Is this “The End”? (Headlines from the Meltdown)
GENERAL COMMENT FROM CARDIN:
Is this THE END?
We’re all familiar with the stereotypical cartoon figure of the ragged, shaggy prophet wearing a sandwich board with the blaring painted message, “The end is near!” By all rights, that prophet ought to be wandering the sidewalks of Wall Street at this very moment in order to highlight the question in everybody’s minds: Is this really the end?
Of course, given present circumstances the question can be taken in one of two general ways.
The first way is, “Is this THE END of the financial and economic crisis?” This version is prompted by the pervasive cheering throughout the mainstream financial news media over the weekend as pundits, analysts, and television program hosts have breathed a collective sigh of relief and announced that the Fed’s dramatic save of Bear Stearns (with the help of JPMorgan), along with their other massive and unprecedented moves to stave off collapse, have apparently done the trick. The Fed has stanched the bleeding, saved the patient, saved the day. That is, they have stabilized the market and brought a finish to the crisis that has been spreading since last summer. True, there are still a few loose ends to tie up. The foreclosure crisis is still mounting, real estate values are still falling, unemployment numbers are still slightly up and rising, manufacturing is down, the dollar still has a challenge ahead of it, etc. But in its heart — according to this popular version of things — the beast has been slain. Team Bernanke successfully located and isolated the problem, triangulated the monster, and hurled a nuclear bomb into its jagged maw. What’s left are mere post-mortem tremors, plus a few of the monster’s lesser minions still scampering around and causing minor mischief. But the mop-up is in process, and we have seen THE END of the main problem.
That’s one version. The second way to take the question of “the end” is to ask, “Is this THE END of life as we know it?” This version is prompted by several factors and leads to several insights and suspicions that are much less pat and comforting. It notices that those various factors that the previous version frames as “loose ends” are actually valves and chambers of the monster’s beating heart, which is still vigorously pumping blood. It also notices that this new hope that the crisis is at an end makes the horrific and fundamental mistake of assuming a return to normal is what we all want and need, when in fact the new “normal” of the past five, 10, and 40 years of America’s financial and economic history — the rise of a “shadow banking system” that managed to get around safeguards implemented in the Depression era and provided a place for sheer speculative greed to run wild, free of all restraint, regulation, and responsibility — is what created this epochal mess in the first place. It notices that beyond the obvious loose ends there lies a field of additional problems that threaten our very economic foundations, including America’s effective bankruptcy as detailed by former comptroller general David Walker for the past several years, the mounting, mind-blowing bill from two apparently permanent wars, and the psychological and economic infantilization of the American populace as we have come to rely on being plugged into a debt-based economic system like hairless adult babies sucking milk from the tit of Mother Matrix, so that what we assume — with a fierce and largely unacknowledged sense of entitlement — is just “normal,” is just “the way things are,” is actually a monstrous overreach that has led to our living beyond our means at the expense of other people and nations. Maybe global economics doesn’t have to be a zero sum game. Maybe it doesn’t have to be the case that a person or people can only have something by taking it from someone else. Maybe everybody can be equally enriched and empowered. But not the way we’re currently playing the game. And the piper will one day call us to pay. That day has arrived.
Finally, the second version of the question notices that there’s a lot more wrong with the current financial and economic environment than just the mess made from financial derivatives, bad mortgages, a real estate bubble, and so on. It notices that these are all, ultimately, symptoms of a much deeper, wider, and more intractable problem that underlies everything. The larger issue is the problem of basic human hubris, greed, and heedlessness as interacting with the fact of our fossil fuel endowment. We have been empowered and enabled (in the sense of enabling a neurosis or personality disorder) to scale Promethean heights of global civilizational excess by our use and mastery of fossil fuels. And this is about to come to an end. The underlying cause of all the acute current financial/economic woes is energy-related. And that’s not going to be neutralized by any surprise moves from the Fed or any other central bank on planet earth.
So . . . is this THE END? Regarding the acute financial and economic crisis facing America right now, the answer is a definite maybe. We’ll find out over the next few weeks and months. There may be a lull in the panic that exploded openly in recent weeks. Financial markets may zoom up. The real estate freefall and mortgage crisis may be addressed in some direct fashion. Or maybe not. New and shocking troubles may erupt tomorrow, or next week, or next month. We just can’t know yet if it’s the end, despite what many in the mainstream media are saying.
