The Hundred Year Financial Storm

Please note that Greenspan was also very critical of McCain's economic plan as it would increase debt more than Obama's. I don't think we know what this means until they tell us what all has been agreed to this w/e. I think the Fed is going to make some more guarantees. (Crawl just said AIG wants bridging loans) Please note, no foreign bank or sovereign wealth fund was willing to buy in. Japan is now talking with G-7.

The immediate risk is a severe tightening of credit. The Fed's primary tool is cutting interest rates. Depending on what is left to crash, we may see the dollar fade again with increased inflation AND a recession.

Steve

I have no idea what this means.

It means the Republicans and going to get their heads handed to them in about eight weeks.

It means the Republicans and going to get their heads handed to them in about eight weeks.

It would be kind of interesting if you ever expressed another thought on this blog but some variation of that one. C'mon, surprise us!

I am no economist, but I wonder if 9/15/08 is going to take its place next to 9/11 as a day when this nation faced a massive threat to its continued existence. Unlike 9/11, I am not sure we can recover from this threat.

Lord have mercy

It would be kind of interesting if you ever expressed another thought on this blog but some variation of that one. C'mon, surprise us!

It would be kind of interesting if you would ever acknowledge on this blog that the GOP mantra of "less regulation" and "freer markets" have screwed this country royally the last 8 years. Bush and the GOP led congress inherited a budget surplus, and have turned that surplus into a "once in 100 years" financial calamity.

So please excuse me, and others, for saying, "We told you so."

I'm continually amazed at how good the GOP has gotten at winning elections, and how bad they've gotten at actually governing.

As to your question: It means we're screwed. It means the middle class, who banks everything on rising home equity, is screwed for at least 5 years. It means we might be entering a phase like the 1970's where equity growth is in the sub 2% average for years, or even a decade.

Either way, it's gonna be ugly.

My complaint, Richard, is not that you believe the GOP will lose, but that that's all you ever talk about.

Eddie: It would be kind of interesting if you would ever acknowledge on this blog that the GOP mantra of "less regulation" and "freer markets" have screwed this country royally the last 8 years. Bush and the GOP led congress inherited a budget surplus, and have turned that surplus into a "once in 100 years" financial calamity.

How long have you been reading this blog? Did you read my book? In its pages I call the GOP the "Party of Greed" because of its refusal to remember that human fallenness applies to economics, and that if people throw out rules governing behavior, things will go very badly. (I called the Democrats the "Party of Lust" because they have the same 'more, faster' attitude toward sex that the Repubs have toward money).

Today's news is of course bad news (how could it be otherwise when big, important financial institutions fail), but any talk of another Great Depression is laughable.

The economy broadly - all those millions of people producing things and buying thing - is anemic but by no means dying. The financial sector, which provides capital and liquidity to the broader economy, is completely in the shitter. That's bad, as it makes it temporarily more difficult for entities in the "real" economy to get financing, but it doesn't change the fundamentals.

We may well be in for a longer-than-average recession. Keep in mind though that a 12 month recession is a longer-than-average recession. That's bad, but it doesn;t send 30% of the workforce to the bread lines.

My complaint, Richard, is not that you believe the GOP will lose, but that that's all you ever talk about.

My job is to counter your arguments and as much as possible, do it with citations from sources you have a hard time arguing with. I try to make you see that things you think are true are not exactly so.

You'll notice I make a great effort to let you know it is the policies of the GOP I despise, and very, very rarely a specific person.

The actions taken using the philosophy of the GOP have done great harm to this country and it did not have to be so, especially after the unity following 9/11. I am regularly called the enemy and anti-American, yet it's me, my father, his father before him, my sister, and my brother who have worn the uniforms of this country.

Torture ought to stop and at the very least, it ought not to be done in my name by the guys on my side. Gays shouldn't be demonized, scientific ignorance shouldn't be elevated, and someone besides the lower classes should go fight our wars. Are you saying I go on and on about that?

If so. Guilty as charged.

Everyone take a breath and calm down. The world isn't going to end. Today.

Here's what's going on. For about 35-40 years or so, the characters who have been running the central government have taken it upon themselves to encourage people to own their own homes. They have made laws and established collections of bureaucrats and spent gobs and gobs of money to encourage and subsidize the buying of homes. For a while, it worked as intended. You could even say it worked better than these people anticipated; everyone and their pet chickens wanted to buy a house. In the 70s, we got the Great Inflation of Home Prices because of it. But people generally adapted to the new state of things---albeit not without lots of pain, but that's Human life for you !--- and life went on.

