and Washington Mutual).
- Two large brokerage firms have closed down, mirroring the pattern of the banks (one failed, one shotgun marriage: Lehman Brothers and Bear Stearns failed).
- The auction rate securities market has failed (worse than the ABCP, it is almost gone) — an important method of financing used by corporations and local municipal entities.
- The government had to guarantee $2T money market securities to prevent a catastrophic collapse of that key piece of the financial apparatus, as firms were “breaking the buck” and runs were starting.
- Treasury bill rates dipped below zero, a first since the Depression — indicating severe financial shock.
- Now the bolts are coming out of the municipal bond market (see this Bloomberg article).
Overview of our current situation
Almost every economic indicator is at levels found in the past only in recessions, esp the five metrics used by the National Bureau of Economic Research to officially define recessions. Many market indicators of stress are off the charts:
- the TED spread — the difference between t-bill and LIBOR (eurodollar) interest rates. Now blowout high at 3% normally under 0.5%)
- Treasury bill rates are near zero; were briefly negative for the first time since the Great Depression).
And that is despite unprecedented levels and types of Fed lending (source). Inevitably the stress has rippled out into the wider economy, as described in “General economy starts to feel knock-on effects of paralysis in the money markets“, The Times, 27 September 2008 — Excerpt:
The paralysis in money markets is feeding through into the wider economy, with blue-chip nonfinancial companies suddenly finding it impossible to borrow short-term, or only at penal rates.
When I read one of these “what crisis?” articles — esp the now delusional “Dude, where’s my recession?” articles — I hope the author is not a doctor. I can hear the cheerful report:
No major treatment on your husband is necessary, madam, as his heart is still beating. Slowly, slowing — but still beating.
If not now, when will these people become alarmed? Perhaps only when the lagging indicators show deep recessionary levels — GDP and employment. GDP for 2007 Q4 was revised to a decline; that is also likely for Q1. Employment has been decreasing for 8 months; revisions will probably make these number much worse. (Note the household employment survey has already flashed red; only the lagging establishment survey shows gradual job losses — due to the phantom jobs added by the birth/death model).
By that time it will be late to take measures that mitigate the downturn. Like a driver who does not turn until the car actually hits the tree.
But the small banks are OK
As for the Washington Post article, I suspect that this prove to be painfully wrong — even by the low standards of US media’s economic reporting. Economic events are all about lags. Events start in one location, usually a weak link in a system undergoing stress, and propagate outward. Like a stone tossed into a pond.
The waves have not yet reached the small banks, but this is inevitable. As the FDIC has warned for several years, many small – medium banks are more vulnerable than their larger cousins due to a concentration in loans to real estate developers (both residential and commercial). Unless we have a big RE recover starting now, massive bankruptcies are likely among residential developers. The coming consumption declines will send many commercial developers (e.g., shopping malls) to the same dustbin.
Also, the proposition is inherently false. Small banks could replace large banks just as well as the nerves in your foot could replace your spine. The difference in scale, in their importance to the overall economy, is night and day.
Update: are we in a recession?
The data strongly indicates that we are in a recession that started in Q4 of 2007 or Q1 of this year. For an analysis (somewhat technical) of the GDP and GDI data showing this see “Gross domestic income and recessions“, James Hamilton, posted at his blog Econbrowser, 28 September 2008
What should we do?
That is a complex question. For a simple answer see A solution to our financial crisis.
If you are new to this site, please glance at the archives below. You may find answers to your questions in these.
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
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