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.
My reply
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.
Afterword
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
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Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
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High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008
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Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
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Another voice warning about the nationalization of AIG, 18 September 2008
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A vital but widely misunderstood aspect of our financial crisis, 18 September 2008
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A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
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Another step away from our Constitutional system, with applause, 19 September 2008
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What do we know about the financial crisis? What are the key questions?, 20 September 2008
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Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
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America appoints a Magister Populi to deal with the financial crisis, 21 September 2008
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Legal experts discuss if the Paulson Plan is legal, 21 September 2008
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Essential steps to surviving the current crisis, 23 September 2008
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How should we respond to the crisis?, 24 September 2008
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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.
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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.
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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.
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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).
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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.
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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.
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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.
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The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
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“The changing balance of global financial power”, by Brad Setser, 22 August 2008
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“The Coming US Consumption Bust”, by Nouriel Roubini, 6 September 2008
They’ll only wake up when they are homeless and jobless on the streets. Once there, they’ll be easy pickings as they will still not really believe that it is happening to them.
Very correct concerning the incapability of the small banks to replace large banks , and They are more vunreable to liquidity problems than large banks.
Small local governments will not be able to take up the slack for a bankrupt federal government either. I think we are screwed, greed has destroyed us. “Hidden Swap Fees by JPMorgan, Morgan Stanley Hit School Boards“, Bloomberg, 1 February 2008.
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Fabius Maximus replies: Don’t worry about this, which is a minor problem. State and local governments have both increased their spending over the past 25 years AND shifted to more cyclical (i.e., economically variable) sources of income (e.g., developer fees, sales and income taxes). An average recession (unlike the very brief, shallow downturns in 1991 and 2001) will prove stressful.
A bad recession, like 1973-75 or 1980-82, might result in severe problems. Probably many banruptcies, something not seen since the 1930’s. Not that the recession will be like the 1930’s, but that state and local governments are so weak financially.
Fabius: “A bad recession, like 1973-75 or 1980-82, might result in severe problems. Probably many banruptcies, something not seen since the 1930’s. Not that the recession will be like the 1930’s…”
I think you’re underestimating the severity of the next (current?) downturn, Fabius.
This country (and by extension the rest of the world) has been addicted to debt for over 40 years. We have finally reached the point that all addicts eventually reach, we have to decide whether we are going to break the habit or let it kill us. Breaking the habit is going to be incredibly painful, letting it kill us will obviously be worse.
The thing I find galling about our current leaders is that when presented with this choice, they suggest we borrow $700 billion. They’ve made their choice and want us to drink the kool-aid with them.
Here’s an article that showcases my concerns quite clearly, do you think any newscaster can bring themselves to say ‘Hobo?’. “Growing ‘tent cities’ blamed on foreclosure crisis“, CNN, 19 September 2008.
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Fabius Maximus replies: The current data suggests that we are in the early stages of a recession, but does not indicate its length or depth. Any forecasts about that are just guesses, unless based upon a reliable macroeconomic computer model. Using the current media narrative to estimate economic conditions is worse than guessing.
This is tangential but relevant article discussing how many of the defaulting low-income mortgagors were targeted by bipartisan legislative initiatives that pushed FNM FRM into looser practices. That being the case, and not mentioned in the article, many mortgage companies acting as ‘servicers’ only, would set up large swathes of such loans knowing that Fanny etc. would take up the underlying financing risk whilst they could collect steady servicing fee residual income for handling the paperwork, payments etc. Since these latter had no real risk, and since the GSE’s were being pushed/mandated to provide more loans to minorities and low incomers, this set up a vicious cycle of the servicing companies getting more aggressive in selling tactics. So yes, plenty of greed going around, but interesting that it was fostered by govt. legislative changes.
http://www.wnd.com/index.php?fa=PAGE.view&pageId=75717
I must comment but I will try to keep it within 250. Please forgive me FM if I exceed and I promise to be coherent.
It is important to keep our current situation in perspective. All economic considerations come back to simple parameters. Let me site a few generalized facts.
