Status report on the financial crisis: we’re at a critical point in time

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Summary:  Here is a brief report with conclusions only.  The situation is moving too rapidly and become too complex for explanations.  This post describes the natural evolution of the trends I have written about for the past year, which are now reaching a climax.  Not yet, but soon we will be able to see the shape of the new world ahead in the fog.  As always, we lack the data or reliable economic theory to do more than speculate about these things.  See the archive at the end for posts over the past year describing how we arrived at this difficult spot.

An economic downturn has 3 stages, each with a different goal.

  1. First Aid — Stabilize the financial system to avoid a depression.
  2. Treatment — apply fiscal and monetary stimuli to mitigate suffering during the recession and get a global recovery in 2010.
  3. Recovery — restructuring and reforms to prepare for the expansion after 2010, and the new world beyond that.

Yes, 2010 is the earliest reasonable date for a recovery IMO from the most severe global downturn since WWII.  Policy errors could length the downturn, of course.

First Aid

This is a worldwide problem, due to two long-term factors.

  1. Globalization has locked us together into the same business cycle, instead of some regions being strong while others are weak.
  2. We all run our economies by the same body of economic theory, Keynesian economics.  No commies (except fringe states like N. Korea), and few socialist ones.

The result is like a monoculture agricultural system, vast fields planted with a generically identical crop.  It is uniformly vulnerable to the same diseases and pests.  We have all contracted the same infection.

The world’s finance ministers are meeting in Washington during the next few days.  This is perhaps governments’ last opportunity to regain control.

Their thinking have run slower than events, leading to inadequate response and disorientation (go here to see more on this).  Large-scale coordinated action by the major nations will be needed to prevent panic as people slowly become aware of the crisis, and restart normal operation of our commercial and financial systems.

Economists are generally agreed as to what should be done, basically recommendations #1 and #2 from my September 25th article “A solution to our financial crisis.”   For detailed proposals see “Rescuing our jobs and savings: What G7/8 leaders can do to solve the global credit crisis“, a collection of 12 essays by leading economists.  It says:

Policy makers must move boldly to stabilise the financial system. The basic elements are:

  • A quick bank recapitalisation with global coordination
  • A guarantee of deposits and/or loans with global coordination
  • Further, coordinated macroeconomic stimulus.

All the authors agreed on the first, many on the second and a good number on the third.

The first two are “first aid”, and will probably be the primary focus of the Ministers.  The third is “treatment”, reducing rates a lot and massive fiscal stimulus (Speaker Pelosi’s call for $150 billion in new spending is just ante in this game).  This list does not include one essential item:  loans from the IMF to nations suffering credit contractions.  See below for more details.

Let’s hope the leaders in Washington act rapidly and wisely.  Tired people acting under pressure make mistakes, such as an inability to force a consensus about collective action, or making policy errors.  Either could have unpleasant consequences. 

Treatment

All we have experienced to date are the foreshocks — tremors in the world’s markets before the full effects of the global recession hit.  Some things we can expect:

  1. Fiscal deficits will skyrocket, as government revenues shrink and social expenditures rise. A $2T deficit for US governments (Federal, State, local)?
  2. Unless prevented or until stopped, debt deflation will result in a cascading series of business and personal defaults (plus bankruptcies and unemployment) rippling throughout the economy.
  3. Aggregate demand will decline, as businesses and households reduce spending and boost savings.
  4. We must keep interest rates low, inflation contained, and the US dollar’s value stable (or an orderly decline); doing all 3 will require global help.

For reasons beyond the scope of this post, I doubt that the conventional treatment — fiscal and monetary stimuli — will work.  Inguinuity will be needed.  Let’s hope we have another Keynes waiting in the wings for his opportunity to come onstage.  {For more on this aspect of the situation, see The new President will need new solutions for the economic crisis.}

Many aspects of the necessary treatment remain beyond today’s consensus thinking.  For example, America may require a global “bailout” — new funds and renegotion of our foreign debts, as described in “Effective treatment for this crisis will come with “The Master Settlement of 2009″.”

Recovery

I believe we will recover from this downturn into a new world.  The recovery period will be our opportunity to prepare for it, using what we learned from the recession to restructure our economy.  How well we do in the following generation or two might depend on decisions made during this period.  For example…

  1. Our pension savings (public, corporate, and personal) will be devastated by the recession, and the boomers will be retiring in steadily increasing numbers.
  2. Our financial system will be largely nationalized.  What do we do:  keep it under government control, privatize it under severe regulation, or some hybrid form?