One thing we can know, however, is that it’s not the end of the wider problem. Two definite answers are as follows:
YES, it’s the end of life as we know it. Even within the parameters of the banking and financial system as it presently exists, everything is different now, because those parameters have been exploded by what Team Bernanke has been forced to do by the magnitude of the current crisis. This will result in real changes in life on the ground, everyday life for you, me, and everybody else. And in the wider sense of those profound problems based on peak oil, America’s national bankruptcy, etc. . .
. . . in that wider sense, NO, the current shift doesn’t mark the end of anything. Nothing’s over. The real storm hasn’t even hit yet. In fact, this is only the beginning.
* * * * *
Paul Krugman, The New York Times, March 21
[Cardin comments: I advise clicking through to read the full article, even though I’ve provided copious chunks of it below. Krugman gives a nicely concise recounting of how we got to where we are now, and how it mirrors in marvelous fashion the precise shape of the buildup to the Great Depression 80 years ago, along with a beginner’s guide to what banks do and how they fit into the overall economy.
Of purely personal interest (to me) is that in his opening three or four sentences, Krugman casts Ben Bernanke in the role of a superhero fighting against the evil villain known as Collapse. This explicitly recalls my own narrative analysis of the economic situation in last week’s installment of “Headlines from the meltdown,” where I spoke of Ben “Skywalker” Bernanke’s attempts to blow up the Death Star of economic collapse. Ah, well. Great minds and all that. Maybe Krugman’s been reading me. I mean, after all, I did beat him to the punch by five days.]
If Ben Bernanke manages to save the financial system from collapse, he will — rightly — be praised for his heroic efforts.
But what we should be asking is: How did we get here? Why does the financial system need salvation? Why do mild-mannered economists have to become superheroes? The answer, at a fundamental level, is that we’re paying the price for willful amnesia. We chose to forget what happened in the 1930s — and having refused to learn from history, we’re repeating it.
Contrary to popular belief, the stock market crash of 1929 wasn’t the defining moment of the Great Depression. What turned an ordinary recession into a civilization-threatening slump was the wave of bank runs that swept across America in 1930 and 1931. This banking crisis of the 1930s showed that unregulated, unsupervised financial markets can all too easily suffer catastrophic failure.
As the decades passed, however, that lesson was forgotten — and now we’re relearning it, the hard way.
….[In the wake of the 1930s disaster] Congress tried to make sure it would never happen again by creating a system of regulations and guarantees that provided a safety net for the financial system. And we all lived happily for a while — but not for ever after. Wall Street chafed at regulations that limited risk, but also limited potential profits. And little by little it wriggled free — partly by persuading politicians to relax the rules, but mainly by creating a “shadow banking system” that relied on complex financial arrangements to bypass regulations designed to ensure that banking was safe.
….As the years went by, the shadow banking system took over more and more of the banking business, because the unregulated players in this system seemed to offer better deals than conventional banks. Meanwhile, those who worried about the fact that this brave new world of finance lacked a safety net were dismissed as hopelessly old-fashioned.
In fact, however, we were partying like it was 1929 — and now it’s 1930.
The financial crisis currently under way is basically an updated version of the wave of bank runs that swept the nation three generations ago. People aren’t pulling cash out of banks to put it in their mattresses — but they’re doing the modern equivalent, pulling their money out of the shadow banking system and putting it into Treasury bills. And the result, now as then, is a vicious circle of financial contraction.
Mr. Bernanke and his colleagues at the Fed are doing all they can to end that vicious circle. We can only hope that they succeed. Otherwise, the next few years will be very unpleasant — not another Great Depression, hopefully, but surely the worst slump we’ve seen in decades.
* * * * *
Bloomberg, March 18
[Cardin comments: This is indeed the paradox or dilemma of the hour, isn’t it? Even if the actions and comments of Bernanke, the Fed, Bush, Paulson, or anybody else may be exactly what’s needed from a practical standpoint, the very fact that they’re saying and doing such extraordinary things underscores and even exacerbates the crisis because this is a game in which perception and confidence are, if not everything, then a great deal of the thing.