20% of the U.S. owns 84% of U.S. wealth
20% of the U.S. owns 91% of the U.S. financial wealth (financial wealth is the wealth not tied up in primary home ownership and other lifestyle related assets, it is the liquid wealth)
The total world net worth is about 160 trillion dollars.
The total private U.S. net worth is about 57 trillion dollars.
The total U.S. private net worth in 1945 was about 1 trillion dollars (and was certainly much less in 1929 hence why comparisons to today are to be doubted.)
The U.S. total net worth is about 1/3 of the world’s net worth.
The total gross external debt of the U.S. is about 13 trillion dollars, 22% of wealth.
0.9% ofthe world (U.S. 20% wealthiest) owns 30+% of the world’s wealth.
The proposed “bailout” in D.C. is 1.3% of U.S. wealth.
The gross unfunded promises(Mecicare, Medicaid, Soc. Sec. etc.) of the Federal gov’t prior to this bailout are about 59 TRILLION dollars(talk about socialism).
The Federal government of the U.S. has no net worth(unlike the governments of “socialist” countries, infact it has a net negative worth, see last fact).
If one takes the above figures and applies them to the U.S. economy one comes to some simple conclusions.
– Our economic situation is in mediocre shape because while we have plenty of wealth to sustain us, it’s not doing most people much good because its in select few hands.
– The .09% of the people who own that 30% of the world’s wealth aren’t going to risk it on something productive in the U.S. unless the rest goes along
-Most U.S. citizens have no earthly idea what wealth, capital or finance is all about
-Most of the people won’t have anything to live on in a tight economy unless the 20% have the confidence to provide the 80% with the money to be productive and work toward better times
– It all comes down to this: if we want a long deep recession then all we have to do is encourage the 20% with the wealth to place it in safe spots and leave it there. If we want a shallow recession we have to give the 20% reason to invest in opportunities. Our current problem is all about opening up confident opportunities. We have overspent. We have destroyed confidence. Wealth will be lost. But at least we can try to generate it while we’re losing it. If we don’t give the 20% confidence it can be generated then 80% of us will just have to live on 9% of the wealth while 20% sits on 91%, and that is whats happening right now.
-If we don’t keep the economy going we can all forget that 59 T in promises because there won’t be money to pay for them UNLESS your in the 20% and then you can pay for them yourself.
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Fabius Maximus replies: A few thoughts on this this.
“The total world net worth is about 160 trillion dollars.”
Treat these numbers carefully. Most of them are just guesses, esp the global ones. Both in the sense of having bad data and vague meaning. Could we liquidate the world and have $160T leftover in cash? If not, then what does this mean?
“All economic considerations come back to simple parameters.”
This is like saying “all medical considerations come back to simple parameters”, then listing the composition of the human body and a few other simple facts. Both the human body and global economy are awesomely complex systems. Does reducing it to a few simple things tell us anything of value?
“The Federal government of the U.S. has no net worth.”
Like many of these facts, this not correct in any meaningful sense. A government’s primary asset is its ability to tax the income of its people. The $50+ liability is a stream of future paymerts, the offsetting asset is the stream of future tax revenue. While massive tax increases would be needed to make these payments, it is possible if we choose to do so. US GDP in 2008 will be aprox $14T. Assuming no growth (absurd) and a 5% discount rate (the government bond yield), the present value of the next 50 year’s GDP is over $250T.
The TED spread is the most worrying sign. As some of the economic experts have pointed out, this signifies that banks are unwilling to lend to each other, that they view other banks as significant risk.
If a bank can’t borrow, it can’t loan out (eg, as Fabius pointed out with the times article): if the general credit market freezes (which a few weeks of TED spread at +3%), businesses won’t be able to borrow at all, and THAT becomes the crisis.
There is a reason why Bernanke et al are practically panicking. This is bad. Very bad. If the trust in the banking system is not restored within the next few weeks, we could very well freeze the economy hard.
Fabius is right that speculation without an economic model is essentially gossip-mongering. I need to thank Al L. for cogently stating my economic model.