Today we can only guess at the shape of the post-recession world.  Prof Delong said that the 1930’s led to government control of riskless rate of interest (the price of money), and the current crisis will result in government regulation of the risk premium (the price of risk).   A long global recession will drive changes in behavior, beliefs, and structure that we can only imagine today.

Also, the center of gravity probably will shift from west to east, as has been long discussed.  Their ideas of major Asian leaders about the proper structure for mortgage lending might be more important than that of American borrowers.  Unless the US government does most mortgage lending, financed by Asian purchases of US Treasury bonds.

Whatever the result, we will learn much about ourselves.  Periods like this test a people’s strength.  Their character, belief in their core values, and ability to work together.  I am confident that America again will withstand adversity.

Two subjects not to discuss in the comments

A little known clause in the FM site’s comment policy allows limiting discussing during times of extraordinary crisis.  Like now.  Let’s have open discussion of this post, subject to two exceptions (which we will save for a later date, where they can examined in detail at leisure).

(a)  Causes of the problems:  

It is irrelevant how we contracted this “disease.”  Save it for church, or for future historians.  Events on this scale have complex causes going back decades, rooted in limitations of our political and economic theory (Keynes did not consider the aggregate debt level a limiting variable) — compounded by a series of public policy mistakes (e.g., misdiagnosis of the 1987 stock market crash in the Brady Report).  Esp absurd are simple single-cause explanation, esp to small events or policies.

(b)  Reforms

By the time things have cooled enough to discuss meaningful reforms — rather than simplistic panaceas to reassure the public — conditions and thinking will have changed from today.  Anything we think of now will be irrelevant; any reforms discussed now will be washed away by the events during the global recession.

A few stories showing the global scale of the crisis

This is a global crisis.  Iceland was only the first casualty.  Hungary and Indonesia may be next.  There are many others to worry about.  Korea and Australia among the developed nations; India and much of Eastern Europe among the emerging nations.  And, of course, the United States.

  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.
  3. “Hungary markets slide on liquidity crunch“, Retuers, 9 October 2008 — “Hungary’s currency and bonds fell sharply on Thursday as concerns grew over the country’s financing and banking system amid the global financial crisis and as the government said it would redraft the 2009 budget.  Liquidity dried up and trading froze in the government bond market…”
  4. “Indonesian stock trading frozen to prevent panic“, AP, 10 October 2008 — ” The president of the Indonesian stock exchange says trading will be suspended indefinitely ‘to prevent deeper panic’ after another huge drop on Wall Street.”

For more information from economists

  1. “The Wrong Crisis“, Brad Delong, 8 October 2008 — About the unexpected aspects of this crisis.
  2. “The world is at severe risk of a global systemic financial meltdown and a severe global depression“, Nouriel Roubini, RGE Monitor, 9 October 2008
  3. “Rescuing our jobs and savings: What G7/8 leaders can do to solve the global credit crisis“, 9 October 2008 — 12 essays by leading economists about what the G7/8 leaders should do this weekend.
  4. “Moment of Truth“, Paul Krugman, op-ed in the New York Times, 9 October 2008 — “… key policy players have largely wasted the past four weeks. Now they’ve reached a moment of truth: They’d better do something soon – in fact, they’d better announce a coordinated rescue plan this weekend – or the world economy may well experience its worst slump since the Great Depression.”

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 from the FM site

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

Some FM posts about the current crisis

  9. How should we respond to the crisis?, 24 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.

  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.
  10. The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.

36 thoughts on “Status report on the financial crisis: we’re at a critical point in time”

  1. Rune Kramer

    Is inflation even a problem any more? A banking crisis tend to be deflationary and this one is big.

    Also while the global economy may start up again in 2010, job creation may not. The hit to savings will force older people to remain in the work force for longer putting pressure on wages. So the possibility of double digit unemployment for a decade or so is good.

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  2. Sho

    Can you elaborate on your mention of Australia as a country likely to experience especially serious consequences from this crisis? Everything I’ve heard so far seems to suggest Australia is in excellent shape, perhaps the best of all western developed countries.

    The IMF predicts 2.9% growth in Australia for 2009, from memory, and 3% worldwide. I’m not mentioning their estimates as an appeal to authority; I’m interested in knowing why your prognosis is so much worse.

    You (correctly, IMO) focus on interbank lending as a primary underlying cause in this situation. The nuclear option, nationalisation, is now on the table in almost every country – indeed, it’s already being used in some. Central banks are also pulling out the big guns. Isn’t the credit problem likely to be contained by those actions?