So: In late 2007 the Fed coordinates with other central banks around the world to inject huge amounts of liquidity into banking systems around the world. People watching this think and say, “Wow, the situation must have been really serious.” Then in January the Fed takes the unusual action of making an emergency rate cut very shortly before a regularly scheduled meeting. This staves off an imminent market crash but leads to water cooler conversations along the lines of, “Wow, did you see what the Fed did? The situation must be really serious.” Then the Fed makes another rate cut at that next meeting, which leads to even more water cooler conversation: “Holy crap, how serious is this situation?” From January to mid-March the Fed draws repeatedly from a bag of tricks both new and old, coming up with sometimes dazzling saves and maneuvers including new liquidity injections and the acceptance of mortgage debt as collateral for epic loans. The water cooler conversation begins to adopt an incredulous tone: “Are you seeing all this? Am I awake? What the hell’s going on?!” Then, over the weekend of March 14-16, Bear Stearns collapses and the Fed helps engineer a bailout, inaugurating its new era of “making policy on the fly,” as the New York Times puts it, by breaking its rule of not lending to investment banks. The Fed also makes the first weekend rate cut since 1979, which the press universally and correctly describes as “an extraordinarily rare move.”
The clear implication is that the severity of the current crisis is itself extraordinary. Water cooler conversation now devolves to the level of, “What the –?!” followed by a terrified whimper and a mutual huddling together for comfort.]
Federal Reserve Chairman Ben S. Bernanke may be readying the deepest interest-rate cut in a generation as the central bank struggles to prevent a meltdown in financial markets and a recession. ….The severity of the crisis was underscored by the Fed’s emergency action on the evening of March 16, the first weekend policy shift since 1979. A week ago, the debate among economists was whether the Fed would cut by 50 basis points or 75 basis points.
….Bernanke has failed to calm the turmoil, which his predecessor Alan Greenspan calls the “most wrenching” since the end of World War II, even after lowering the overnight rate five times since September and committing to pump an unprecedented $400 billion in cash and securities into the banking system.
….Harvard University economist Martin Feldstein, a member of the committee that officially declares when a recession has started, said last week that he believed a recession was under way and it could be the most severe since World War II.
….”Things are still very fragile” [said Stephen Stanley, chief economist at RBS Greenwich Capital Markets Inc. and a former member of the Richmond Fed staff]. “We are in a situation where credit tightening has started to feed on itself, and it has real economic implications.”
….Fed Governor Frederic Mishkin said March 4 that the economy may face an “adverse feedback loop,” where tightening credit and a declining economy create a cycle that leads to further deteriorating conditions. The FOMC discussed that possibility during the January meeting, according to its minutes. “The overriding concern is the condition of the financial markets.” said William Ford, former president of the Federal Reserve Bank of Atlanta and now chairman of the finance department at Middle Tennessee State University. “They are fighting a financial panic and want to preserve orderly markets.”
* * * * *
The New York Times, March 23
[Cardin comments: This long investigative article provides a great overview of how the financial system arrived at its present system of catastrophic overreach and disarray. Two other good ones are “The Bear Trap” (Time, March 21) and “What Went Wrong” (the Economist, March 22).]
The Federal Reserve not only taken has action unprecedented since the Great Depression — by lending money directly to major investment banks — but also has put taxpayers on the hook for billions of dollars in questionable trades these same bankers made when the good times were rolling.
“Bear Stearns has made it obvious that things have gone too far,” says Mr. Gross, who plans to use some of his cash to bargain-shop. “The investment community has morphed into something beyond banks and something beyond regulation. We call it the shadow banking system.”
It is the private trading of complex instruments that lurk in the financial shadows that worries regulators and Wall Street and that have created stresses in the broader economy. Economic downturns and panics have occurred before, of course. Few, however, have posed such a serious threat to the entire financial system that regulators have responded as if they were confronting a potential epidemic.
* * * * *
MarketWatch, March 19
[Cardin comments: Um, don’t look now, but this is either nuts or shocking. Or both. The strategists at Citigroup have acknowledged the onset of the “great unwind,” that is, the deleveraging of the economy as people and businesses everywhere flee en masse from the epic circumstance of multi-layered indebtedness that has come to seem normal over the course of many years. That means they recommend avoiding “companies and countries that have grown to rely too much on borrowed money.” Country-wise, that means the U.S., as they explicitly state (see below). Company-wise, that means entities like — themselves! They don’t state that explicitly, but the meaning’s there.]
The Great Unwind has begun, Citigroup Inc. strategists warned on Wednesday. As markets and economies de-leverage across the globe, investors should avoid companies and countries that have grown to rely too much on borrowed money, they said. That means favoring public-equity markets over hedge funds, private-equity and real estate, while leaning toward emerging market countries and away from developed nations like the U.S., the bank’s global equity strategy team advised. Within equity markets, the financial-services should be avoided because it’s still over-leveraged, while other companies have stronger balance sheets, the strategists said.