Fabius made the comment that “The current data suggests that we are in the early stages of a recession, but does not indicate its length or depth.” Normally I’d agree with you but the circumstances of this recession do indicate that the severity of this recession will be greater than average.
The reason I say this with any degree of confidence is that the current situation is the direct result Federal interference since 1992 to prevent economic downturns of any sort. Yes, we had the 2001 recession but it was very small due to the massive Federal intervention. I was interested to note at the time that although the Feds could make the recession small, they couldn’t spark a serious recovery for over a year after the recession ended.
This indicated to me at the time that their ability to manipulate the situation was reaching its outer limits and that the natural economic forces were beginning to overcome the Fed’s ability to produce a recovery. This sparked my analogy of the addict needing ever greater quantities of the substance of choice (debt in this case) to produce ever diminishing ‘highs.’
As Fabius has indicated, my theories are just the speculations of an experienced layman but I’m pretty confident that we are reaching the point I mentioned earlier, that we either have to wean ourselves off of debt or let it kill us. I’m eagerly awaiting to the most recent version of the bailout plan to see if perhaps Congress has offered a better way of dealing with the crisis than to borrow $700 billion.
P.S. – A local economist recently quoted a World Bank study of 40 bank panics and the bailouts that followed said that the median bailout is 13% of GDP. The current proposal before Congress is for 5% of GDP. This means that either we are getting a relatively good deal compared to past events or we may need somewhere in range of another $1 trillion in another bailout to stabilize the economy (assuming we are near average, personally I’ve always thought of us as above average).
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Fabuis Maximus replies: It is not that I disagree with your guess, but we must be realistic about our ability to do these things. Guesses about the economy’s current state, even by economists, have a poor record of accuracy.
The study you refer to is “Systemic Banking Crises: A New Database“, Luc Laeven and Fabian Valencia, International Monetary Fund, September 2008 — Abstract:
“This paper presents a new database on the timing of systemic banking crises and policy responses to resolve them. The database covers the universe of systemic banking crises for the period 1970-2007, with detailed data on crisis containment and resolution policies for 42 crisis episodes, and also includes data on the timing of currency crises and sovereign debt crises. The database extends and builds on the Caprio, Klingebiel, Laeven, and Noguera (2005) banking crisis database, and is the most complete and detailed database on banking crises to date.”
For a summary of the study and analysis of its lessons for us I recommend reading “New IMF Study of Banking Crises Contradicts Bailout Bill Premise and Details“, Yves Smith, RGE Monitor, 27 September 2008.
Fab, you’re right that my points were more generic against short term panic than against your consistent deeper doom & gloom. But I notice you don’t clearly support or oppose the current bailout — I did support it (at 2 pages), but now oppose it (some 192 pages?).
Bruce Bartlett supports it
I oppose it now not because I think “no recession”, but because I think we DO have a depression coming … for the banking/ financial industry. And because we do see it coming, we can protect the ‘real’ economy (non-finance) some, from the worst effects of the inevitable financial meltdown.
(Current Mortgage Backed Security bubble has popped).
In non-finance, if we “now” have a recession, still not a crisis — but if not fixed well, it becomes a depression.
Where is the Fiscal Stimulus? One time tax rebate was a reasonable start — why not continue to target the hardest hit industries and areas, at a lower middle class level of target? House construction is dead, but should remain so while there’s a huge overhang of overbuilt houses.
Increase infrastructure maintenance construction — roads, bridges, New Orleans’ dikes, old schools & buildings.
Unemployment over 6% (but after a lot of excessive debt overemployment), is not yet an employment crisis, but makes other problems worse.
Increase the size of the Army.
Pay high school drop-outs to go back to school.
Create a civilian job corps.
Build windmills (start a $10 mil./month program on gov’t land)
Build solar panels (start a $10 mil/month program on gov’t parking lots in Southern states).
Build nuclear power plants, especially in areas that have had a blackout in the last 10 years.
Replace/ enhance/ do maintenance on the electric grid.
How bad is it now for good companies? Well, it’s not easy, it’s impossible to borrow short-term, or only at penal rates.