    Next week is when we’ll have all these answers and more, I guess, but my “zeitgeist” sense is that governments will simply not allow things to get much worse, and will likely intervene soon to force a return to function (assumption/forcing of credit roles, forex pegging, stockmarket freezes (already in Russia!), etc).
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    Fabius Maximus replies: Australia’s large current account deficit is the danger, a bad thing in a global credit crunch. The collapse in commodity prices, its major export, will both decrease the value of its exports and its national income. For more on this see:

    Current account data at the Australian Bureau of Statistics: source.
    IMF table of current account deficits as %GDP, by nation: source.
    An article about the Aussie c/a deficit: Wikipedia,

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  3. Paul from Florida

    I was wondering what you thought of Nobel James Buchanan and Public Choice theory and his general observation that the primary motivation of bureaucracy is for it to grow and prosper. At all most all levels, governments are the largest, wealthiest, highest paying, best benefited, quickest retirement employer at every political level. And at each level, the most politically powerful. It appears that government and it’s staff will yet again grow, and prosper.
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    Fabius Maximus replies: It has much explanatory power, and plays a valuable role reminding people that public organizations do not act altruistically (that is a common assumption, however silly). The behavior of organizations exhibits similar behavior to that of the individuals composing them, another valuable insight.

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  4. K T Cat

    Keynes was wrong all along. He forgot that people are rationalizing creatures, not rational ones. If you excuse yourself for deficit spending when times are bad, then times will always be defined as “bad” so you can spend more than you take in. Great point about all nations being Keynesian.

    Today’s sale of Lehman’s assets, the first in a series, will change things dramatically for good or ill. More here. In the meantime, chill out. It’s the uncertainty of the value of the CDS assets that’s got things all messed up. It’s going to take some time to value these assets through the auction process. Between now and then, there’s not much the government can do other than buy commercial paper while the short term lenders figure out how much they’ve got in assets to back their loans.

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  5. zoagria

    I’d like to bring up an aspect of your process that is left unsaid (I suspect because you thought it so obvious it didn’t need to be said):

    If there has been active manipulation of U.S. financial markets by either factions of Americans hoping to use a crises to their own political advantage, or 4GW operations by foreign powers acting alone or in collusion with Americans, these contributing factors to the current crises must be confronted and exposed, as if allowed to persist and remain in positions of political power (if Americans) or foreign operatives are able to actively continue, then there is about zero percent chance that either category would act in good faith as attempts were made to address the deeper problems involved.

    … Thus to claim that it is moot what “caused” the current crises due to the complexity of said causes, is deeply flawed. It is correct that ALL the contributing factors are too complex to know absolutely per say, but because the Audit community, political and fiscal Executive management, and Congressional leadership are all needed to be “good faith players” if we are to have ANY HOPE of “fixing” the financial system, the only reasonable grounds for dismissing contributing causal factors across the spectrum is certainty that none of the institutions needed to undertake the clean up have a direct conflict of interest stemming from active involvement in CAUSING the crises in the first place.

    … My point isn’t a dispute of your economics reasoning, but rather based on a practical personal experience with both Parties “fixers” and back room fund raisers. The civilian power players in the beltway are NOT going to act responsibly or in anything remotely close to “good faith”, nor are the staffers or courtiers or etc. If those factions that so brazenly maintain their openly corrupt members are allowed to continue in positions of leadership in the legislature, then every step of the process will be poisoned and sabotaged. …

    Best, A. Scott Crawford
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    Fabius Maximus replies: This comment was 775 words, far over the FM comment policy of 250 max. I have trimed it to a still-too-long 330 words. You can see the full comment here.

    (1) I doubt “there has been active manipulation of U.S. financial markets”.

    I — and many others — have been predicting events broadly like this for many years, so no unusual explanations are needed to explain it (Occam’s razor works well here).

    (2) Debating casuses is irrelevant at this time, IMO. Think of this as emergency medicine. You are rolled into the docter after a cardiac attack. Does he get the paddles to restart your heart? Or suggest a diet and more exercise?

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  6. ErikZ

    “It is irrelevant how we contracted this ‘disease.'”

    What nonsense. Say we manage to pull out of this perfectly fine by 2010. And in 2011 it happens again, because we never got around to fixing the issues that caused it to begin with! What if it’s mostly due to bad policy? Do you think leaving those people in charge of the recovery will help or hinder the effort?

    You have no “Preview Comment”, I have no way to test my comment to see if the italicizing worked.
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    Fabius Maximus replies: The system that we will have in 2010 will, IMO, have little resemblence to that of 2006. Whatever those policies and institutions were and did, they are being washed away by events. You can see this happening right now, so this is not a very bold prediction.

    As for formatting, WordPress provides this service for free. I doubt you or have grounds to complain!