….Leveraged economies, like the U.S., should also be avoided, in favor of emerging market countries, which have reduced borrowing, the bank advised. With less capital sloshing around the world, and the dollar falling, the U.S. may have to compete more to finance its deficits. “The U.S. shows up as the world’s greatest consumer of external capital,” Citi noted. So it “has the most to lose as this capital becomes less freely available.”
* * * * *
The New York Times, Jan. 23
So, how bad could this get?
Until a few months ago, it was accepted wisdom that the American economy functioned far more smoothly than in the past. Economic expansions lasted longer, and recessions were both shorter and milder. Inflation had been tamed. The spreading of financial risk, across institutions and around the world, had reduced the odds of a crisis.
Back in 2004, Ben Bernanke, then a Federal Reserve governor, borrowed a phrase from an academic research paper to give these happy developments a name: “the great moderation.”
These days, though, the great moderation isn’t looking quite so great — or so moderate.
The recent financial turmoil has many causes, but they are tied to a basic fear that some of the economic successes of the last generation may yet turn out to be a mirage.….The great moderation now seems to have depended — in part — on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges. Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn’t go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak.
Now, some worry, comes the payback.
…[I]t’s hard not to believe that the economy will pay a price for the speculative binge of the last two decades, either by going through a tough recession or an extended period of disappointing growth. As is already happening, banks will become less willing to lend money, households will become less willing to spend money they don’t have and investors will become more alert to risk.
Welcome to the new moderation.
* * * * *
Ambrose Evans-Pritchard, The U.K. Telegraph, March 18
The US Federal Reserve has resorted to the nuclear option in its ever-more depleted arsenal, invoking a Depression-era clause to shoulder the risk of losses stemming from the collapse of Bear Stearns, and to lend money directly to broker dealers.
It is the first time since the Great Depression that the Fed has stepped in directly to absorb credit losses, crossing a line deemed unthinkable just months ago. The dramatic late-night move on Sunday required dredging up Article 13 (3) of the Federal Reserve Act, which allows the Fed to shower money on almost anybody it wishes by a vote of five governors in “unusual and exigent circumstances”.
The Fed also took the extraordinary step of cutting the Discount Rate a quarter point to 3.25pc just two days before its scheduled policy meeting in Washington, a move underscoring the high drama of the crisis. The markets have priced in an emergency 100 basis point cut in the key Fed funds rate to 2pc today.
“These are massive, unprecedented actions,” said Hank Calenti, from RBC Capital Markets. “Their gravity is likely to scare the markets to death, but the Fed is trying to inhibit a margin-meltdown.”
Bernard Connolly, global strategist at Banque AIG, said invoking a 1930s-era emergency clause was a “very big deal”. “We have moved one step closer to the direct purchase of assets by the US authorities. I’m afraid this has horrible implications but it may be the only way to avoid a serious risk of Depression. This is a Greek Tragedy set in motion by Alan Greenspan a long time ago,” he said.
….The Fed’s hyperactive coups are in stark contrast to the wait-and-see policy of the European Central Bank, which has held rates steady at 4pc since the credit crunch began — despite a jump in the (market-driven) three-month Euribor rate used to price mortgages. Dominique Strauss-Kahn, the head of the International Monetary Fund, suggested yesterday that Europe had misjudged the severity of the crisis that now threatens to engulf the world economy. “Obviously the financial market crisis is now more serious and more global than a week ago,” he said. “It will have significant implications for many countries. At this time, the priority for European governments should be containing the economic damage from the financial market crisis.”
Martin Hutchinson, The Bear’s Lair (at Prudent Bear), March 17
On August 27, 2006 this column suggested that US house prices would fall by 15% nationwide, peak to trough. On March 11, 2007 this column suggested that the total bad debt loss from the mortgage crisis would be about $1 trillion. At a meeting at the American Enterprise Institute Wednesday, it became clear that in both cases I was not pessimistic enough. Sorry!
….This is not a pretty picture. The losses to come are probably large enough to wipe out the banking system, and the interconnected network caused by modern finance is sufficiently fragile that the failure of any one major house, if carried out through normal bankruptcy processes, would be sufficient to bring down the world economy as a whole.
