Summary: Nothing has happened, yet something has happened. A financial shock is an elusive event, largely psychological in its immediate effects. We can fight through this by staying cool and rational, and working together. As America has in past times of crisis.
Look around after the events of last week. America’s industrial plant remains undamaged. It’s great natural resources remain. America’s greatest resource, its skilled and hardworking people, remain in place.
Yet something has happened. It is a financial event, the real-world effects of which we will see in the coming weeks and months. Continuing to use the medical analogy of previous posts, the economy has suffered shock. More specifically, this is like circulatory shock, which Wikipedia defines as follows:
{Shock} is a serious, life-threatening medical condition where insufficient blood flow reaches the body tissues. As the blood carries oxygen and nutrients around the body, reduced flow hinders the delivery of these components to the tissues, and can stop the tissues from functioning properly.
We can carry the analogy one step farther. This is like Cardiogenic shock, caused by the failure of the heart to pump effectively. The US economy went into cardiac arrest early last week, as the flow of money (the blood” of the economy) slowed due to a near-collapse of the financial system (its “heart”, but not its soul). If not restarted, the economy will slide into a depression (GDP decline of 10% or more) in a few weeks (perhaps months).
The impact is great, but only slowly becoming visible to the general public from articles like these:
- “Grain piles up in ports“, Financial Post, 8 October 2008 — “international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.”
- “Capital One Ends Financing of NY, NJ Car Dealers“, Bloomberg, 10 October 2008 — “”Banks are seeing the bottom fall out of the dealership business and they don’t want to be caught sitting there owning a bunch of Chevys, instead of getting cash.”
The meeting in Washington this weekend of world finance ministers may be the last opportunity to stop this slide. But even if successful, this brief interruption will have severe effects. The most significant will be a collapse of business spending and investment. Businesses want cash, and are fearful of making investments in plant, land, or people. This will rapidly slow the economy, no matter what measures the government takes during the next few months.
To some as yet unknown extent, people (“households” in econo-speak) will slow their spending and boost savings, also slowing the economy.
The result is Keynes’ paradox of thrift, an immediate response to an economic shock. From Wikipedia:
The paradox states that if everyone saves more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population. One can argue that if everyone saves, then there is a decrease in consumption which leads to a fall in aggregate demand and thus leads to a fall in economic growth.
Like most economic dynamics, there is negative feedback from this. Over time, as the shock passes (more from the Wikipedia entry):
First, {as} demand slackens and prices fall, the resulting lower price will stimulate demand, which tends to limit the decline in demand. Second, and perhaps more important, “savings” represent loanable funds; an increase in the supply of loanable funds tends to lower interest rates and stimulate borrowing, so a decline in consumable goods with a short time horizon is offset by an increase in production in sectors with longer time horizons. For example, the demand for personal electronics might decline, but the demand for such things as real estate would be stimulated by favorable borrowing conditions.
This is good, but not necessarily fun. Just one example, for now. Investment in the energy sector will likely crash in reaction to the crash of oil and natural gas prices. Drilling high cost prospects (e.g., deepsea, arctic, coal-bed natural gas) is irresponsible if not irrational when one can buy reserves on Wall Street at less risk for lower prices. That not only will mean that we will be far less prepared for peak oil (whenever that occurs), but might mean much higher prices in the future (2010 – 2012). Think of this as putting an air bubble in the pipeline carrying the worlds energy supply.
Multiply this a hundredfold to see the disruptive effect of this on the global economy.
Focus on the solutions as an antidote to panic
For a summary see A solution to our financial crisis. An economic downturn has 3 stages, each with a different goal.
- First Aid — Stabilize the financial system to avoid a depression.
- Treatment — apply fiscal and monetary stimuli to mitigate suffering during the recession and get a global recovery in 2010.
- Recovery — restructuring and reforms to prepare for the expansion after 2010, and the new world beyond that.
A global recession like this requires global coordination, otherwise national policies might conflict and offset their effects. This weekend’s meeting is a first step in this long process. At some point we might be forced into the “The Master Settlement of 2009″.
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:
- 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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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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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
- 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
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Prof Roubini prescribes first aid for America’s economy, 4 October 2008
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Dr. Bush, stabilize the economy – stat!, 7 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.
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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
If letters of credit are no longer obtainable is the credit crisis even possible to contain by the central banks anymore? No central bank has the manpower and infrastructure/organization to take over ordinary everyday banking activities of that kind. This is starting to look like large scale nationalization will be needed or at least the threat of nationalization.