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  7. K T Cat

    In reply to #5 – the solution comes from the source of the problem. The politics of the situation are symptomatic of the disease. We’re a self-indulgent world. Keynesian economics is the economic partner to secularism. It excuses self-indulgence which we later have to pay for. (See also: prison population, post sexual revolution.)

    The short term solution is to allow the smoke to clear in the valuation of the mortgage backed securities. The long-term solution is much harder. It’s time to put down the vibrators and throw away the Sharper Image catalogs and get back to thrift and self-denial. It’s not about the politics at all.
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    Fabius Maximus replies: Perhaps true. But irrelevant to our situation. The patient’s heart has stopped, and the doctors (at least, those posting comments) prefer to discuss his diet and lifestyle.

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  9. K T Cat

    Fabius, part of the short term solution might be to recapitalize selected banks so that they know they have enough assets to begin lending again, but the biggest part of the short term solution is to wait out the auctions. Until then, the uncertainty will totally constrict credit. So, in summary:

    1. Allow the government to buy commercial paper so that otherwise healthy companies don’t go under because they can’t get short-term financing.
    2. Spew some cash reserves into the big banks so they can relax a little and be bankers again.
    3. Wait out the auctions.

    If we don’t fix the underlying culture of self-indulgence, then add the following step:

    4. Wait 6-18 months and repeat until full Weimar Republic status is reached.
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    Fabius Maximus replies: Perhaps so. Almost every expert I know in economics and finance considers such measures as grossly inadequate. If we take your recommendations and the experts prove correct — so we slide into a depression — will you apologize?

    #4 seems a large leap of logic from #1 – 3. We are in a deflationary debt spiral. Weimar had hyperinflation. Also note that Weimar survived the hyperinflation of 1922-23. Hitler took power a decade later, so there were obviously many links in the chain between the two.

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  10. K T Cat

    No, Fabius I won’t apologize. We’ve followed the Keynesian consensus of the economists and pretended that the government could manage the economy when it no more did so than a 2 year old drives a car from the back seat with one of those Playskool car dashboard toys. We’re $10T in debt because we keep following the Keynesian model. As you indicated in your post, the rest of the world is in the same fix. Once this all settles down, we’ll be even further in debt. States and municipalities, ditto. Families, ditto. The recession is coming. Deal with it. That’s what happens when you spend more than you earn, year after year.

    Touche’ on my Weimar gaffe. I’ll have to find a better analogy. How about lifting one from the shampoo commericals? “Borrow-spend-repeat.”
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    Fabius Maximus replies: It’s not that I think you are wrong from a “big picture” view. Rather, that these structural factors (e.g., role of Keynesian economics) are irrelevant to the emergency. A better analogy is May 1940. France learned that its national defense systems were not very good. With NAZI troops pouring over the border, a debate about the theoretical basis of their military strategy was not relevant.

    I suspect that if the folks posting comments here had any idea how bad things could get, their attention would be more focused on the current emergency — and less on long-term (past and present) issues.

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  11. Tom T

    Let the interest rise. Why would we put price controls on interest rates? High interest rates are just a reflection of our current situation and should be allowed to play themselves out in order to avoid continuing, sustained pain.
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    Fabius Maximus replies: I love the casual manner of these suggestions. Why not let rates rise in a high debt, rate-sensitive economy like ours? Cascading defaults and bankruptcies are just part of the great circle of life!

    The the spirit of President Hoover and Andrew Mellon (his Treasury Secretary) live on today. President Hoover wrote in his “Memoirs” that Mellon had…

    “… only one formula: liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate…. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

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  12. Nicholas Weaver

    An interesting observation from DeLong: “The Wrong Financial Crisis“.

    This is not playing out exactly as he, Roubini, and others initially thought. They were expecting a meltdown of the “financial Balance of Terror/Bretton Woods II” as the precipitating event first, not a solvency/trust crisis in the global banking system.

    However, the solvency/trust crisis could further trigger the collapse of Bretton Woods II, as pointed out by Krugman here and here.
    Thats the question: Will the crisis of trust/confidence hit the US treasury before calm is restored? IF not, the financial heart attack may be followed by a financial stroke…
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    Fabius Maximus replies: Note I linked to Delong’s article in my post. That is a specialist’s comment, that they did not forecast the sequence of events — which is setting the bar quite high. From our perspective, it should be impressive that their warnings proved broadly accurate.

