Weekend Reading … about the financial crisis

This was a big week for news and analysis about our financial crisis.  Here are some you may have missed.

  1. Stricter regulation of business sought, Americans say“, LA Times, 15 October 2008 — A survey finds that nearly 70% of Americans in each of a wide range of demographic categories say the lack of controls is responsible for the nation’s economic problems.
  2. Ship Rates Plunge as Credit Freeze Strands Cargo, Demand Slumps“, Bloomberg, 15 October 2008 — A possible “air bubble” in the global trade bloodstream.
  3. From Plan A to Plan G“, Brad Delong (Professor of Economics at Berkeley), Guardian, 16 October 2008 — “The US has tried to stave off depression in half a dozen ways. Will partially nationalising America’s banks do the trick?”
  4. Let’s Get Fiscal”, Paul Krugman, op-edin the NY Times, 17 October 2009 — It’s time for the government to spend lots and lots of money.
  5. We had to burn the village to save it“, posted at the blog London Banker, 17 October 2008 — “There is no free market when the government owns the actors and sets the terms of transactions. There is no village once it has been burned to the ground.”
  6. Amid Pressing Problems, Threat of Deflation Looms“, Wall Street Journal, 28 October 2008 — Suscription only; here is a open copy.

Quote of the day:  About taxes, by economist David Rosenberg:

Any politician that tells you we can afford to maintain taxation rates let alone cut them is, well, dreaming in technicolor. The taxpayer is obviously going to foot the bill to pay for the massive cost of saving the financial system, and it will most likely be, in this populist age, the high-income worker that is going to get dinged. Just remember, the top marginal personal tax rate went from 24% in 1929 to 79% by 1936.  Who else do you think paid for that FDR New Deal?

{FM note:  in 1932 President Hoover increased the maximus rate from 25% to 63%; In 1936 FDR increased it to 79%, and in 1941 to 81%}

Excerpts

1.  Stricter regulation of business sought, Americans say“, LA Times, 15 October 2008 — A survey finds that nearly 70% of Americans in each of a wide range of demographic categories say the lack of controls is responsible for the nation’s economic problems.

A new Los Angeles Times/Bloomberg national poll shows Bagley is far from alone. The survey found that nearly three-quarters of respondents thought the lack of regulation was partly responsible for the current financial and housing crises. The need for stronger regulation of financial markets was cited most as the top issue for the presidential candidates to address in the remaining weeks of the campaign.  And nearly half of those surveyed now think there is too little regulation of business.

… This was not always the case. L.A. Times polls conducted in 1991 and 1981 — both times of economic unease — found that only 29% and 18%, respectively, thought there was too little regulation of business and industry.

… Asked if the government should provide assistance to homeowners facing foreclosure, 61% said they were in favor and 27% opposed such a measure.

2. Ship Rates Plunge as Credit Freeze Strands Cargo, Demand Slumps“, Bloomberg, 15 October 2008 — Excerpt:

Commodity shipping rates plunged to the lowest in more than five years as a lack of trade finance left cargoes stranded and the global economic slowdown limited raw material demand.

Traders are finding it harder to get letters of credit that guarantee payments for goods, shipping executives said. Together with a slowdown in trade, that has contributed to this year’s 82 percent drop in shipping costs for grain, coal and other commodities. Rates are so low that Zodiac Maritime Agencies Ltd., the line managed by Israel’s billionaire Ofer family, announced today it may idle 20 of its largest ships.

“Letters of credit and the credit lines for trade currently are frozen,” Khalid Hashim, managing director of Precious Shipping Pcl, Thailand’s second-largest shipping company, said in Singapore yesterday.  “Nothing is moving because the trader doesn’t want to take the risk of putting cargo on the boat and finding that nobody can pay.”

The Baltic Dry Index fell 11% today to 1,615, the lowest since February 2003. Rates for larger ships of the type Zodiac intends to idle fell 17% today, taking this year’s plunge to 85%, according to the London-based Baltic Exchange.