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Fabius Maximus replies: The key point is the interbank market. Governments’ giving a guarantee on their banks’ transaction will set this machinery in motion. It’s a step of previously unimaginable magnitude. Like sending bolts of electricity into someone’s heart, it seems weird at first.
Is this the first step to de facto nationalization, or just very intense regulation? Either way, it is the end of an era. Those expecting this to be a temporary event are, IMO, mistaken. There is no going back to the old world after events of this magnitude.
Your analysis of financial crisis stages is completely wrong, and does not reflect history or reality. The “facts on the ground” you cite as coming AFTER the financial crisis, actually come BEFORE the financial crisis and are magnified AFTER the financial crisis.
This is what comes from not paying attention to the FACTS. The desperate attempt to funnel money to consumers reached the tipping point in June-July 2006. It is after that time that you begin to see the demographics, the on the ground facts, start to deteriorate. THEN, as less business is done, the financial structure built on the assumption of on the ground business, starts to collapse. The financial structure does not “inflict” a collapse on the real economy.
What happened was that governments ceased to support the population and began withdrawing from it.
So your prescription of “top down” in order to preserve facts on the ground, will not work. Indeed, it meets resistance from the top itself. This is why there will NOT be bank recapitalization. The financial structure rests on profit. Recapitalization of banks will tell markets that the real economy will no longer generate profits.
Capital will flee at such a program, which is why the G7 did not do it. They simply do not have a political mandate to change the power structure.
Actually, you will know that the political regime has changed–from the “scrutiny” regime of West Coast Hotel v. Parrish (1937), which is the policy behind each and every economic decision made today–to the new “maintenance” regime which I describe in my book The Eminent Domain Revolt, where you get a ban on housing evictions.
Roubini–a technocrat who is starting to make wrong predictions because he has stopped being an economist and become a social policy maker–is now advocating what he refused to advocate for two years, even though I told him to advocate it: he is calling for an end to “all” home mortgage foreclosures.
I am very demanding, and that is not good enough, by a long shot. We must have a ban on ALL housing evictions. It must be
1. individually enforceable
2. permanent
3. complete
4. absolute
In terms of the now-defunct “scrutiny” regime, this means that housing must go from Lindsey v. Normet style “minimum” scrutiny, to “strict” scrutiny.
You obviously know nothing about the legal structure which keeps this whole economic system in place. Very well. Cure your ridiculous ignorance. Ask a lawyer to explain the kinds of changes which flow from raising the level of “scrutiny” for housing. You are completely out of your depth and sound–and are–utterly ridiculous. Grow up.
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Fabius Maximus replies: Perhaps so. But mine is a conventional analysis. My view of the causes echos those of a large number of major institutions; see here for links. My recommendations are conventional, as shown by the reports cited in the section “For more information from economists” of my October 10 post Status report on the financial crisis: we’re at a critical point in time” (articles by 15 eminent economists).
I might be “completely wrong”, even “ridiculous”, but many of the world’s financial leaders seem to share my views, since most of my recommendations are being implemented.
* The Fed has already implemented by suggestion to buy commerical paper directly from corporations.
* This weekend’s meeting of Finance Ministers is likely to recommend some form of broad guarantee of the banking system.
* In November, after the election, Congress is expected to quickly pass spending bills to simulate the economy (see theres articles:
“Pelosi says $150B economic stimulus plan needed“, AP, 8 October 2008
“Time to grasp the fiscal nettle“, Barry Eichengreen, op-ed in The Guardian, 9 October 2009
“Lawmakers Weigh Plan for Stimulus“, New York Times, 10 October 2008
While ahead of the consensus when written, my analysis and recommendations are now mostly mainstream — with two exceptions:
(1) My belief (guess) that the conventional economic measures will have relatively little effect.
(2) My forecast of a conference to reschedule the US government’s foreign debt. It is early days for that drastic step.
While your self-esteem is impressive, your rather rude and broad criticism seems a minority view. That does not make your analysis incorrect; it does suggest that a bit less invective and bombastic assertions — and a bit more evidence — would make your case more convincing.
John R, it seems pretty clear that the facts about house building and house vacancy increases are key issues and that houses not selling at the peak house prices was if not THE trigger than at least A trigger for bust.
And now society has many houses bought by ‘low income speculators’ who were betting, with money they don’t have, that house prices would keep going up.
