Swirling galaxy of systemic risk (Headlines from the Meltdown)

The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster

Nouriel Roubini’s Global EconoMonitor, Feb. 5

[Cardin comments: Read this one very carefully, bearing in mind that Roubini’s grim outlook on the American economy is now being embraced by many of the very same economists who formerly dismissed him. Case in point: At Davos last year he was an outsider for his views but this year he was vindicated, as explained in, among other places, a Wall Street Journal blog post from a couple of weeks ago:

Last year, Nouriel Roubini was the lone pessimist on Davos’ five-person opening economics panel. His colleagues predicted the world economy would continue to grow strongly without overheating, a rosy scenario economists dubbed ‘Goldilocks.’ Mr. Roubini, chairman of Roubini Global Economics and a New York University economics professor, demurred. ‘Goldilocks is threatened by three ugly bears,’ he said, predicting a subprime meltdown, an end to cheap credit and rising oil prices would bring U.S. consumer spending to a halt. At the time, Mr. Roubini’s ‘ugly bears’ provoked more laughter than concern. But Goldilocks has already met two of those bears and signs are mounting that the third — in the form of a sharp falloff in U.S. consumer spending — could show up soon.”

What follows is just the introduction to Roubini’s “twelve steps to financial disaster.” The rest is behind a paywall at his site. But if you’re a savvy Internet searcher you just might find it available elsewhere. In any case, the introduction alone makes for riveting reading.]

Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.

To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.

That is the reason the Fed had thrown all caution to the wind — after a year in which it was behind the curve and underplaying the economic and financial risks — and has taken a very aggressive approach to risk management; this is a much more aggressive approach than the Greenspan one in spite of the initial views that the Bernanke Fed would be more cautious than Greenspan in reacting to economic and financial vulnerabilities.

To understand the risks that the financial system is facing today I present the “nightmare” or “catastrophic” scenario that the Fed and financial officials around the world are now worried about. Such a scenario — however extreme — has a rising and significant probability of occurring. Thus, it does not describe a very low probability event but rather an outcome that is quite possible.

Start first with the recession that is now enveloping the US economy. Let us assume as likely that this recession — that already started in December 2007 — will be worse than the mild ones that lasted 8 months that occurred in 1990-91 and 2001. The recession of 2008 will be more severe for several reasons: first, we have the biggest housing bust in US history with home prices likely to eventually fall 20 to 30%; second, because of a credit bubble that went beyond mortgages and because of reckless financial innovation and securitization the ongoing credit bust will lead to a severe credit crunch; third, US households — whose consumption is over 70% of GDP —have spent well beyond their means for years now piling up a massive amount of debt, both mortgage and otherwise; now that home prices are falling and a severe credit crunch is emerging the retrenchment of private consumption will be serious and protracted. So let us suppose that the recession of 2008 will last at least four quarters and, possibly, up to six quarters. What will be the consequences of it?

Here are the twelve steps or stages of a scenario of systemic financial meltdown associated with this severe economic recession. . .

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FDIC gearing up for large bank failures

MarketWatch, Feb. 4

[Cardin comments: This article builds on something I talked about in last Sunday’s “Headlines from the meltdown” post (2/3/08). In that one I mentioned a recent item posted to the FDIC’s Website about an overhaul of their rules for processing depositor benefits in the event of bank failures. I also highlighted my ignorance by stressing that I don’t know enough about these things to know if this should be cause for alarm. Now this article from MarketWatch, the most popular mainstream financial news and information site, answers that question. And the answer is yes, prepare for impact, and not just psychologically but practically by double-checking that your bank deposits conform to FDIC insurance limits. It is of course encouraging to know that the FDIC is taking steps in advance of an expected crisis, and that they are actively seeking to improve their ability to handle large-scale problems in a changed banking environment. But that encouragement is tempered by this confirmation that they are, in fact, expecting a crisis.]

The Federal Deposit Insurance Corp. is gearing up for the prospect of a large bank failures. So double-check that all your deposits, including interest, are well within FDIC insurance limits.