About 10 years ago, the intellectual and ideological descendants of the original Happy Monkeys Of Washington, DC decided to make MORE changes in the rules about who could buy real estate. Instead of having to be able to actually PAY BACK THE LOAN for a house, mortgage companies found themselves in the position of basically heaving money at people who either couldn't pay the loan back ("interest-only" mortgages), wouldn't pay the loan back, or who didn't know enough about money to realize they had to pay the loan back. I've lost track of how many stories I've read over the last 18 months, some on this site, about the people with $40,000 in income taking out a $ 400,000 mortgage and then getting in trouble when they couldn't pay it back after the teaser rate expired.

To make matters even more interesting, some of these changes in the rules made it a lot easier for the original lenders to package and sell these loans to investors who didn't know a thing about the original deals. The original lenders got their fees up front. The borrowers got what they thought were good deals on their loans. The investors got what they thought were good deals on their investments---guaranteed income streams over long periods of time.

The end result was what you'd expect: sooner or later, the poor slobs who got sold these mortgages got into trouble and started bailing out on their mortgages. They moved out and sent the new-investor banks the keys (some of them literally did; hence the addition of the term "jingle mail" to our language). They didn't do that badly. They got months upon months of free housing. The new-investor banks started noticing that their income streams were drying up, and they couldn't meet THEIR rules about how much in good loans they had to have. Some of them found themselves with so many bad loans that they became essentially valueless. They did what any good 21st century National Socialist American does when faced with bad news---they screamed to the central government to save them from their folly.

So SD has a point: the financial sector is going to get the stuffing knocked out of it while the resources get reallocated. The other parts of the productive economy are going to get pinched, and it's going to hurt some. I'd say things are going to be tight for two years or so, and I wouldn't consider real estate as the Hottest Idea In The Whole Wide World for retirement investing. But the productive economy---the people who make things and do things for other people---is still intact and still functioning more or less tolerably. We're going to get through this one.

Shoot, we may even suffer a collective attack of good sense and not elect Barack "I'm From The Government And I'm Here To REALLY 'Help' You" Obama to the White House. (I'm in a good mood today, all right ? So sue me.) This crisis isn't going to be the one that gets us.

That happens in 15 years or so when the retired Boomers have to get "bailed out". An entire sector of the American population crying for their Medicare and free prescription drugs, and a smaller productive class to pick up a bigger tab---that's the one we're going to have to sweat for.

Your servant,

Lord Karth

"Shoot, we may even suffer a collective attack of good sense and not elect Barack "I'm From The Government And I'm Here To REALLY 'Help' You" Obama to the White House."

We can elect McCain of the borrow and spend party. The party that took down the barriers between commercial and investment banks since the Great Depression. Greenspan recently criticized McCain's plan for promoting even more debt than Obama's. There were people who saw this coming, but Bush's administration refused to look at it. How can people ignore what has happened to our debt, to our financial institutions under conservative presidents. Republicans/conservatives have totally divorced themselves from the concept of financial responsibility.

Steve

Eddie, You say what the party of lusts policios dont lead to as if what they do lead to is preferable. Higher crime rates, destruction of the family with the resulting premanant underclass. Not te mention there is no historical evidence that democrats would be any more fiscally responsible than republicans and the only time we have recently seen anything like fiscal responsibility from our government was when Bill Clinton and the Republican congress didn't want to give each other anything. I personally am sick of the alternatives offered and am seriously considering Ron Pauls call to vote third party. Just because the Republicans have failed doesn't mean the democratic options are better. Personally, I think they will probably go down the same road somewhat faster.

And for all the "bleeding heart" liberals out there, consider this bon mot:
"The hazard of financial crisis may have much bigger and more immediate impact on world trade and welfare of the trading nations than, say, climate change."

The mess in our financial sector could cause more starvation and depletion of natural resources than... Al Gore's Oscar-winning bogey man CLIMATE CHANGE!

We have a lot to answer for in this election, and those who poo-poo'ed Ron Paul have a lot of 'splainin' to do. Our economy is the fruit of our vocations as Americans, why are we letting the power-corrupted few to spoil the harvest? We have to reclaim our property rights, and that begins by disbanding the Fed and renegotiating a Gold Standard...