A ban on all evictions, including those who lied? Including congressfolk who have multiple houses and have stopped payments?
That’s a ‘cure attempt’ far worse than the current disease.
(I think FM can defend himself from your other insults — but I’d guess you’d insult me, too, similarly or worse, so it’s time to quote you, but ask you to look in the mirror and repeat your own words: grow up. )
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Fabius Maximus replies: Tom know this, but for the benefit of those new to this site — the FM site’s policy requires comments to be civil. Personal insults are not allowed. I am easy-going about those directed at me, but those directed at others will be edited out. Repeat offenders will have future comments moderated.
I think that we are in something of a shock. People are pulling cash out of stocks, commodities, and seem to be sitting on cash. An article in today’s Observer even suggested that this is the case, that sales at steel safe companies have gone up dramatically…people certainly are not going to put it in the banks.
I am quite sure that the situation is bad, and though I hated it, I am also sure that some action was necessary. I think that the situation has been made worse though by the dramatic manner in which this has all been foisted upon us. People reacted strongly, with for example, a 5 billion dollar run in one day on Wachovia deposits. The mood is bad. My own mood is bad. Its made worse by watching one’s investment portfolio evaporate. We could really use some good news, or at least, an extended period of no bad news, so like turtles with our heads in our shells, we can poke them out and start focusing on being productive.
I am not sure I agree with this business of ending all home mortgage foreclosures…or at least, if we do this clearly brilliant thing, do I get to know in advance so I can stop paying on my mortgage and let my house go into foreclosure too? Or would that matter? I have always wanted a free house. In fact, I think everyone except for say, lawyers, should be eligible for this no foreclosure program. In fact, this makes a lot of sense. Lawyers are dramatically overpaid, and are generally societal parasites. Afterall, most of our legilsators are lawyers. So, this all fits together nicely. They would pay higher taxes to subsidize our free houses. And we of course would continue to use their services, because they make the laws, and are the only ones who can navigate through self created seas of bullshit.
But then, if there are no longer any foreclosures, there must therefore be no more mortgages. Because what bank would take a mortgage if they could not recover their collateral…Uhhh, I am not sure I get it. But I am just a lowly engineer.
Bush, the lousy communicator (in a media trying to make him look bad), is clearly failing now. I’ve been a huge Bush supporter since 2003, but the world needs a US president to calm the panic. It’s the panic, more than the fire, which kills folks in theaters, or rock concerts.
Letting grain pile up because sellers don’t trust buyer’s banks. Some banks are going to die. The economy needs to end the fear of your new debtor bank dying. Gov’t guarantees is one way to help.
Gov’t replacing the bank is a better way — because then the banks not making new loans can more easily be closed/ with less cost. They’re not making loans anyway. What the economy needs from banks is trusted loans. Let the gov’t make those loans, let more banks die sooner.
Here’s Tough Love v. Moral Hazard:
“Policy makers should stand down for now and make the case that the series of rescue measures already introduced simply need time to work, Mr. Paulsen said. “They’ve been looking like chickens with their heads cut off. It makes you wonder who’s even running this country. Is it policy leaders or the Dow Jones industrial average?”
We have certainly entered terra incognita here. Analogies by other people to the Great Depression do not hold, since this crisis involves an entirely different etiology. We have never seen anything quite like this before. Roger Ehrenberg and Nouriel Roubini contend that the fundamental problem involves lack of transparency in the outstanding derivates. Because they’re unregulated, not only is it unknown how much those derviatives are actually worth, no one (AFAICT) has any idea of the total magnitude of the derivative instruments currently outstanding.
The range of estimates in current derivatives is remarkably wide. I have heard estimates as low as 450 trillion, and as high as 1,300 trillion. No one seems to know. There appears to be no central clearing house for amassing all the information about the types and values of all currently outstanding derivatives. This isn’t surprising, inasmuch as the derivatives market is currently unregulated.
Roubini and Ehrenberg propose a full opening of the books of all institutions with derivatives on their balance sheets, followed by a triage to shut down insolvent institutions and strengthen those that aren’t underwater. An unswered question remains: what is all financial institutions are technically insolvent? If the outstanding value of derivatives is large enough, this could happen.
Theoretically, restarting the credit markets is not nearly as hard as reviving consumer demand during the Great Depression. Nationalizing the banks and ordering them to resume interbank loans at a reasonable rate, say, 20 basis points over prime, would do it. Temporary holds on forelosures and defaults followed by restructurings seem as though they’d work.