OK, big companies should borrow a bit more, for the longer term — and stop short-term borrowing. Maybe defer executive pay for a week or so? (They’d rather put in a hiring freeze).
Financial costs of all types will be going up — this is inevitable, so whatever the average cost of easy money in the last 5 years was, it will now be more. What are penal rates? The TED rate spread of 3% is huge — so those with cash can make loans and those without can’t. If they can’t they shouldn’t.
I read the IMF summary as that the bail out is to protect the rich bankers, but the future economy needs far fewer bankers, so losing the imprudent rich ones now is best for the mid & long term.
Fab also claims that small banks can NOT do what big banks do: The difference in scale, in their importance to the overall economy, is night and day.
I don’t fully believe it. There will be, in all cases, big transition costs. And many transaction costs will go up, and thus be fewer transactions (like HP buying Compaq? increasing efficiency). But I doubt that the big companies who can’t easily borrow from big banks have really tried to borrow from small banks yet.
The bailout also doesn’t answer the house price valuation question — how much are the houses worth, and who will be buying them? See John Allison’s proposal (President & CEO of BB&.
A significant and immediate tax credit for purchasing homes would be a far less expensive and more effective cure.
I don’t see the need for a days or even a single week’s rush — but fast as in less than a month has big advantages. Not so big that the wrong strategy, fast, is better than nothing now. I’d rather nothing now, and honest reduction of the banking sector.
I’m actually looking now for reasons to ‘do it now’, but not finding them. The biggest investment banks are already gone! (Goldman & JP Morgan have become banks) Nothing to save there. Except big-buck bonuses.
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Fabius Maximus replies: I wrote 1800 words explaining why I believe all of this is either wrong or irrelevant, building on my 50+ previous posts providing analysis of this crisis. So there is not much more to say other than only time will show whose analysis is correct.
That I consider the Paulson Plan both inadequate in scale and irrelevant in conception is obvious to anyone who has read my proposed solution. My new post spells this out in more detail: A time-saving review of the “Emergency Economic Stabilization Act of 2008″
Just to keep score, here are some of Tom’s past forecasts.
“I expect a recessionary-type reduction in real wages, yet with positive, slow growth. Until oil prices start coming down.” 13 June 2008
“And even after the huge housing bubble pop, and despite the oil increase, the US economy stubbornly refuses to go into the recession the anti-market/pro-gov’t elite are rooting for” 29 July 2008 {the data suggests that the recession started in Q1}
“Still, that will likely mean 18 more months (from Sep 2008) of low GDP growth, and slower income growth — possibly the ‘new’ recession.” 6 September 2008
The tax system should stop (and never have started) encouraging interest over equity in houses. The mortgage interest deduction should be replaced with a flat 35% mortgage payment tax credit, up to a lifetime maximum of 10 years average wage (~$450 000, slowly rising every year).
A few comments in response to comments on my comment #5.
– The numbers are to be treated carefully. They are quoted not because I have absolute confidence in them, but because they give one a sound understanding of relative position, globally and historically.
– The global economy is enormously complex and so is the human body, never the less when I go to the doctor for advice I always keep in mind his job is to sell me medicine, mine is to keep myself well and wealthy. When I look at how to weather a financial storm I keep in mind my greatest protection against destitution is my wealth. My job is to understand it and use it wisely.
-FM, I would argue your last comment does nothing but sustain the status quo national thinking about debt and economic structure.
1. One of a government’s assets can be its ability to impose taxes. Weather the gov’t does it on income, wealth, real estate, consumption, peanuts, sex, drugs, or anything else is a cultural decision. Some don’t hardly impose taxes at all they just own most of the assets, assume most of the wealth and dole out income as they see fit.(See Kingdom of Saudi Arabia)
2.Discussing GDP in relation to capacity for future taxation is B.S. I have a business. My business makes a “gross profit” (my share of GDP) of about 75% of gross receipts. But this is not my income, my income is 25% of gross receipts. If you assume you can tax me by my gross profit you will find I’ll shut my business down at the point where the taxation stops the growth of my wealth since I can sit at home and be just as comfortable. Where is this point? I don’t know and neither does anyone else since the effect of increasing taxation is hard to predict. But at the point where my future liabilities exceeded my wealth I’d probably just go home and hord it. Hence the importance of the 57t and the 59t figures. We’re in a wealth hording episode right now. Although I think this is just a temporary wealth hording episode. So does Hank Paulson. We could turn it into a protracted one if we try.