    As for the “trust in treasury’s” issue, I think that is an irrelevancy in this stage of the crisis. Private actors flock to treasury debt, and governments will do nothing to rock the boat. Down the road the situation gets more complex, as I describe in “Effective treatment for this crisis will come with ‘The Master Settlement of 2009’.″

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  13. Nicholas Weaver

    Also, for those who still think this isn’t hitting the real world:
    * The TED spread is now 4.59%. Anyone who has a loan pegged to LIBOR which adjusts now is looking at a huge hit.
    * IBM just issued some 10 year bonds. They had to pay an interest rate of treasury + 3.8%. This is gold-standard credit risk is paying what a year ago were junk-bond rates to borrow.
    * And, little noticed, two companies owned by the same private equity firm, Mother’s Cookies and Sleep Concepts, both declared Chapter 11 with no notice, probably because the private equity firm can’t roll over short-term debt.

    That the US has NOT started triage on the banking system, like the UK has, is a bad BAD sign.
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    Fabius Maximus replies: Agreed. We are following along Japan’s path to failure.

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  14. K T Cat

    “IBM just issued some 10 year bonds. They had to pay an interest rate of treasury + 3.8%.”

    That tells you that the interest rates are out of whack. If very few are willing to lend money, then what money there is will be very expensive.

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  15. Nicholas Weaver

    OOPS, sorry, missed the pointer. Apologies.

    Although I don’t think its DeLong “setting the bar too high”. DeLong et al were focused on a currency crisis first, rather than a global bank run. They were very right in warning that the system was unstable, but it is akin to the doctor going “You’re going to have a stroke” when the person then has a heart attack: They have similar root causes (too much debt, too much easy money, too much spending), but some significantly different aspects and perhaps very different treatment.

    EG, a collapse of Bretton Woods II would probably not cause the crisis of trust in the CP market: interest rates would rise in the CP market, but wouldn’t probably rise so out of joint with treasuries, as you probably wouldn’t have quite the complete fobia of “whats on everyone’s balance sheet” issues, or the need for massive recapitalization/nationalization of the quasi-banking system.
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    Fabius Maximus replies: Perhaps the stroke/heart analogy is correct. I suspect rather they just got the sequence wrong (something almost impossible to forecast). The US dollar is the keystone of the global financial system, and all stress concentrates there. A currency crisis is highly likely before this cycle concludes, IMO.

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  16. Tom Grey

    Wow, too many good things to read. On some details of stabilizing the financial system,
    Angel Ubide states:
    “There are three steps that must be applied quickly and decisively: close the bad or small banks; recapitalize the good or too big to fail banks; and remove the bad assets from the system so that banks can return to lending.”

    My problem is how the gov’t should choose the good or bad banks, and in particular why they should be trying to close any good, small banks. But he refers to an IMF paper that probably should be read, too. No link: Financial Sector Crisis and Restructuring: Lessons from Asia, OP 188, 1999

    If recapitalizing means giving gov’t money to banks that will disappear within two years, it’s a mistake (for those banks, anyway). If the financial sector, now at some 4-5% of total GDP, drops down to 2%, it’s clear that not so many banks will be needed. For instance, if CDS (credit default swaps) and MBS (mortgage backed securities) become much less traded.

    So why should gov’t urgently recapitalize to 200% of economic need the financial sector (back up to 4% say)? Yes, maybe to get loans to companies. But maybe the Fed / Treasury can make fairly expensive (10%) loans to companies directly, and bypass the bank intermediary.

    Like available $5/gal gas after a hurricane, rather than $3/gal “Sold out” unavailable, expensive direct loans to companies avoids the requirement to save the financial institutions before they can lend again. When the desire is to allow production companies to make payroll, for instance.
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    Fabius Maximus replies: The government already has announced it will make direct loans to non-finanical companies, as Prof Roubini and I (and others) recommended (see this post), buying commerical paper.

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  17. Tom Grey

    Klaus Zimmerman makes a strong point: The stock markets are and will remain crazy and unpredictable until the architecture of a reinvented financial system comes into view.

    So I support trying to stabilize the financial system’s ability to lend money to production companies, but don’t believe in financial stability before fiscal policy.
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    Fabius Maximus replies: Note that this posts uses a medical analogy, in which stabilization means keeping the patient alive so that treatment is possible. Not stabilization in the sense you mean.

    Also — as I state quite clearly in this post — and the previous ones on this topic — fiscal and monetary policy will be needed to mitigate the downturn and assist the economy to recover. This is a commonplace; does anybody other than fringe crazies disagree?

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  18. Nicholas Weaver

    I don’t think its a matter of “wrong sequence”, I think its “unexpected behavior”. DeLong et al are not the psychological-centric economists. But the bank run mechanism is in many ways psychological: in addition to everything else, there was a negative-bubble in risk that nearly everyone failed to notice outside those screaming about stupid mortgages.