3. From Plan A to Plan G“, Brad Delong (Professor of Economics at Berkeley), Guardian, 16 October 2008 — Excerpt:

The Bush administration, having entered office as social conservatives, leaves office as conservative socialists, proprietors of the most sudden large expansion of the state’s role in the US economy since mobilisation for the second world war. Why did they decide to partially and quasi-nationalise America’s banks – to invest $250bn in preferred stock plus warrants and tell the banks that it wanted them to use the capital to expand their loan base rather than contract it via deleveraging? It is certainly not what Henry Paulson signed up as Treasury secretary to do.

… Now we get to see whether Plan F will work, and whether this recapitalisation of the global banking system with public money will stop the slide of the world economy, and keep us in mild recession rather than severe recession or even depression.

There is every reason to hope that it will. The liquidity-squeeze theory, the expected-deflation theory and the Bernanke banking-collapse theory were the only live theories of the Great Depression. The first two no longer seem viable. (The past year has been a big intellectual victory for Bernanke-as-academic.) So if we can counteract the chain of causation of the third – the only one left standing – we should be in no danger of even a not-so-great depression. But the theory that recapitalising the banking system will cure what ails the global economy is, at the moment, only a theory. It could be wrong.

If Plan F fails, we move to Plan G: we pull the Keynesian fire alarm and begin an enormous government infrastructure building programme in the whole North Atlantic to keep away depression.

But as of now there is every reason to hope that it will work – that this time, for sure, what our magicians pull out of the hat will be the desired rabbit.

4. Let’s Get Fiscal”, Paul Krugman, op-ed in the NY Times, 17 October 2009 — Excerpt:

All signs point to an economic slump that will be nasty, brutish – and long. … And how long? It could be very long indeed.

… In other words, there’s not much Ben Bernanke can do for the economy. He can and should cut interest rates even more – but nobody expects this to do more than provide a slight economic boost.

On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case.

… {the next President} will face a chorus of inside-the-Beltway types telling him that he has to be responsible, that the big deficits the government will run next year if it does the right thing are unacceptable. He should ignore that chorus. The responsible thing, right now, is to give the economy the help it needs. Now is not the time to worry about the deficit.

5. We had to burn the village to save it“, posted at the blog London Banker, 17 October 2008 — Excerpt:

There is no free market when the government owns the actors and sets the terms of transactions. There is no village once it has been burned to the ground.

The collapse of the financial sector is unacceptable. It is unacceptable to bankers who have vested careers, status and equity wealth in the disproportionate expansion of the financial sector. It is unacceptable to politicians who have risen to high office doing the bidding of the financial sector in ceding progressively more generous taxpayer subsidy and regulatory forbearance to its chieftains.

And so in the US, UK and EU we have politicians appropriating more petrol to hand to the arsonists who started the conflagration which is consuming our economic and political fabric. The regulators whose forbearance is a root cause of the current conflagration are handing the arsonists fresh zippo lighters. The policies adopted in these debtor nations will fail, must fail, because they destroy what remained of market economies.

In the meanwhile, however, the bankers and the politicians and the regulators cannot conceive of failure and so insist on more of the same – ordering hundreds of billions in more incendiaries to fuel the blaze. The same tax breaks. The same housing subsidies. The same regulatory forbearance. The same ill-transparent, off balance sheet, accounting sleight of hand. The same eradication of market incentives to productive, disciplined saving, investment and labour.

Those who would prudently save will be punished with negative real interest rates and asset deflation. Those who would prudently invest in productive industry will be starved of scarce capital and forced into liquidation. Those who would prudently labour for a decent wage will be slowly robbed by inflation and kept docile by the threat of unemployment.

6. Amid Pressing Problems, Threat of Deflation Looms“, Wall Street Journal, 28 October 2008 — Suscription only; here is a open copy.  Excerpt:

Policy makers navigating the U.S. through the global credit crisis may have a new concern on the horizon for 2009: deflation.  The risk of deflation — generally falling prices across the economy, beyond volatile energy and food costs — remains slim. But the financial shock and a faltering economy can set the stage for a deflationary environment.

Federal Reserve officials view broad-based deflation as unlikely but possible. Federal Reserve Bank of San Francisco President Janet Yellen said in a speech this week that the plunge in oil prices along with slackening demand for labor and goods should “push inflation down to, and possibly even below, rates that I consider consistent with price stability.”