….If you have uninsured deposits at a bank, should you worry? Possibly. Depositors without FDIC coverage lost money in at least two recent failures — NetBank, Alpharetta, Ga., and Miami Valley Bank, Lakeview, Ohio.

….Weren’t you reassured about our deposit-insurance system with the bailouts of three colossal banks in the past — Continental Illinois, First Republic and Bank of New England? Each large bank approached an eye-popping $40 billion in assets. Today, however, a bank of that size would not rank in the top 40, FDIC chairman Sheila Bair warned in a speech last year.

FDIC data indicate that as of Sept. 30, there were 65 institutions with assets of $18.5 billion on its list of “problem” institutions. [FDIC spokesman David] Barr would not elaborate on their sizes. Nor will the FDIC name the institutions.

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The Fed’s main task now is to prevent financial meltdown by saving the banks

The Christian Science Monitor, Feb. 1

In moving with unusual speed to cut interest rates, officials at the Federal Reserve are aiming to prevent a nationwide recession, but they’re also doing something more targeted: throwing a lifeline directly to the beleaguered banking industry.

…[T]he central bank is moving to stimulate growth. But it is also trying to forestall a possible bank meltdown that would worsen the situation.

“This is more about Wall Street than Main Street,” says Ken Goldstein, an economist at the Conference Board, a business-sponsored research group in New York. “We’ve got the monetary strategy we’ve got because financial markets are nervous.”

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Banks shutting down HELOCs to defend against soaring borrower defaults

Fortune, Feb. 4

One of the last sources of ready cash for homeowners looking to get money from their house appears to be shutting down and the results aren’t likely to be pretty for the economy.

….[I]t looks like a lot of ready cash is getting taken away from homeowners, at least in California. Coupled with rising unemployment, this could pose a major headache for already strapped homeowners.

To head off more defaults, Countywide sent out letters to 122,000 homeowners last week informing them that their home equity credit lines were shut down since their estimated home values had dropped below their loan amounts.

Right behind Countrywide was Chase Home Lending, which notified borrowers in Los Angeles, Imperial and Orange Counties that they could tap their credit lines for no more than 70% of the value of their house. Previously, the limit had been 90%.

….If tightening lending standards are put rapidly into place for home equity loans, it is not inconceivable that $50 billion or more of spending power is instantly removed from the economy. In other words, at least one-third of the recently passed $150 billion stimulus package is already canceled out.

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Retailers bracing for worst January report on record

MarketWatch, Feb. 4

With consumers worried about their wallets, retailers may be about to report the industry’s worst January sales numbers on record.

U.S. chain-store sales in January are expected to be flat and even decline from a year earlier, according to the International Council of Shopping Centers.

By either measure, that would be the worst reading, unadjusted for inflation, since 1969 when ICSC began to compile the data, according to ICSC’s chief economist, Michael Niemira said.

….”It’s an economic blizzard that seemed to be weakening demand,” Niemira said. “The story of recession seemed to be in every daily newspaper. It just starts to increase the worry level. As the uncertainty got worse, the consumers’ unwillingness to spend seemed to get worse.”

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Mortgage insider says new and worse problems are about to explode all over the place

Herb Greenberg’s MarketBlog, MarketWatch, Dec. 6, 2007

[Cardin comments: I urge you to follow the link after reading the excerpt below, so that you can read the piece in its entirety. It was published two months ago. That means we’re right now at the point where things are about to get very, very bad. Watch for blatant denial, doublespeak, partisan solutions, and other manglings of the truth from pundits and, especially, politicians of all stripes. The fact that this is all happening during a U.S. presidential election year, when the engines of propaganda always churn most frantically and fatuously, is almost unbelievably…what’s the word I’m looking for? Unfortunate? Fascinating? Fortuitous? Synchronicitous? Poetic? Symbolic?All of the above.]

Even before this mortgage mess started, one person who kept emailing me over and over saying that this is going to get real bad. He kept saying this was beyond sub-prime, beyond low FICO scores, beyond Alt-A and beyond the imagination of most pundits, politicians and the press. When I asked him why somebody from inside the industry would be so emphatically sounding the siren, he said, “Someobody’s got to warn people.”