Well, I think this financial crisis is going to be far more severe than the prevailing opinion here in the comboxes. As you can probably imagine, Rod, I'm kind of busy this morning. But here's something of an outline of my thoughts:

[1] The independent broker-dealers are goners. The two remaining big ones, Goldman Sachs and Morgan Stanley, are going to have to find a large commercial bank with a broad and stable depositor base to buy them.

[2] There is a very real possibility that the Lehman bankruptcy will lead to a systemic crisis. Lehman is something like the tenth largest counterparty in the multi-trillion dollar credit default swap market.

[3] AIG is a goner, and it is only the first of many insurers who will go belly up. Has anyone here seen those AIG commercials with the obnoxious kids talking about retirement planning? I told my wife that my nine year old should be inserted into those commercials to say, "My dad the economist says AIG will be bankrupt within a year."

[4] Washington Mutual and hundreds of regional banks are almost certain to go bankrupt. Just look at their balance sheets. FDIC is not going to be able to cover that many depositors. Congress will step in, but even they will soon run up against limits. That is, unless they really don't care about the credit rating of the United States Government.

[5] I'm a so-called specialist on the Japanese economy (as if anyone could possibly understand an economy of this scale), and so my opinions are colored by what happened in Japan twenty years ago. The situation is very similar to the one we face here in the United States ... on the theoretical level. So I believe the Fed is going to end up adopting many of the tactics employed by the Bank of Japan: make disclosure requirements extremely opaque in order to hide non-performing assets on the books of financial institutions (we've already made progress on this front), adopt a zero interest rate policy (ZIRP, coming soon), and MONETIZE (create money out of thin air) to increase capital reserves at the surviving banks. This monetization will not create (asset or consumer) inflation, however. (See [6].)

[6] These banks will be so weak that not much lending will be done except to those who don't really need loans, and "consumers" will become "savers" even though they're getting nothing for their money in the bank. They will do this because they fear for the future and because prices will be falling across the board. Asset deflation is already here (real estate, stocks, etc.), and it will soon spread. I don't think this deflation will be severe, but deflation is more dangerous in many ways than inflation. It causes people to postpone purchases, for example, creating a vicious cycle.

[7] In sum, I believe we're looking at a 15-year flat economy with a series of anemic cycles of growth and contraction. This anemic growth will not be able to meet the demand for jobs, and will make it impossible for public and private entities to meet their pension obligations.

[8] This forecast will change if the financial system collapses. I'd give that a one-in-twenty chance of happening. It's not likely, but it's completely obscene and outrageous that we're even reached this point!

Pyrrho @ 11:27 AM writes:

"[1] The independent broker-dealers are goners. The two remaining big ones, Goldman Sachs and Morgan Stanley, are going to have to find a large commercial bank with a broad and stable depositor base to buy them."

Two questions, sir, and without intention to be flip; I'm not an expert in any kind of financial field. To wit: are independent broker-dealers truly necessary in the kind of worldwide financial market we have today ? And which large commercial banks do you see as having the wherewithal and (more importantly) the inclination to merge with either GS or MS ?

"[2] There is a very real possibility that the Lehman bankruptcy will lead to a systemic crisis. Lehman is something like the tenth largest counterparty in the multi-trillion dollar credit default swap market."

What about the other nine ? I will bow to superior knowledge as to Lehman's position in the said "swap market", but is it really that large compared to the others ? And what form would such a systemic crisis take ?

"[3] AIG is a goner, and it is only the first of many insurers who will go belly up. Has anyone here seen those AIG commercials with the obnoxious kids talking about retirement planning? I told my wife that my nine year old should be inserted into those commercials to say, "My dad the economist says AIG will be bankrupt within a year."'

I've seen the AIG commercials, and they do have a certain black-humor aspect to them. How far do you see the insurance failures going ?

"[4] Washington Mutual and hundreds of regional banks are almost certain to go bankrupt. Just look at their balance sheets. FDIC is not going to be able to cover that many depositors. Congress will step in, but even they will soon run up against limits. That is, unless they really don't care about the credit rating of the United States Government."

I suspect that it is possible that they don't, or that they think the central government's credit could take something of a hit that could be recovered from. After all, a large wave of bank failures would do some serious damage to Congressional re-election prospects---and McCain could make a plausible case that the "do-nothing Congress" controlled by Democrats is at least partially to blame.