    This has collapsed, and ?perhaps? swung the other way, leading to this global-bank-run we are in.

    However, I think why they are worried IS one of ordering: Bretton Woods II is going to have to unwind, treatment #4 is going to have to involve a decline of the dollar. A big worry, however, and eg, why Krugman’s “Faustian Bargan” post, is that Bretton Woods II represents one more big heavy event if it unwinds quickly.

    I think the only thing which HAS saved the dollar is the risk-void-bubble and reaction ARE global: Russia. China. The Middle East: All our creditors are having it happen internally as well. So there is no natural inclination to flee the dollar because this particular systemic problem was truely globalized.

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  20. Nicholas Weaver

    Well, leading in part. One factor of many of course, but its a factor I don’t THINK they saw.

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  21. Tom Grey

    There’s little more ‘monetary policy’ left to do in the US; getting the ECB and other banks to lower rates seems correct.

    The value of housing has to be stablized — so that the MBS and the leveraged CDS values can be seen to be meaningful.

    Just as most post Friedman discussion of the ’30s focuses on the gov’t failure to provide more money, I believe a lot of future history of this crisis will draw attention to the failure of the gov’t to support house buying NOW, after too much support in the past (which caused/ contributed to the problem).

    Perhaps our economic athlete has been doping his blood, and has added 1 pint, 2 pints, 4 pints — and burst a blood vessel (in his nose?). He’s now bleeding and has already lost blood. Lots. Besides stopping the bleeding, he needs … more blood (even tho adding blood before caused the problem).
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    Fabius Maximus replies: This is a valuable comment, showing the type of cognitive error that often hinders effective response to a crisis.

    When I was eight I had spumoni ice cream for desert, and was sick that night. For years I believed that the spumoni made me sick: the post hoc ergo propter hoc fallacy. It’s wired into us.

    Consider dropping grains of colored sand to form a pile. Eventually one grain will collapse the pile. If it is a green grain that does so, was the collapse a “green grain problem”? That’s the natural response, no matter how absurd the logic, how disproportionate the response to the alleged cause.

    In a crisis, directing responses to a minor cause — ignoring the larger factors at work — is the easy and often fatal course. Making it more attractive is that these are “single factor” explanations. Almost always wrong, their simplicity gives them immediate popular appeal.

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  22. RealThink

    Ave Fabius,

    given that you are somewhat Peak Oil-aware, and are a regular poster at Roubini’s RGEMonitor, I thought it would make sense to post the following here too.

    In view of one of the “Urgent and immediate necessary actions” advocated by Nouriel Roubini in his latest diagnostic and recommendations piece

    “- a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;”

    And given that, having NR predicted this meltdown back in February, his thinking now weighs a ton with the establishment and therefore his advice will most probably be heeded, it is evident for anyone aware of physical limits to growth that the world is facing a most critical and urgent issue: how smart or dumb, from a Hubbert’s Peak-aware perspective, the forthcoming massive public works, infrastructure spending, tax rebates, etc. will be? E.g., are governments going to:
    – spend on airports or railways?
    – build new roads or electrified urban rail networks?
    – offer tax rebates for SUVs or efficient PHEVs?
    – finance building in Las Vegas or wind farms?

    In a word, using the Easter Island model, are governments going to start a massive moai construction program or a massive reforestation program?

    So, this is “the” point, and this is “the” time for all good Peak Oilers to come to the aid of their country (actually planet because this is global), by speaking out as loudly as possible to influence public thinking to ensure that the forthcoming stimulus packages will be conducive to helping society withstand the oncoming descent from Hubbert’s Peak and not to accelerating its collapse, this time due to shortages of physical “liquidity” that no Central Bank can provide.
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    Fabius Maximus replies: This is an important question! Japan responded tothe 1989 crash by spending themselves into debt with largely useless capital projects, which could have instead postitioned them to be a star of the 21st century.

    Today we have the opportunity to use this emergency to prepare for Peak Oil, esp important as private investment in new energy systems will collapse! Let’s not make the same mistake as Japan!

    Reply
  23. BarryD

    In reply to #7:

    What in the world do vibrators have to do with the causes of this?

    WRT the solutions, thrifty forms of entertainment, like vibrators, might be just what America needs in the coming months. Furthermore, my wife and I have enjoyed a better sex life since we started saving money — not because sex is cheap, but rather because the overuse of credit is stressful as hell.

    This brings me to my concern and question for Fabius:

    It seems that one of the paradigm shifts that may well occur here is the tightening of credit, both on the supply and demand sides. At least some of the booms we’ve seen over the past decades have been based on people, businesses and governments routinely spending more money than they actually have.