Since then, I’ve kept up an active dialog with Mark Hanson, a 20-year veteran of the mortgage industry, who has spent most of his career in the wholesale and correspondent residential arena — primarily on the West Coast. He lives in the Bay Area. So far he has been pretty much on target as the situation has unfolded. I should point out that, based on his knowledge of the industry, he has been short a number of mortgage-related stocks.

His current thoughts, which I urge you to read:

The Government and the market are trying to boil this down to a ’sub-prime’ thing, especially with all constant talk of ‘resets’. But sub-prime loans were only a small piece of the mortgage mess. And sub-prime loans are not the only ones with resets. What we are experiencing should be called ‘The Mortgage Meltdown’ because many different exotic loan types are imploding currently belonging to what lenders considered ‘qualified’ or ‘prime’ borrowers. This will continue to worsen over the next few of years. When ‘prime’ loans begin to explode to a degree large enough to catch national attention, the ratings agencies will jump on board and we will have ‘Round 2′. It is not that far away.

….The ‘Pay-Option ARM implosion’ will carry on for a couple of years. In my opinion, this implosion will dwarf the ’sub-prime implosion’ because it cuts across all borrower types and all home values.

….So, in a nutshell we have 90% fewer qualified buyers for five-times the number of homes. To get housing moving again in Northern California, either all the exotic programs must come back, everyone must get a 100% raise or home prices have to fall 50%. None, except the last sound remotely possible.

What I am telling you is not speculation. I sold BILLIONs of these very loans over the past five years. I saw the borrowers we considered ‘prime’. I always wondered ‘what WILL happen when these things adjust is [sic; he means “if”] values don’t go up 10% per year’.

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Cities fight glut of vacant houses from foreclosures and walkaways

Reuters, Feb. 5

Rust Belt cities, already beaten down by a miserable economy before foreclosures began spiraling nationally, are moving to cut the number of houses left vacant when the mortgage can’t be paid. At stake are valuable tax dollars and the survival of neighborhoods.

County treasurers and mayors are filing lawsuits and developing land banks to buy distressed properties and either demolish them or repair and sell them. Buffalo, N.Y., brings property owners and lenders together in court on monthly “Bank Days” to find solutions for cleaning up vacant homes.

….Vacant houses [in Cleveland], some stripped bare of aluminum siding, dot the streets, casting a gloom on their well-maintained neighbors.”It scares people,” said Joyce Porozynski, a block watch member who has lived in the neighborhood most of her life. “Many people have given up.”

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Millions of middle class American families on the verge of economic collapse

PBS: NOW, week of 2/1/08

[Cardin comments: The link above and information below come from the most recent broadcast of the PBS investigative newsmagazine NOW, which airs on Friday nights, at least on my local PBS station. I watched this edition, as I watch most of them, and found that the information it presented fell right in line with and illuminated much of what I’ve been reading and chronicling here at The Teeming Brain. Not incidentally, if you’re not a watcher of NOW, and also of its quasi-companion program on PBS, Bill Moyers Journal (regarding which, see below for a link to a recent program about middle class economic anxiety), then you’re missing what is hands-down the best progressive journalism on American broadcast television.

Note that at the NOW Website you can watch or listen to this and all other editions of the show in podcast or streaming video form.]

Are politicians listening to middle-class families on the edge of economic collapse?

Leading up to the Super Tuesday primaries, polls indicate that the economy ranks as the number one issue on the minds of Americans, beating out immigration, global warming, even terrorism. NOW on PBS heads to America’s heartland — Illinois — to investigate rampant anxiety among America’s middle class. How did families on the edge of financial collapse get to this point, and which presidential candidate do they think can restore economic hope and stability?

* * * * *

Middle class economic anxiety heating up

Bill Moyers Journal, Jan. 25

[Bill Moyers interviewed Princeton sociologist Katherine Newman on the January 25th edition of his PBS program. Below are excerpts.]

BILL MOYERS: What do you make of all this bad news [about the economy]?