[5] I'm a so-called specialist on the Japanese economy (as if anyone could possibly understand an economy of this scale), and so my opinions are colored by what happened in Japan twenty years ago. The situation is very similar to the one we face here in the United States ... on the theoretical level. So I believe the Fed is going to end up adopting many of the tactics employed by the Bank of Japan: make disclosure requirements extremely opaque in order to hide non-performing assets on the books of financial institutions (we've already made progress on this front), adopt a zero interest rate policy (ZIRP, coming soon), and MONETIZE (create money out of thin air) to increase capital reserves at the surviving banks. This monetization will not create (asset or consumer) inflation, however. (See [6].)"

If my poor memory recalls the Japanese market crash in the 80s, I see some major differences between that situation and ours today. First, Japanese banks had at least some access to capital domestically (the postal banks and suchlike). The US has no such cushion.

I also seem to recall that some of the larger players (I'm thinking China) have been reluctant to subscribe to some of the recent T-bond issues. If the Fed tries to monetize in order to cushion some of these surviving banks, is an expectation of no consumer or asset inflation really realistic ? I'll grant you the no-consumer-inflation scenario, particularly since there's no real push for higher wages, but is a no-asset-inflation scenario a real prospect ?

"[6] These banks will be so weak that not much lending will be done except to those who don't really need loans, and "consumers" will become "savers" even though they're getting nothing for their money in the bank. They will do this because they fear for the future and because prices will be falling across the board. Asset deflation is already here (real estate, stocks, etc.), and it will soon spread. I don't think this deflation will be severe, but deflation is more dangerous in many ways than inflation. It causes people to postpone purchases, for example, creating a vicious cycle."

What about State pension funds ? I've read recently that quite a few states have at least technically insolvent pension- and retiree-health-care funds. What are the prospects that (at least) the more credit-worthy states will try to borrow ? Do you see any changes in large-corporate borrowing on behalf of their pension funds ? I'm sure the retirees at GM and Ford aren't really going to give a hang if GM gets nailed---they want what was promised, and they'll sue like maniacs if they don't get it.

"[7] In sum, I believe we're looking at a 15-year flat economy with a series of anemic cycles of growth and contraction. This anemic growth will not be able to meet the demand for jobs, and will make it impossible for public and private entities to meet their pension obligations. "

Do you really think it will only take that long to work through all this debt load ? And do you really see entitlement spending flattening during this period ? From what I see, THAT is only going to get worse, and I suspect the prescription-drug bill Bush signed a couple of years back is only now going to start kicking in---which will REALLY do wonders for central-government spending.

"[8] This forecast will change if the financial system collapses. I'd give that a one-in-twenty chance of happening. It's not likely, but it's completely obscene and outrageous that we're even reached this point!"

"Obscene" ? You're too generous, sir. One last question: which bank or banks do you see as the potential KreditAnstalt of 2009 ?

I hope I don't sound too silly asking these questions. I am aware of how busy you must be today, and any response you care to give will be very much appreciated.

Your servant,

Lord Karth

I

Lord Karth,

All good questions, but I'll have to respond sometime this evening. I'll be up late communicating with people in Tokyo. In the meantime, I have to figure out what I'm going to tell them.

But quickly, I agree in general with everything you say in your posts prior to mine above but think it is a subset of the overall problem.

More later.

And we have the unedifying sight of Greenspan quoted in the MSNBC crawl saying the country "can't afford another Republican administration" while his wife sits on a panel for MSNBC explaining in very careful chosen, loaded words that Palin "is no reformer" and implying that she's a liar and opportunist.

Even if you could somehow convince me that Mitchell isn't biased against McCain-Palin (and that explanation would have to account for the obvious deep sorrow she showed as the crowd responded to Palin's acceptance sppech and again the next night before she drowned in GOP balloonage), how can no one at NBC/MSNBC not sniff a smell test problem as their lead political correspondent does damage control in tandem with a spouse? Greenspan has plenty of reason to want to make the economic failures we're working through today an entirely Republican problem, when his work in a Democrat administration and the Democrat Congressional resistance to repair work can and should be laid in some part at his door.

Pyrrho @ 8:46 AM writes:

"I have a full day of stress testing ahead of me, and I'm both stressed and testy. I'll have to return to lurker mode for the time being. We'll take these issues up again at a later day, I'm sure."

Having been through stress testing myself, I must say that I sympathize. By all means take care of your business.

Some later day we will address this business. Hopefully without GETTING the business from some of the more....shall we say "colorful" characters who hang about this place. :-)

Your servant,

Lord Karth