Afterword

If you are new to this site, please glance at the archives below.  You may find answers to your questions in these.

Please share your comments by posting below.  Please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

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:

Key posts about the financial crisis

  1. A solution to our financial crisis, 25 September 2008
  2. A picture of the post-WWII debt supercycle, 26 September 2008
  3. America has changed. Why do so many foreigners see this, but so few Americans?, 1 October 2008
  4. A sitrep on the financial crisis: why has the treatment been so slow, so small?, 8 October 2008
  5. The new President will need new solutions for the economic crisis, 9 October 2008
  6. Forecasting the results of this financial crisis – part I, about politics, 13 October 2008
  7. Forecasting the results of this financial crisis – part II, a new economy for America, 14 October 2008

9 thoughts on “Weekend Reading … about the financial crisis

  1. Deflation is the one thing that I wouldn’t worry about: Bernanke’s Helicopter is all about the ability to prevent deflation (at the potential cost of high inflation later).

    That is, in fact, the whole POINT of his helicopter speech: He believes that deflation was one of the great amplifiers of the great depression and since he controls the printing press, he can always “drop bags of money out a helecopter” to fight deflationary effects.
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    Fabius Maximus replies: Monday’s post will discuss this in some detail. Unfortunately, as usual, it is not that simple. Japan’s experience proves that.

  2. While I prefer the faster re-structuring of Sweden over Japan (thanks for prior links, perhaps you’d like to link to your posts on those experiences more often. I consider them the best guides for ‘best practices’ yet known), even 10-year stagnation in Japan did avoid a depression.

    My son came in and asked about the joke: answer #5 more music/pictures — ha ha, I come here to avoid that junk.

    But more posts with a ‘key chart’ might help. (Not Brad DeLong’s interesting S chart; too different and complex from other analysis, even if true, of which I’m not convinced.)

    #1 more folks want more regulation — McCain, like Bush, has been lousy at defending the “Market”; Obama’s success at blaming the Free Market, instead of lousy, political based Gov’t. Supported Enterprises, has been very depressing. (Didn’t read)

    #2 is really important — the IMF / Fed should be offering direct letters of credit, at a higher than prior cost, to shippers who’ve been successful in the past. Bypass the clogged up banks.

    #3 Brad’s A-G plans is perhaps the best summary I’ve seen of the recent past, what decisions were taken, policies tried, and the theory behind them. On recession he states: But the economy fell toward (if not into) recession, and interest rates had already … lost … vigour.
    (So Brad isn’t willing to fight the ‘in recession’ or not definition battle, which is the position I’ve had for awhile). Only at plan G does he call for fiscal expansion, as compared to his adoration object…

    #4 Nobel prize winning big Bush critic (reason he won?) Krugman. Whom I now agree with that fiscal stimulus is needed — but he’s faster to criticize McCain than to state we should be building nuke power plants, and wind power, and solar power, and do more drilling. He’s also right that mortgages should not be bought at full price — although he fails to state what percentage. (For me, 50%, or the ratio on recent foreclosure auctions in that area. No foreclosures, no gov’t purchases).

    #6 was merely another anti-deflation screed, with unconvincing details about the Fed’s new tools to avoid deflation.

    #5 Was a cool, implicit don’t give more gas to the Big Brain Financial arsonists who burned down the prior system.

    Missing is the idea that up to half of the whole ‘financial industry’ is excess waste — perhaps a lot like the newspaper industry. The real economy doesn’t need that many financial services.

  3. First they must both outlaw and also immediately cancel out the quadrillion plus notional uber-derivatives. If America acted unilaterally on this probably within 48 hours the rest of the world would follow. Nothing else can function until this almost invisible but massive elephant is removed from the world economy’s living room. I agree with Grey above that much of what is now being deleveraged is worthless to begin with, but nevertheless has the power to bring down the worthy elements of the economy. I also find it disturbing that this is not regularly highlighted as one of the key drivers of the current problem.

    Yes, we are going into a cyclical recession but what might make it worse than the norm or more prolonged is the extraordinary value we have placed on paper versus actual productivity. That entire culture must change, and change fast. In this context, better regulation is called for. This does not have to devolve into so-called ‘socialism’ but it will require that laissez-faire capitalism is over.

