Summary: In the past few posts I have discussed a possible solution to this crisis. Unfortunately, it will not work. The reasons why are both depressing and technical, so let’s defer them until the next post and instead concentrate on what must be done by the new President. A reminder: we can only speculate about these things, as they lie beyond both fact and theory.
Old Recommendations
For a summary see A solution to our financial crisis. This series of posts took you to the cutting edge of insights about the crisis. Now we will attempt to go beyond that.
(1) Stabilize the financial system — Being attempted, probably now it’s too late.
(2a) Stabilize the economy with monetary stimulus— Rates are coming down and money printed, but probably with relatively little effect.
(2b )Stabilize the economy with fiscal stimulus — Just now being considered; will work but slow to implement and slow to have effect.
(3) Arrange long-term financing for steps #1 and #2 with our foreign creditors — Unacceptable to our leaders at this time.
None of these will work, in the sense of having full effect before next Fall. That does not mean they are not worth attempting (i.e., the Fed and Treasury have programs included in numbers 1 and 2 ). Or worth doing, to help at a future date (number 3, recently advocated by Pelosi). Or worth advocating, hoping it will done before disaster strikes (number 4).
However, we must prepare for the possibility that the economy will be in a severe recession — or even depression — when the new President takes office in January. A depression does not mean like the 1930’s — the Great Depression. There is a large gap — usually ignored by analysts — between the severe post-WWII recessions (1973-75 and 1980-82) and the horror of the 1930’s. The frequent depressions of the late 1800’s lie in that gap, and for various technical reasons we may now be experiencing one of those.
The challenge
The new President must be prepared to immediately take action after inauguration. There is no time for the usual drill: search for staff, redecorate the Oval Office, have meet-and-greets so the new officials get to know each other, schedule meetings to formulate a plan and build support. The damage to the economy will be terrible by that time these things are completed, and (worst case) the economy still might be sliding downwards. Also, any plans will require time for Congressional approval and implementation, and plus lag times until results appear.
Then there is is the bad news. The conventional solutions which the new Administration could easily put into effect — fiscal and monetary stimuli, plus devaluation of the dollar to stimulate exports — probably will not work (in the sense of sparking a recovery of the economy). Let’s defer the reasons why until a later post, and consider the implications. We have two alternatives (not exclusive):
- Wait it out. Rely on conventional mitigation efforts to cushion the downturn until the economy’s natural recovery begins.
- Explore the fringes of economics, seeking some smart people who can take us beyond the now-exhausted standard Keynesian theory. We need new ideas.
New Recommendations for the new President
These are things to do, not arranged in a sequential order.
(1) On November 5 start assembling your “shadow cabinet”, and their key assistants. Get them working together ASAP. This poses all sorts of operational and marketing problems, plus the risk of conflict with (or undercutting of) the existing guys running the show. Deal with it.
(2) Get a small team searching for solutions outside the conventional beltway consensus. This is America, the brainstorming center of the world. There are new ideas out there.
(3) Prepare a plan. It will be complex.
(4) After the election, start building support among key political and business leaders for the plan. Coordinate to the maximum extent possible with the outgoing Administration.
(5) Once in office, move immediately to implement it.
We do not know if these things are even possible, esp (2). An unprecedented crisis requires extraordinary responses.
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
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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
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Is the US economy in good shape, or in terrible shape?, 27 September 2008
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A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 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.
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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
Since orientation is the key, how about an analysis of the orienting ability of the presidential candidates? This will give the electorate some basis for comparing their ability to assemble a new set of solutions starting today.
We should ignore their published platforms as these are now irrelevant. Analysis should consider the candidates’ decisionmaking at key points in the campaign.
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Fabius Maximus replies: I would love to see that. The man-hours required for such a project would be considerable.
Excellent recommendations, even if not publicly discussed until 5 Nov.
If quick action is important, and I think it is, then Obama is probably the better guy on the economy. Even if he’s wrong to blame the Free Market for everything, and propose a Big Gov’t solution for every problem. If the new President is working with a Dem Congress, a Dem President probably makes it easier to get things done. Especially if they are things that McCain has recently advocated.
I’m still supporting McCain — who can also do what the Dems want, quickly, but as aRep is better on abortion and stronger on Victory in Iraq.
Unemployment is going up … why not hugely increase the size of the US military? Including better in-military training programs, and possibly even a 3-12 month junior military ‘pre-training’ for all those who wish to join but fail for one reason or another.
Tom Grey: “why not hugely increase the size of the US military?”
don’t worry, they’re already thinking of it. Some Brigade is currently being moved from Iraq to DC, to be available for “public emergencies” — for example, extreme financial crisis. I understand that Obama has also mentioned an expanded Peace Corps, with a domestic aspect. “Peace Corps”, Civilian Conservation Corps — I’m in favor of it! Just dont call it “military”!