It is as if the US power grid had been installed without fail-safe mechanisms, so that a local outage caused by a snowstorm in Vermont or a hurricane in Florida could cascade through the whole system and wipe out power service for the entire United States. Needless to say, failsafe mechanisms have been put in place precisely to prevent such an occurrence. When we dig ourselves out from what seems likely to be an unprecedented banking system catastrophe, we will no doubt design similar mechanisms to prevent contagion throughout the banking system. They will destroy much legitimate business, just as did the 1933 Glass-Steagall Act, which de-capitalized the investment banks, making it almost impossible for companies to raise debt and equity capital for the remainder of the 1930s.
The barriers to new business caused by the new control regulations will be the last but by no means the least of the enormous costs imposed on mankind by the crack-brained alchemists of modern finance.
* * * * *
The New York Times, March 21
In Seattle, sales at a long-established hardware store, Pacific Supply, are suddenly dipping. In Oklahoma City, couples planning their weddings are demonstrating uncustomary thrift, forgoing Dungeness crab and special linens. And in many cities, the registers at department stores like Nordstrom on the higher end and J. C. Penney in the middle are ringing less often.
With Wall Street caught in a credit crisis that has captured headlines, the forces assailing the economy are now spreading beyond areas hit hardest by the boom-turned-bust in real estate like California, Florida and Nevada. Now, the downturn is seeping into new parts of the country, to communities that seemed insulated only months ago.
The broadening of the slowdown, the plunge in home prices and near-paralysis in the financial system are fueling worries that what most economists now see as an inevitable recession could end up being especially painful.
….“It’s not hard to construct very dark scenarios, primarily because the financial system is in disarray, and it’s not clear how to get it all back together again,” said Mark Zandi, chief economist at Moody’s Economy.com.
To be sure, there are many places where talk of recession still seems as out of place as a diner trying to score a table at a trendy Los Angeles restaurant without reservations on a Saturday night. First-class cabins of airplanes are jammed. So are spas, cigar bars and children’s clothing boutiques selling upscale dresses. Unemployment, meanwhile, still remains at a relatively low 4.8 percent.
But even after the Federal Reserve’s extraordinary efforts to prevent the collapse of Bear Stearns from spreading to other financial institutions, the danger still lurks that banks will grow even tighter with their funds and will starve the economy of capital.
….For now, there are still pockets of prosperity across the country. Farmers are enjoying record crop prices as the adoption of ethanol makes corn a way to fill gas tanks, and as rising incomes in China, India and elsewhere spell growing demand for meat. The weak dollar is helping exporters and retailers that cater to foreign tourists.
Eastern Mountain Sports, the outdoor clothing dealer, says sales increased by one-third this month compared with the year before at its store in SoHo. “A lot of that is Europeans coming over,” said Will Manzer, the company’s president.
With oil selling at approximately $100 a barrel, the Taste of Texas Steakhouse in Houston — a popular spot for events held by BP, Shell and Exxon Mobil — is reveling in days of plenty.
….For the country as a whole, recent data shows that the economy is deteriorating at an accelerating rate. From September to January, average home prices fell 6 percent compared with a year earlier. Consumer confidence has been plummeting. The private sector shed 26,000 jobs in January and 101,000 in February, while those out of work have stayed jobless longer, according to the Labor Department.
Now, the broader discomfort is filtering into cities and towns that only recently seemed beyond reach.
* * * * *
Richard Benson, Guest Commentary at Prudent Bear, March 19
No one can ever be too rich, too thin, or too beautiful. We would all like to look into a mirror that tells us that. But in tough economic times like these when inflation is raging, unemployment is climbing, and the economy is falling apart, our government is forced to look into the mirror and create a magical image by reassuring the American people that everything is just fine with the economy, when it’s really not. So how exactly do they go about doing this?
When the government releases economic statistics for prices and employment, a magic mirror is used to make numbers look much better than they really are. Both the Democrats and Republicans use this smoky mirror when they control the Presidency, and neither party dares to glance into it in fear it may shatter from the reflection. Washington is a company town and a political machine that spends trillions of our tax dollars to mislead the public. Sad, but true!
….The paternalistic government view that creating phony economic statistics is really good for the American people may be fine for the masses, but it’s not fine for me. And since it appears that the economy is far worse off than the government lets on, I’ll continue looking in my mirror and believe I can never be too rich, too thin or too beautiful. After all, it’s only an image and what harm is there in believing? But when it comes to investing my money, I plan to stay short emerging markets in China, and I’m doing this because America’s main export to the rest of the world (in the coming year) will be its big ugly recession. Yes, it’s true, we’re in a recession, but that won’t stop the government from using magical smoky mirrors to conceal it.