Clearly a lot of the features of our current economic system are unsustainable. Banks could not ever have hoped to continue charging 30% on credit cards in a 3% inflation environment — that’s usury, plain and simple, and it destroys the consumer. That’s unsustainable. Ditto the balloon payments on ARMs, the practice of leasing cars rather than buying them, or our current balance of payments deficit with China… None of that ever made any sense in the long term. It was always unsustainable.
People who talk about “free houses” don’t appear to have a grasp on what’s being proposed. A temporary halt to foreclosures followed by negotiation of the loans is what’s proposed, in my understanding. In some cases people won’t be able to pay even a drastically renegotiated loan, so in that case, those houses will have to be foreclosed. However what’s at issue here is that houses were absurdly overvalued and in order to get into the housing market, many people had to buy at existing prices or continue to rent. If a house is worth $200,000 but gets overvalued to (say) $500,000, a mortgage is then issued on it, and the house drops back down to $200,000, it seems obviously unreasonable to foreclose and then leave the house empty to rot because the buyer can’t pay for the $500,000 mortgage especially if the house value has dropped back to something reasonable now. What ought to happen is that the foreclosure should be halted and the value of the house reset to what it actually is, and the mortgage renegotiated at that value. This has nothing to do with “giving away free houses.” That’s absurd. People who talk about that nonsense aren’t paying attention. A great many real estate appraisers lied, a great many loan officers lied, and a great many homebuyers got stuck in the middle.
The alternative is to throw millions of people out on the street and leave the houses empty to rot and get used by transients, drug addicts, and homeless people who will trash the houses. What good does that do? How does that help the economy? If people can pay a renegotiated mortgage on an overvalued house whose selling price has now dropped back to the ballpark of something rational, why is that a bad idea?
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Fabius Maximus replies: In a crisis the natural tendency is to look for the simple cause, with a magic bullet to fix it. Such explanations abounded during the Great Depression, which somehow lasted — despite the fast, sure analysis — until the WWII mobilization ended it.
IMO imbalances grew during the post-WWII era, largely due to the rise in debt (esp. but not only in America). This was noticed, warnings were repeated so often we came to ignore them. Warnings disregard because they came early enough to allow easy corrective action. See “We have been warned. Death of the post-WWII geopolitical regime” for a tiny fraction (just 25) warnings from A-team experts.
The debt will go away through one of these four mechanisms. Some paths to this end are easy, some difficult. Some prepare America for a good future, some don’t. The decisions we make now will echo through the lives of our descendents.
It is vital that we see the full scope of the problem. Mortgages, CDO’s, derivatives — all just manifestations of the underlying structural problem. Even more important to understand, we got here due to limitiations in the Keynesian theory by which we steer our economy. Failure to correct that will likely land us on the rocks again in the future.
Fabius Maximus,
I appreciate having a website that allows me to read about the current events in a way mostly undiluted by bias/prejudice (a complete unbias may not be possible, it’s hard to battle our own ego’s, or to face up to cognitive dissonance completely). I love the clear, honest, open-minded and logical thinking you are capable of.
I do not have an economic background, but I am, in my own way, trying to understand our situation.
Recently, I was graphing the down jones index over time, as well as various stocks and noticing that there are some strange patterns. I don’t have a background in statistics, but even inflation-adjusted (and realize, I’ve had trouble finding accurate information as CPI calculation has changed or varied over time). It seems to me that something is *odd* about the graph. I’ve looked at housing graphs from Shiller as well, and it’s clear that something is strange there as well.
As a layperson, I feel that the concept of “inflation” is very strange to me. *Why* do we have inflation? Why is there an assumption that every year prices go up – a loaf of bread today is more then a loaf of bread a hundred years ago? Why are there so many more dollars now then in the past, and especially in the last 20 years? During the roman empire, inflation (the debasing of coins) was one of the theoretical causes of it’s downfall. Have we just debased the dollar slowly for 100 years? And compared to the difference in house prices in 1700 and 1800, there was relatively little change, compared to 1900 to 2000 or even 1950 to 2000. Are houses really worth more intrinsically then houses built then (because, they seem more flimsy even if we have better insulation or heating systems). It seems to me that $1 us dollar is worth very little in actual value compared to 100 years ago. Was this necessary and why have the printing presses been turned up recently (so we *feel* wealthier?). Is this how all fiat currencies die?