We are all a bit behind the curve. Now it appears that the TARP is not necessarily just about buying up bad mortgages, but can also mean injecting capital directly into banks and taking preferred stock in return (Paulson news conference, yesterday.) This is also the Gordon Browne plan, favored by economists. We can’t be sure that Obama isn’t already talking about this stuff in private, though it’/s way too complicated to inject into the American beauty, oops, presidential contest.
Last week there were reports that China’s president had talked with Bush directly, expressed willingness to buy our next $trillion of Treasuries, and looked forward to cooperation on areas of mutual interest, including Taiwan. Yesterday, the US announced the sale of $6bn of military hardware to Taiwan. What’s up with that?
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Fabius Maximus replies: Speak for yourself with “We are all a bit behind the curve.” My post about the need for drastic action to stabilize the financial system was up on October 3. The government is still talking about what to do, but subsequent posts are considering what the new Administration will need to do — after the current efforts fail to halt the slide.
I am surprised that the above suggestions are all so statist in nature, particularly Tom Grey’s. In the end there is nothing that can be done. The debt must deflate. Replacing private with public debt will make no difference. For example, who is going to pay for all the extra soldiers and training programs? Our grandchildren’s grandchildren? What Hank and Paul are doing is equivalent to stepping on the gas as your car heads toward a brick wall. Perhaps we should start by forcing all the bad debt out in to the open. Then we can at least start with a clear picture of where we stand. How can you even orient when so much is hidden.
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Fabius Maximus replies: Perhaps a bad medical analogy will help you to understand this. Even naturalists — believers in a healthy diet, organic food, fresh air and exercise — accept the need for heavy intervention when critically injured. Drugs, surgery — nothing natural about these things. But the alternative is long suffering, perhaps being disabled.
This insight is the essence of modern economics, won when the more laissez faire economists were discredited during the 1930’s. The long summer in America obviously has resulted in many folks forgetting this, but enough do remember that lesson.
As for the “so much is hidden”, I disagree. Everybody knows to a large degree what the score is, which is why so many leaders of financial institutions are so fearful.
I don’t see any problem with #2 – outside the box consultants. That is very easy to accomplish at least in the analysis stage.
Clearly there must be a comprehensive review of the entire monetary system without which anything else is just tinkering after the fact. I wonder if such a thing will ever come to pass. Right now the main players who have caused this are in charge of fixing it. That clearly also must change but there are almost no signs that it will.
Perhaps we can muddle through to another recovery, but I suspect that the US$ hegemony days are over in which case the entire underpinning of a credit-based hegemonic imperial power providing the underlying impetus and sustenance for the national economy are also over. In which case a leveraged-credit based system can no longer work since massive investment in easily-printed hegemony-currency will no longer be credit worthy.
In other words, if more out-of-the-old post 1913 Fed box solutions are not seriously considered, debated and ultimately adopted, it ain’t lookin’ all that hot.
Question I have is do any of these politicians understand whats caused the problems in the first place? I see the Democratic Party trying to take political advantage and not really caring about a solution. I see the Republican Party also without solutions nor the will to push any. If Obama holds to the idea of taxing the rich and large corporations we might as well plan for the worst. If we are to manufacture and export products we need to build and that means capital. Taxing those at the high end will restrict capital formation. Perhaps a total revamp of our tax structure would help.
Something along the http://www.fairtax.org plan or some other alternative. We need a ground up evaluation of how to make the US competitive in free trade and keep most of the work here. We will need to pay our debts to whomever they belong. But in the current political climate the likely hood of positive rational debate what needs to be done is just not possible.
As I have learned more about this current financial crisis, it becomes more obvious that common sense and competence could easily have prevented it. Transparency in terms of how derivatives were created, valued, and marketed, along with reasonable guidelines for cash reserves when any form of insurance was provided for same, would have made this a regular cyclical setback, no more and no less. Smaller problems such as a few extra home loans are not the cause of this crisis. The real estate bubble itself was at least in part caused by the murky world of derivatives and the ease of providing phony insurance for mortgage backed securities. Tiny problems were systemically compounded and spread utterly unnecessarily and incompetently.
A period of austerity lies ahead and that is a good thing. Americans have to stop defining themselves, and being defined, as consumers. We have to become citizens, and producers. It will take sacrifice to get there but it can be done.