    Meanwhile, if military expenditures are halved, investing in infrastructure and new energy technology would provide more work and local stimuli, but more importantly also refocus the US on building an economy on home ground reality versus imperial, debt-financed hubris.

    Unfortunately, this is not going to happen as the Brezinski crowd are now in charge and they are no less imperialistically maniacal than the lame duck neocons.
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    Fabius Maximus replies: This seems quite hysterical. By the numbers…

    (1) What is an “uber-derivative”?

    (2) Where did you get an estimate of a “quadrillion plus” in notinoal derivatives? The best estimate is by the Bank for International Settlements (BIS), whose 22 May 2008 report estimated the totals as follows:
    * Notional amounts of all categories of OTC contracts rose by 15% to $596 trillion at the end of December
    * Gross market values, which measure the cost of replacing all existing contracts, increased by 30% and reached $15 trillion in total at the end of December 2007.
    * Gross credit exposures, after netting agreements, also rose by 22% to $3.3 trillion.

    An analysis of derivatives written for a general audience is:
    $596 Trillion!“, Jacob Leibenluft, Slate, 15 october 2008 — “How can the derivatives market be worth more than the world’s total financial assets?”

    (3) Derivatives are perhaps #5, perhaps even lower, on the priority list. If normal flows of credit are not restarted soon, the collapse of routine commerce will spark immediate descent into a depression. Fortunately, the global governments are working on this. Ditto large-scale fiscal and monetary stimulus to mitigate the global slowdown (probably global recession) now in progress.

    The derivative problem is not even difficult to solve, although operationally challenging. Regulators can order the banks to increase credit requirements, so as to force “cashing out” the contracts. Simultaneously, the futures exchanges can offer standardized listed contracts, settled through the existing clearinghouses and subject to the usual supervision. Some fraction of existing contracts, esp interest rate swaps, might be converted to listed versions.

    The resulting litigation might last for years, but the governments’ attorneys can probably find authorization for these measures. Much as attorneys for utilties did when voiding natural gas contracts in the late 1980’s (which litigation was fought in the courts for the next decade, as in this example).

    (4) “That entire culture must change, and change fast.”

    I doubt that is either possible or necessary. Nor have you given anything remotely like sufficient cause for such a thing. If our culture does change rapidly, it is 50-50 that the changes will be imprudent, poorly concieved, or undesirable. Perhaps all three.

  4. Raise taxes! Right. The goal of taxes is revenue. Historically speaking higher taxes does not increase revenue: “Taxes and Income“, op-ed in the Wall Street Journal, 17 December 2007 — Excerpt:

    “Keep in mind as well that the IRS only records the income that taxpayers report. Its data don’t include income that the rich hide in tax shelters or otherwise defer. And there is evidence that lower tax rates since 1981 have caused the rich to declare more of what they earn. In 1980, when the top income tax rate was 70%, the richest 1% paid only 19% of all income taxes; now, with a top rate of 35%, they pay more than double that share.”

    Yep, lets raise those taxes to make sure the rich won’t invest and we get to stay in a recession and Democrats will continue to peddle the politics of envy.

    I find it very amusing that these so called experts continue to beat on the same old drum. The current tax structure is a hinderance and prevents us from being competitive in the world market. We must work our way out of this circumstance and that means enhanceing our economic capabilities. That’s something I have not heard from any candidate.

    Of course it’s much more fun to punish those we envy, even though we punish ourselves in the process.
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    Fabius Maximus replies: Income taxes are just one form of taxation in the US, and for most people the least significant. Taxes are going up, right or wrong. And they will be raised to the point where they generate more income.

  5. Tom:

    a) Simply put, the GSEs are small potatoes compared to the bipartison abdication of regulation in this mess, and the problems contributed by the GSEs were largely when they strayed from their regulatory framework. Pretty much every commentator who focuses on the GSEs as being to blame are either inadvertantly or deliberately misleading people.

    b) The reason why Krugman is so against McCain is that, on economic and regulatory issues, McCain really parrots Bush’s lines (eg, what good would a FURTHER capital gains tax cut do? Nada! The current rate is already a giveaway for hedge-fund managers and anyone less than a multi-millionare is not really affected, ESPECIALLY in a down market. What good would buying up mortgages at issued value do? Bail out the idiots who should have never written the loans in the first place!).