3. I’ll repeat it over again. All that all the economists study, and the Fed gov’t figures attempt to represent is summations of human behavior. While the effect of the movement of a billion dollars around the globe might take an economist to analyze, the effect of the behavioral constraints on the economy we live in everyday are not hard to understand if you take the simple lessons of life (and some education formal or not) combined with simple facts. Its not hard to figure out that if people with money trust it to someone to loan out in return for interest, and then ask who they loaned it to and the answer is “every Tom, Dick and Harry we could find”, the cash faucet will be shut off tight and locked closed until someone figures out exactly who Tom, Dick and Harry are and where they live. You don’t need an economist for this, just sample the average Rotary club.
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Fabius Maximus replies: My comments must not have been clear, because your replies have little to do with the points I was attempting to make. I doubt this will help, but a few quick comments.
GDP is not like gross or net profit. The analogy is spurious. The government can siphon off only so much of the national income, so the tax/GDP ratio is an easy way to roughly calculate the ability of fund future obligations. Nor does our government have much “wealth” other than its ability to tax, so the calculations of its “net worth” are also specious.
As for point #3, much of the commentary about the current crisis since Dec 2006 consists of attempts to show that it has simple and relatively small causes. This is possible only by ignoring the data, which many people find easy to do. It does not, as I have shown at considerable length in many ways over the past year. This is the result of a systemic crisis with deep roots, and requires proportionately large responses — or a long, painful adjustment period.
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
(Is ‘Fab’ too familiar, or do you prefer FM? Or Fabius?)
Yes, we disagree, and I’m enjoying noting the disagreement. On points, you’re likely winning so far: by a GDI income measure we ARE in a recession. Altho the graph shows strong recent growth in 2008 q2. On the most widely accepted definition, GDP, still no recession — but I agree that we should be acting like we’re in one.
On your solution (from A solution to our financial crisis):
(a) Recapitalize the financial sector by a transfer of wealth from the taxpayers to banks and brokers
I now think this is terrible, ok, sub-optimal. The current financial sector is like super-duper buggy whip makers after Ford — there’s too many buggy whips and not enough buyers.
Nobody wants to buy Mortgage Backed Securities right now.
The Federal Gov’t should NOT be choosing to keep Bear Stearns alive, but letting Lehman Brothers die. Lots of big banks need a huge diet, and we won’t have a stable financial system for months, no matter what bailout plans are offered.
I fully agree that there’s a huge debt monster out there — on Social Security and Medicare, especially. But no likely bailout now, and certainly nothing rushed, will be addressing that. The current US problem is too many houses (as you’ve well stated previously).
So the gov’t should buy houses, NOW, in a rush (but for low prices, like 50%), and then figure out what it wants to do with them, with more time.
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Fabius Maximus replies: This misunderstands what I said.
“Recapitalize the financial sector by a transfer of wealth from the taxpayers to banks and brokers”
This was one of the three methods I listed to avoid a the meltdown of our financial system. I don’t know what “suboptimal” means in this context, but it would work — which was all I said. IMO it is a terrible idea, but for non-economic reasons.
“Nobody wants to buy Mortgage Backed Securities (MBS) right now.”
There is no difficulty selling GSE-guaranteed MBS. Those not guaranteeed by the government are another story.
“there’s a huge debt monster out there — on Social Security and Medicare. But no likely bailout now…””
These are liabilities — promised future payments — not debts (money borrowed to fund past payments). Hence no “bailout” will be needed until the promises come due.
The rest is a misunderstanding of the problem, as I have described elsewhere.