One thing that is becoming obvious is that we are arriving in a post-ideological era. Pragmatism will have to rule; with problems so dire only efficacy counts. Anything that works. This can be an opportunity for people of intelligence and good will formerly separated by political parties, social issues and the like, to work together for the good of all in the really important areas, like ensuring our country survives, is stable, and eventually thrives again.
One place to begin is to realize that in terms of victory in Iraq, our troops have already achieved that, and should come home. Overall, however, we, the American citizenry, have irrevocably lost in Iraq. We have lost influence there to Iran which cannot be reversed; we have lost a trillion dollars we could use now and will never get back; and we have lost some wonderful young men and women who could have been part of our recovery.
The main difference between the Great Depression after 1929 and the Great Crash of 2008 is the fact that the United States in the meantime has become a superpower. Unfortunately that doesn’t mean better leadership. If I understand history correctly Roosevelt tried to solve the Great Depression with ideas borrowed from Keynes – at best with mixed results and some historians think New Deal failed completely. But at least Roosevelt could concentrate on the economy as a president. The problem today is that any new president would be forced to look at the crisis in Pakistan, war in Iraq and Afghanistan, the war against terrorism, Russia, China etc – and, oh yeah, the financial meltdown. At some point things will go wrong. So many things can go wrong and divert attention from the economy. It can’t see how any person – man or woman – could handle all that.
Perhaps the solution would be to empowering the vice president and make him something like the Prime Minister of the United States. Cheney took steps in that direction, but without making himself accountable. Making the VP stronger would help the president, but of course this also means the VP actually has to have some basic knowledge. Like what the Bush Doctrine is and stuff like that.
Hi Fab Max, great series of posts you are running here. I would suggets we need to re-impose the Glass-Steagall act which was repealed in 1999, which was put in place in 1933 with the sole purpose keeping banking SEPERATE form wall street for the very reasons we are seeing today. Credit and Securities do not mix well. Then get rid of Paulson a wall street guy and put a real banker incharge and get the money in then banking system NOT….securities of any kind.
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Fabius Maximus replies: There is no longer a Wall Street in the sense you are thinking of. That model was broken in the 1990’s by collapse over the previous 2 decades of profit margins in its traditional products. The model for “Wall Street” which replaced it just died. The majors are now all “bank holding companies.”
As I note in today’s post, there is no point in discussing reform at this time. That is like fighting a fire in your home while discussing how to redecorate afterwards. Time enough for that later.
FM – Good thoughts, as always. Before we get to the next president, we’re going to have to try to survive the results of the last 4, because events are heading to a nexus that is bigger than any political solution.
Tomorrow, $400 billion in Lehman Bros CDS will be settled. They have to be settled under their contractual terms, because Lehman has defaulted on its debts. The current guess (no one really knows, of course) is that recovery from Lehman directly on those debts and commitments will be $.10 on the dollar. If so, that means the “insurers” of the CDS – the ones who have been taking money form all the Lehman creditors who wanted to “hedge” against default, plus those who bought the CDS as pure speculation – will have to pay $.90 on the dollar of loss. The insurers are many and include JP Morgan, Morgan Stanley, AIG etc.
This means, in the anticipated scenario, these banks and insurance companies would have to produce $360 billion dollars in cash for immediate payment TOMORROW. It’s no coincidence that the DOW fell almost 700 points today when Treasury announced it interpreted the “spirit” of the TARP (it sure ain’t in the language) to permit it to give – on its own authority – “around “$300 billion” directly to banks and other companies inexchange for preferred stock. This will be a make or break moment, since failure to settle these CDS “successfully” means the remaining $50 trillion in CDS are essentially worthless, and there is no more financial system to worry about saving. Sound drastic? If I were King of the Forest, I’d put a moratorium on CDS settlements in place (yes, that would produce its own – much lesser – panic), until we calmed the rest of the financial system down – a matter of months at least.
Let’s just hope Treasury can either manipulate the settlement process to insure it’s “orderly” and appears successful (losses are “minimized”); or Treasury immediately writes several hundred billion dollars in checks to “recapitalize” the big players for the losses of the day; or…financial Armaggedon may become more than an over-used metaphor.
2010, interestingly enough, is the date at which the baby boom begins to draw social security, and attempt to retire en masse.
This problem is not the worst, but there is a succession of problems lined up to trigger shortly, possibly before recovery from this one.
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Fabius Maximus replies: Agreed! And this crisis is weakening our ability to deal with many of them (e.g., capital losses weakening pension plan solvency) or — even worse — actually making the problems worse. For example, capital investment in new energy systems — research, development, and construction — will be slashed to the bone as a result of the last few months’ market turmoil. This will substantially reduce our ability to deal with peak oil, should it arrive in the next 10 years (as most forecasts suggest).