    This crisis will be weathered better by individuals who have been conservative with finances; those people who actually followed the advice of, say, a Dave Ramsey, tend to be better off now than those who are upside-down in the homes they should never have bought.

    But what happens on the macro level, as consumer spending plummets because a critical mass of people have jumped off the train of borrowing and overspending?
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    Fabius Maximus replies: That’s difficult to forecast without the aid of a powerful computer, good software, and a team of economists. Lower debt growth, higher interest rates, perhaps higher rates of business investment — higher rates of economic growth? Who knows? Much depends on the choices we make during the transitional period. We cannot see beyond the choices we do not yet understand.

    Reply
  24. David Taylor

    Fabius, I just discovered the site in the last few days, and find it very interesting; but I can’t find what to me is one critical piece of information. Who are you? I find it impossible to evaluate the credibility of posts on the internet without knowing the identity of the poster. Sorry if it’s on the site and I’m just not seeing it–but if you could point me to where I can find your name and a brief bio I would appreciate it.
    .
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    Fabius Maximus replies: OK. John Smith, head librarian of Oxford. Now, tell us how this changes your interpretation of what I have written? Or Joshua Jones, corn farmer in Iowa Does that make what I have written more or less correct?

    If you are looking for appeals to authority, you are at the wrong website.

    Reply
  25. Duncan Kinder

    If credit is so tight, then why are credit card companies continuing to offer checks for unsecured cash advances in sizable amounts at approximately the same interest rate as a current fixed mortgage?
    .
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    Fabius Maximus replies: The same reason banks used to give away free toasters. The long-term value of the account — merchant fees plus interest plus fees to customers — is highly profitable. The low interest rate is a promotional expense.

    Reply
  26. mistah charley, ph.d.

    To David Taylor, #24 – see “About Fabius Maximus and this blog” — The closest direct answer to your question is the following statement:

    “On another level, a work of intellectual analysis stands on its own logic, supported only by the author’s track record. You can easily assess my record by using the dropdown calendar to read old articles.”

    I don’t know if you’ll find this answer satisfying. I am content with it.

    Reply
  27. bc

    So, the analogy with a heart attack is a good one. Downward spiraling blood pressure becomes analogous to ever declining liquidity, surely the financial counterpart to blood. But what is the ER countermeasure? De fibrillating an already synchronously beating heart is a bad idea. The machinery of banking (Our “heart”) appears in great shape. We need blood and fast! Open the fed window directly to borrowers. Allow any borrower to borrow more pro-rata. If you can show you have a million dollar mortgage, recently up to date, you can borrow $300,000 more, no other questions. If your business carries a 2 million dollar loan, you get $600,000 more line from the fed, and so on. Past is prologue, that’s the screening criterion. If you were good for $X yesterday, you’re good for 1.3$X today. Come one, come all. Get your blood transfusions here!

    Reply
  28. Nicholas Weaver

    One other thought: Apart from the not ACTUALLY lending, I wonder if the rates for credit simply represent a “radical return to normality”. Perhaps we’ve had a 20 year long bubble in “risk”, where there was a much lower risk premium put on assets then there is today.

    “Credit Spreads: Still Getting Worse“, Calcuated Risk, 10 October 2008 — This shows the history. TED spread at 4.5 is VERY unusual today, and since 85, but before that it was pretty much at the levels today.
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    Fabius Maximus replies: A powerful point. Many folks said that risk premia were too low! Except for those with access to government capital, risk premia will likely be higher in the next cycle.

    Reply
  30. Rik

    I disagree with the power shifting to Asia. Neither Japan nor Australia show any meaningful leadership and Beijing is so far curiously silent (Russia, with its hiv and tbc epidemics, shrinking population, lower life expentancy and overdependence on gas & oil isn’t even worth mentioning).

    I agree that a blamegame is useless. If only global authorities and policymakers weren’t all equally irrelevant!

    I’m just a bewildered layman, but I think power is shifting to markets – away from any congress, authoritarian republic, federal banking system or, for that matter, any kind of Executive. To me it seems neither recession nor depression, but a system fault.

    In a global economy / world, you must stress regional difference / national leverage. I can’t help but think of “chiemgauer”, an alternative regional currency in Germany. Many Germans (I’m Dutch) don’t like the euro and think it’s too expensive. Well. The point of chiemgauer however, is that you can keep up community consumption and investment. Can’t say why, but I find the idea of chiemgauer attractive: a regional currency for consumption and the euro / dollar / rmb for saving. Nice.

    Last but not least, I think the next president will have to cut spending, raise taxes and install reform. He should start by abolishing pensiosn, say by 2020. If only!
    .
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    Fabius Maximus replies: These are interesting comments!

