Status report on the financial crisis: why has the treatment been so slow, so small?

Summary

1. The US government has at most a few weeks to restart the nation’s financial machinery.
2. The delay might result from the time required to assembly a sufficiently large policy package.
3. Or the US government’s leaders may have become overwhelmed by the rapid evolution of events.
4. If the latter (#3), a depression may result (not a Great Depression, more like those in the late 1800’s).

I am confident that the government will act soon. But no matter how we resolve the immediate problem, a global recession is probably coming.  Although just a normal cyclical event, it seems likely to reshape the world, marking the end of the post-WWII era.  In other words, this is the start of a new world order.  Let’s hope that, after the birth trauma passes, it is even better than the one now fading away. 

Update:  coordinated interest rate cuts made today by 6 nations’ central banks, including the Fed.  See the BBC story here; their joint statement is here.  A good step, and it might have been decisive if taken 6 months ago.  More action will be needed soon.

The situation

The nation’s financial machinery — that complex apparatus that circulates money throughout the economy — suffered a “cardiac arrest” last week.  Most short- and long-term credit markets now operate only at a low level of activity.  Normal commerce continues but many organizations — even the State of California — are drawing down their cash reserves, and a large liquidity event (e.g., a large bond maturing) can force a serious crisis.  As a result…

1. unless corrected soon, we risk a cascade of corporate and municipal defaults on their loans, and
2. business spending and investment is probably collapsing, although we have no real-time measures of this.

Sunday was the ideal time for the US government’s leaders to announce measures to restart the economy.  Nothing was done.  On Tuesday one necessary step was taken, direct lending to corporations.  Why the delay?  Why has the government’s response been so slow, reactive, and incremental since the crisis began in December 2006?

Too slow thinking, too slow action

The late John Boyd (Colonel, USAF) spoke of the OODA loop — observation, orientation, decision, action.  A fast OODA loop allows an organization to stay abreast or even ahead of events, acting proactively to shape its environment.  If the organization’s OODA loop runs too slowly, it becomes unable to effectively cope with events, falling ever more behind.  Disorientation follows, leading to inappropriate — or worse — erroneous responses.

The US government’s OODA loop — that of its leaders, operating as individuals and collectively — might be unable to cope with the rapidly deterioration of the financial system and the economy.  We see by their 16 major responses, each too small and too late.  Even the Paulson Plan, all $700 billion of it, was ideal … if implemented in June.  They are gearing up to implement it in October or November, by which time it is almost irrelevant.

Leaders who see America as a global hegemon, master of the world, might find these events disorienting.  Perhaps all they can do is stare at CNN while their staff sings “The World Turned Upside Down.”  Also, fatigue may be setting in after countless weekend and night meetings; days of endless stress.  There are many historical precedents for this, such as Captain Smith‘s passivity after the Titanic struck the iceberg, and General Gamelin‘s after the German breakthroughs of Allied lines in 1940.

Contrast that with readers of the FM site.  Over the last year they have read 62 articles about the End of the post-WWII geopolitical regime.  Although thinking that the author is the most pessimistic geopolitical analyst not actually in an asylum, they have in their imaginations an overall framework into which events since 2006 comfortably fit — and from which they can anticipate the future evolution of events.

Update:  For a deeper analysis of the OODA loop’s relevance to our financial crisis, see Chet Richard’s article at Defense and the National Interest.

Historical Irony

Chairman Bernanke’s reputation as an academic results in part from his analysis of the Great Depression, and especially his criticism of Andrew Mellon’s response to the early stages of the crash.  Now 22 months into a crash, he find himself wearing Mellon’s shoes — looking back at over a dozen responses, each too little and too late.  The parallels are astonishingly close, right down to both worrying about inflation and moral hazard as the deflationary fires burned around them.  Steering the US economy must have seemed so simple while writing in his office at Princeton University.  Historians will write with amusement about this historical irony.

Also odd is that he was feared to be too activist, too likely to over-inflate the economy.  “Helicopter Ben” they called him.  Who could have guessed that his (and his fellow governors’) error would be excessive caution, excessive worry about inflation?  Just like their predecessors in the 1929-32 period.

This is a global problem, we are the epicenter

Space and time constraints prevent analysis of the global dimensions of this problem.  Two articles will have to illustrate the scope of this crisis:

1. “Pakistan facing bankruptcy“, The Telegraph, 6 October 2008 — “Pakistan’s foreign exchange reserves are so low that the country can only afford one month of imports and faces possible bankruptcy.”
2. “Iceland teeters on the brink of bankruptcy“, AP, 7 October 2008 — And a more recent update on rescue operations from Reuters.

What next?

For a summary of my recommendations see A solution to our financial crisis, consisting of three initiatives.

1. Stabilize the financial system (first aid)
2. Stabilize the economy (emergency medicine)
3. Arrange long-term financing for steps #1 and #2 with our foreign creditors (finance the treatment)

I suspect there are few alternatives to these measures, although their timing and sequence remains unpredictable.  The primary alternative is collapse, which I consider unlikely.  Our major concerns should be, IMO, passivity and/or policy errors by our leaders.

Afterword

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).

For more information

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest these days:

• about the Financial crisis – what’s happening? how will this end?.
• about The End of the Post-WWII Geopolitical Regime.

Some FM posts about the current crisis

1. Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
2. High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008
3. Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
4. Another voice warning about the nationalization of AIG, 18 September 2008
5. A vital but widely misunderstood aspect of our financial crisis, 18 September 2008
6. A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
7. Another step away from our Constitutional system, with applause, 19 September 2008
8. What do we know about the financial crisis? What are the key questions?, 20 September 2008
9. Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
10. America appoints a Magister Populi to deal with the financial crisis, 21 September 2008
11. Legal experts discuss if the Paulson Plan is legal, 21 September 2008
12. Essential steps to surviving the current crisis, 23 September 2008
13. How should we respond to the crisis?, 24 September 2008
14. A solution to our financial crisis, 25 September 2008
15. Is the US economy in good shape, or in terrible shape?, 27 September 2008
16. A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
17. America has changed. Why do so many foreigners see this, but so few Americans?, 1 October 2008

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.

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, 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. Prof Nouriel Roubini describes “The Decline of the American Empire” ,18 August 2008
10. The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
11. “The changing balance of global financial power”, by Brad Setser, 22 August 2008