And if not the dollar, or another currency, what? Some abritary object that we agree to give value to (cowrie shells, gold, etc..) or just reverting to bartering? Would inflation be necessary with those, or would their limitations (real objects can’t be increased exponentially, they are limited) cause inflation to stop?
Did we have less inflation in the past because hard assets (a limited quantity, though growing every year) backed paper money and therefore limited it?
It seems mindboggling that a risky bet like derivatives would have no limitations in growth, that unwinded it (this imaginary mess of contracts) could encompass an entire GDP of a country.
It seems to me that the fiat money system has failed. Is this a naive view? I’m not a goldbug, just an average american trying to understand the complex world of finance, economics.
Response to #6.
Your points are certainly valid, but as far as letting these people stay in their homes I disagree for personal reasons. I rent. My credit sucks. I live paycheck to paycheck and have no savings. I have no business owning a home. I could never afford anything beyond a minor repair that I could do myself. Yet, I could have easily qualified for a loan. These people who speculated (I live in Seattle), jacked up property values so much that it made my rent double, which doubtlessly has led to my poor finacial situation. Why should I care? They, and the banks who gave them the loans on over-valued property, certainly did me no favors. I get nothing but stick with the bill.
(For those familiar with Seattle who dispute that properties are over-valued. I have this to say: My former neighbors in the Central District paid $500K for a house where one may occasionally have the “pleasure” of witnessing a shooting. (It also wasn’t a great house either regardless of location.) How can that be worth half a million?)
Seems like the UK is handling this in a more aggressive and maybe constructive way?
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Fabius Maximus replies: Agreed. For details see the links to several UK news articles in “Damage Reports from home and abroad“
I agree entirely with FM that there is no simple “magic bullet” to fix the global (or U.S.) economy. Didn’t mean to suggest there was. FM also seems exactly right about the 4 mechanisms for getting rid of the debt that has built up; all 4 are likely to come into play in varying degrees in different sectors of the economy over the next decade or so. (It is however certain that we will not simply use the Andrew Mellon solution for the entire economy. That’s politically unacceptable, as FM has pointed out. But individual sectors of the economy will probably liquidate, viz., parts of the derivative market) Restarting the interbank short-term credit market seems doable, but does not represent any kind of cure for our problems. It’s the equivalent of restarting a critically injured patient’s heart. Necessary but not sufficient for a recovery. The patient can still die after hi/r heart gets restarted. Many further measures are needed.
People don’t seem clear on why it’s crucial to halt foreclosures and move to renegotiated revalued mortgages. As George Soros has pointed out, foreclosure depresses property values, and depressed property values create more foreclosures. This becomes a vicious cycle which pushes home prices below their fair value — moreover, it has no obvious natural endpoint. If foreclosures continue long enough, all property prices become unnaturally depressed. This leaks over into commercial real estate, strip malls, etc., sparking further waves of foreclosure, which in turn further depress the overall economy In fact, commercial real estate represents a much bigger bubble today than individual houses.
Foreclosed houses wind up trashed, used as shooting galleries for addicts or flop houses by the homeless. Banks that have to foreclose don’t have money to hire security guards to patrol ’em, and police certainly don’t have time to guard foreclosed houses 24/7 in a depressed economy. With no obvious end to the vicious cycle, foreclosures have the capacity to send property values into an endless downward spiral. Some defaults are obviously necessary. Unending waves of self-reinforcing foreclosure, however, endangers the entire economy for no good reason. Nothing virtuous is gained by unending waves of foreclosure.
I’m familiar with Seattle and live a few hundred miles away. The housing market is Seattle is wildly overvalued even today. However, the entire Pacific Northwest real estate including small towns like mine is bizarrely overvalued, and the California real estate market is even more wildly overvalued. These inflated home values must drop — and will. The question is: how? People proposing foreclosure as the solution are proposing Andrew Mellon’s “lliquidition,” which is unustainable because prices don’t jsut return to reasonable values, they become unnaturally depressed with no natural bottom, spiralling ever downward without end, as the Great Depression showed. Speculators shouldn’t be rewarded if they can’t afford to pay renegotiated revalued mortgages. However, unending waves of self-reinforcing foreclosures threaten all homeowners — and also threaten the tax base of the community. As the number of homeowners spirals ever downward due to accelerating foreclosures, communities find themselves forced to raise property taxes to make up for lost revenue. This increasing the number of foreclosures, further depressing property values. At every level it’s a vicious cycle, and one we need to break.