    “Beijing is so far curiously silent ”

    When your rival is destroying himself, why say or do anything?

    “but I think power is shifting to markets”

    Almost certainly power is shifting away from markets. We have had a quarter century of crisis — from the 1980-82 years, the 1987 stock market crash, the commercial real estate bust, the 1997-98 emerging market bust, the tech bust, the home real estate bust, and now this. I suspect that popular opinion will support a massive shift to government control of capital allocations, as per the Brad Delong quote in this post.

    “cut spending, raise taxes and install reform.”

    That is the failed New Deal formula, which I think unlikely to be repeated. For the next few years we will almost certainly see higher spending, flat or lower taxes for most people, and “reforms” (not necessarily reform).

    Reply
  31. Janice N. Richards

    The Lost America! Growing up in an average middle class American Family where the mother stayed at home and the father worked I remember the wonderful family values we were taught. A person was only as good as there word, a handshake was all that was needed to get a house or a car. Families spent time together.Education was respected and had a value on it. Work ethics existed.There was separate of state and government. Freedom of religion and speech. Live was great and everyone had a dream for a better life. Now none of this exists. No one respects anything in America. No respect for family, education, ethics, religion, work, and the role models in our Congress have all but destroyed the faith of our young people. Our country is no longer a democracy. Everyday government is taking more and more control. Property has been bought by many people or corporations who are not citizens of the US. Social Security is paid out to those who are not citizens of US. People who have worked all their life can not get financial assistance when needed yet illegal immigrants do. When this contry started everyone that came here from various contries came with the same dream. THey wanted a better life. Today American’s aren’t able to hold their heads up in other countries. The country is being taken over by other countries without the average citizen even being aware. The constitution has been ammended to the point of people not really understanding it. When do we stop and take a stand for the sake of our own country and people. When do we put ourselves first. When do we review the original constitution and interpret it correctly and why do we always feel the need to compete for the approval of other countries. If we lived by what we truly believed in and acted on our beliefs we wouldn’t be in the mess that we are in today and we could hold our head up high. Yes this applies to our economical distruction. We have gone out of our way to destroy everything that our forefathers believed in. It is time that we go back to the old ways that worked. Union, better work conditions, respect, religion, education, family values, and yes even a good spanking once in a while. Maybe if our economical leaders had their hands slapped once in awhile we wouldn’t be where we are. It’s time our country stops thinking about the almighty dollar and starts thinking about what is truley important in life. “THE PEOPLE!” It’s time to gain control of our country and stand tall with PRIDE.

    Reply
  32. Shogunole

    It is truly amazing and scary to be a witness to a repeat of history. I am wondering if the financial system, as constituted, is worth fixing at all. I am curious to know what your thoughts are on the possibility of a major shooting war (including a second US civil war) starting by 2015? Why, you may ask? Economic crashes like the one we are facing usually are followed by major violence at the scale of the civil war and WWII. I would also not be surprised if the next president will have to deal with a nuclear detonation during his term. Will we get through this? Yes, we have before and we will again. In the mean time, we get to re-learn the importance of people, family, community and teamwork among communities to survive and make this world a better place.
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    Fabius Maximus replies: Is it in fact correct that “Economic crashes like the one we are facing usually are followed by major violence at the scale of the civil war and WWII.” The 19th century (1815 – 1914) was a period of great instability for the US and Europe. Note all the “panics” (aka depressions) in the US during this time. Yet it was one of the more peaceful periods in our history. The Civil War was the exception, and that had different causes.

    Reply
  33. Mongo

    Fabius,

    Do you have any advice on what Americans should do to prepare for what’s coming on an individual level?
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    Fabius Maximus replies: We all know what to do. Be careful with big decisions — expenditures, changing jobs, starting or expanding a business, etc. Build savings.

    Unfortunately these things all slow the economy. Keynes called this the paradox of thrift.

    Reply
  34. Celebau

    “Neither Japan nor Australia show any meaningful leadership”.

    Assuming Australia or Japan … or a country called Utopia, were perfect models to hold up high, and their leadership were making highly public statements as to the failings (both before and after the credit crunch) of other countries and how to fix the mistakes made, would other countries really pay the slightest attention?

    I suspect they would not.

    There are plenty of people pointing out the errors of our ways. Who in the policy realm is listening? Its called the not invented here syndrome, and is also known as Exceptionalism.

    For those who want advice, its pay off/down your debts, get rid of any unnecessary credit cards, save every cent that you can as a hedge against hard times. If you have a back yard, grow food in it.

    Reply

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