    Building energy infrastructure (solar, wind, nuclear) would be excellent stimulus, and is one of the areas where McCain is right (drilling, OTOH, is irrelevant), but 8 years of the current administration has taught us that even when the current administration does something justified (Afghanistan, IMO), the implementation screws up, and there is no evidence that, in this area, McCain would be any different than the current occupants of the executive branch.

    And lets face it, by in large, Krugman has been right far more often than he’s been wrong. He may be a partisan asshole, but far better to be a mostly correct partisan asshole than a mostly incorrect one.

    c) Brad DeLong is describing what HAS happened. He (and most other professional economists, from all parts of the spectum) have been pushing for plan G for a while, although his rationalle for supporting plan F (the backwards-S-curve business) is, to my mind, bullshit: I don’t think there is a “two stable” equilibrium point on bank trust, I think its more just “curve shifts down” when people realize you can’t trust em. Given the abject failure of plan F, it might be possible to convince him that the S-curve cartoon doesn’t reflect reality.

    FxConde: Actually, its also that the massive redistribution to the upper end overall that has the wealthiest paying a higher total share.

    Look at it this way: Warren Buffet pays less (percentage wise) income tax then his secretary does when you include social security & medicare taxes! The tax code, especially with regards to capital gains, already so favors the wealthy and uber-wealthy that nobody in the Forbes 400 has taken Warren Buffet’s bet on the subject.

    And Obama’s tax plan is remarkably mild: Let the bush tax cuts (well, tax shifts, unless you cut spending also, all tax cuts do is raise taxes later when you attempt to pay off the debt, or the silent-tax of inflation to inflate-down the debt) expire (the big one is eliminating the differential treatment of capital gains, and the cut of the estate tax to 0 insead of 33% above 1.5M or so), and a relatively minor (3%) increase on income tax above $250K adjusted gross income (thats AFTER deductions!).

    I WISH I was in a position to pay more taxes under Obama!
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    Fabius Maximus replies: Your last point is IMO very important: the rich (upper several %) pay astonishingly little in taxes, as a fraction of their income and wealth. Income taxes are just part of the bite: social security taxes (aprox 13%, half paid by the employer to hide the bite, but in effect part of wages), medicare tax, sales taxes (5-7% in many urban areas), property taxes, and estate taxes (which the wealthy usually avoid).

    From the Forbes article you cited:

    “Buffett wants to take the argument further. He says he will bet any Forbes 400 member $1 million (proceeds to charity) that the average federal tax rate (income and payroll) paid by The Forbes 400 is less than the average rate of their secretaries and receptionists. ‘So far only three close friends, all 400 members, have made the calculation for me,’ he tells Forbes in an e-mail exchange. ‘They all came up with results similar to mine but have no interest in being identified.'”

  6. Estate tax is about the only one the poor and middle class DON’T pay. Everything else, they get soaked percentage-wise hard.

    At $1.5M before the estate sees any tax ($3M for a couple), you have to be pretty much like my grandparents: Mini-moguls, with a million dollar house and a lot of other assets before you start to even think about the estate tax under the pre Bush rules. And even they, as wealthy as they managed to be, I don’t think their estate was significantly impacted.

    One of the greatest frauds perpetrated on the American public is the idea that the estate tax may affect them, and the notion that its the “death tax”. The debate would have gone the other way if the democrats reframed it as the (actually more accurate) “Paris Hilton tax”.
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    Fabius Maximus replies: Absurd. A business worth $3 million generates aprox $150 thousand of taxable profits (probably generates $3million in sales, $150 thousand at 5%). Not exactly a “mini-modul”. And that’s before the house and other assets acculated over a lifetime of work.

  7. So the rich don’t have the capability to change their income structure to pay less in taxes? The whole point is to get revenue as high and as efficiently as possible. Or is that no longer the goal? We are currently competing for capital in the world market and there are plenty of countries more than willing to take the rich off our hands. Or will we make it illegal to leave? Tax slaves! How fitting.