I see then, the no foreclosures idea is simply temporary, until someone, I guess the government, decides that the danger time period is up. That would be the federal government I assume? Would this be all over the USA or just in some markets? Would all income levels be elegible? Would it just apply to one owner occupied house per owner, or are second homes and investments also in play? I would assume so, because George Soros theory does not seem to differentiate between owner occupied houses and investment properties.
When the time period is up, will there simply be no more quarter given, and back to that terrible business of where there are penalties for failing to pay a debt? Where creditors who make bad loans get to take losses? What happens after the bailout, after we have proven that we will not let people suffer the consequences of their own actions? Also, is the government going to stop mandating loans to people who cannot afford them, and buying mortgages from banks who lend to them, or are we doomed to doing this all over again?
Unfortunately my grasp on what is being done and is proposed is that I see this as the beginning of the end of the private financial sector, because the time value of money is predicated on the willingness of someone to repay a debt with interest, and the willingness of someone to lend that money for profit. Now, if we default, or take risks, we can count on our neighbor who is frugal, to bail us out, and create more government on top of it. What has happened here is grotesque. People who have been smart and responsible, are forced to pay for people who have been greedy and/or stupid.
Since starting to read this site only a few months ago, I now fully agree with FM that ‘there is no going back’.
For annette on inflation — it is essentially ‘more money’, like monopoly or counterfeit money, chasing the same quantity of goods. There’s a famous Econ 102 (?) macro equation about prices of goods P, quantity of goods Q, amount of money M, and a very strange thing called velocity of money V: PQ = MV
A key reason all democracies have inflation is that the effect, in practice, of increasing money M is that there are more goods Q produced, and more jobs and more GDP (or GNP) growth and more real wealth, even though prices also increase. More than in those countries with 0% inflation, so current central banks usually have a 2-3% target.
I bring this up here now because derivatives are unregulated ways for bankers to increase the V velocity, which is what they’ve been doing. And now, with trading in MBS and CDS so much less, the PQ side is poised to drop, which is what gov’t action must now be oriented at preventing.
A partial solution is to have the 8 (?) Federal Reserve Banks around the country to immediately begin loaning cash to small businesses that have asked at least 3 banks for loans and have been turned down, despite having had at least 3 prior loans that they’ve paid back, without having unpaid prior loans (except for the current loan they may now be trying to roll over). {FM note: I proposed something similar, but faster, on October 3rd here}
Mr. K, you refer to Moral Hazard, when bankers or other lenders who make bad loans don’t suffer if the folk getting the cash don’t pay it back. It’s a terrible problem and sure to get worse, despite the gov’t allowing Lehman Brothers to go broke.
mclaren notes half the right basic issues: “the inflated home prices must drop — and will. (But) How?” The other, more important half, is: To What Level? Given that houses are overvalued now, what is the right level? Nobody knows.
I suggest the gov’t should set a floor of 50% of the last mortgage as a reasonable starting level.
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Fabius Maximus replies: Note that from a monetarist’s perspective, massive monetary explansion (like now) during a debt deflation does not produce inflation because velocity (V) crashs to extraordinary low levels — as everyone seeks to get and hold cash.
Mr. K asked various questions about the temporary halt on foreclosures. This has been discussed by Nouriel Roubini, George Soros, et al., so you should read those folks for more details. As Roubini points out, the model on which this idea is based is the HOLC formed during the Great Depression (the Home Owner Loan Corporation). Not as well known as the RFC, but arguably as important.
Most people who bought houses for investment purposes will have no prospect of getting any revenue from their investment properties, and will therefore probably not be interested in (or capable of) paying for an additional mortgage on top of the home they already own, so issues about investors or condo-flippers getting an undeserved bailout solve themselves.
All of this may be moot. Time appears to be running out for resolving this crisis. The world financial system may have already cracked up and may now be in the process of falling apart completely. If that happens, we’re in unknown territory.
Fareed Zakaria has an upbeat take on the global financial situation. Let’s hope he’s right. However, since Zakaria was one of the strongest initial boosters of the invasion of Iraq in 2003, his track record for prediction remains dismal.
It seems to me that “The bailout package” treats hypovolemic shock when it should be treating cardiogenic stock.When that is done to a human,he (she) ends up in congestive heart failure. Muscle fibers and neurons are not perfused and the production of goods and services is decreasing.