KATHERINE NEWMAN: Well, it’s a bad news situation out there for millions of Americans who are really going to worry about their futures and their children’s futures. I think the world’s looking like a shakier place, and the country’s looking like it’s not in control of its destiny in ways that people had hoped would be true. And I think they’ll be pleased to hear that Congress and the president have found some way to cooperate with one another. But I think a lot of people will be left out and left in the cold, especially in — in places like the Midwest.

….KATHERINE NEWMAN: There’s some really unusual features to this downturn. One is that poverty remained high. The other is that the long term unemployed are a larger proportion of the people who are unemployed, than they were before.

BILL MOYERS: And aren’t more of them college graduates? That’s a new factor, isn’t it?

KATHERINE NEWMAN: That is something that I find very worrying. So if we think of education as protective of the individual out in the labor market, which it is, of course– if you are college educated, you ‘re better off than someone who isn’t. But the proportion of long term unemployed who college graduates has jumped up. So it’s not as protective as it once was. It’s lasting longer, it’s lasting longer into the business cycle, long term unemployment. And that is a real worry. Because the longer you stay out of work, the harder it is to find another job, the more devastating the consequences for your family. And that, I think, is a real worry for all of us.

…. KATHERINE NEWMAN: The American people have never been fond of the idea that someone else needs to rescue them. They want a chance. They don’t need a guarantee. They want a chance. But if the see the chance start to slip through their hands, if they see that the next generation won’t have the kind of credentials it needs because they can’t go to college, or if they’re heavily burdened by debt when they finish college, their ability to compete will be impeded. And so, what most of us want to see is that we have the tools. Just give us the tool, or give us the opportunity to gain the tools for ourselves, and we will try and take care of the rest. But absent those tools and absent the kind of security that we need to hold on to the assets we have, when we feel like we’re falling in an elevator that’s got no back stop to it, and that, I think, will be very frightening.

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The ugly truth: Post-Reagan capitalism has made most Americans poorer and nobody knows what to do about it

The Daily Reckoning, Feb. 4

The biggest stories are always the ones that go unreported. They are missed because they are too hard to understand or too ugly to look in the face.

….[After the global turn toward politics and political solutions in most of the 20th century] the world turned again — towards money . . . . “Government is not the answer,” said Ronald Reagan. What, then? Money. The real solutions to the world’s problems were thought to be financial solutions . . . . Ronald Reagan and Margaret Thatcher led the way, speaking of ‘market solutions’ and of how the free enterprise system could make people rich…and how entrepreneurs could be unleashed to create wealth for everyone.

….Reagan’s capitalism was a failure. Cometh now the nasty facts. We’ve been talking about them here in The Daily Reckoning for the last eight years. Everyone knows them. But they are so disagreeable and so at odds with everything we have come to believe, they are ignored.

[During the uber-capitalistic Reagan and post-Soviet years] Americans should have gotten richer, faster, than at any time in history. They were the world leaders in capitalism, technology, innovation, financial sophistication, education and market efficiency. But in practice, the average man in America got poorer. According to figures sited by Robert Reich, a former U.S. Secretary of Labor who ought to know, the average man today earns 12% less per hour worked than he did in the early ’70s, a fact disguised by longer working hours, more spouses on the job, and debt.

And now word is getting out that the boom of the last five years was a fraud. “Boom was a bust for ordinary people,” says a Washington Post story. The common man didn’t get ahead in the boom; he fell behind.

….How could it be? How is it possible that in the greatest explosion of economic activity in human history, the economic front-runners were left out?

The candidates for America’s highest office don’t know what to say. They promise to “bring back the American dream” but have no idea what happened to it . . . or what made it possible in the first place. The Democrats propose higher taxes on “the rich” and more regulations on Wall Street. The Republicans propose more giveaways . . . higher spending . . . and hint vaguely that, when it comes to money, they know what they are doing.

But no one really knows anything.

About Matt Cardin


Posted on February 6, 2008, in Economy and tagged . Bookmark the permalink. 4 Comments.

  1. Everybody send your local mortgage broker and banker a copy of _The Illustrated History of the French Revolution_

  2. Ha! Good call. Perhaps the inciting phrase for the revolution-to-come might be “Let them eat credit,” uttered by a central banker or U.S. President.

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