    What will simply happen is the taxes on rich will go up they will move their incomes to non-US base corporations and other shelters they have access to. We will loose those capital assets for small and medium size companies. Is that the goal? Is the goal to get out of a recession or not? Apparently not.

    I actually know two families who lost business’s because of estate taxes in the middle of economic down turn. They escaped without to big a tax bill but their employee’s were not so lucky. We got those rich folks though.

    There are many reasons the policies of Hoover and FDR did not work and taxes is one of them. I’m sure we will get to experience that lesson again. Of course those who are proposing these higher taxes are rich themselves, and since I’m sure they don’t plan on paying more taxes, the taxes rates will go up but they will leave plenty of outs for themselves and their contributors. But at least the public will feel good about it as they get their unemployment and welfare checks.
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    Fabius Maximus replies: Perhaps you are not clear how business income is taxed, or (for an individual) the consequences of giving up US citizenship in order to pay less taxes. Neither is as simple as you suggest.

  8. There is NO excuse for a small business “going under” due to estate tax. I suspect there is something else at work.

    For a small business, the value ABOVE the estate tax limit can be deferred over a 14 year period, with the interest rate on the first MILLION IN TAX at 2%, with any amount beyond that at .45 of the “late tax payment” interest rate, so a couple percent more (but still very low).

    And thats on the “Mark to market” value of the business, which can be nicely underpriced for tax purposes, under pre-bush rules.

    Lets take an example of a couple with a business worth $5,000,000. Big money. A good tax layer can make it look like $4M. Thus the total estate tax bill however is only $300K (30% or so of the amount ABOVE $3M), and thats payable over 14 years at a whopping 2% interest rate. Or about $13K/year. This is hardly “business killing” for a 5 million dollar business.

    After all, a reasonable business return-on-investment should be at least 5%. So 5% ROI on $5M is $250K/year in PROFIT.

    The estate tax issue is effectively a fraud: It is a significant source of income for the US government, mostly on the backs of monster-estates, and mostly because it is suprisingly HARD to evade.

    And estates are taxed far less then any other transfer of wealth. If someone GAVE you a $4M business without them having died, you’d have to pay over $1M in federal tax, and you couldn’t get a 2% loan to defer your taxes over 14 years!
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    Fabius Maximus replies: Repeal of the estate tax would result in loss of $50 – $90 billion/year of tax revenue (source). The cost of collection (the IRS army of attorneys and accountants plus the private sector costs (unnecessary insurance, trust attorneys, etc) are an absurd fraction of that. I am not sure if that counts as a “significant source of income” for the government. Just a thought — a simplier and much more difficult tax to evade might be worth consideration.

  9. I used the term uber because a) they are not regulated so their exact existence, value or impact is somewhat unknown b) there are CDS’s on other CDS’s etc., i.e. levels upon levels.
    I criticized the author of an article citing the 1.4 quadrillion figure by referencing the same report you did above. However since then I have learned a) that by no means all such instruments are reported to IBS; b) as they mention the 596 trillion is half of the full value since they divide the total by 2; yes, the notional value is not all that meaningful since there is also 1.7 quadrillion in stock transactions handled by the DTCC but that is a function of volume not value. So I am happy to concede the point, whilst also pointing out the the 596 trillion is definitely low and
    c) the gross and net values that are more important are also incorrect since the original risk algorithms were wrong,just as the Black Scholes theory has been proven wrong in reality, so the risk value in gross and net is far higher than they report.

    So the quadrillion figure is both right and wrong.

    I agree it is easy to fix. But it isn’t being fixed precisely because of the cultural underpinnings for their thriving in the first place.

    Although it looks like a bona fide recession is underway, it is also true to say that the derivatives melt-down has had a huge effect on everything, one that is both denied and ignored. You simply can’t have an economy leveraged by one industry or all of its major titans around 30 to 1. The turbulence is way too high when they unravel. It’s a bit like trying to do regular maintenance work on a ship in the middle of a hurricane and pretending that the hurricane has nothing to do with why all the sails are getting shredded and blaming the crew for the weather.

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