Brad Setser

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Just how bad is it?

by Brad Setser
September 25, 2008

There seems to be a bit of a debate. I am not a fan of many of the policies of the current Administration, but I don’t think though that the Bush Administration is exaggerating the depth of the problems in the US (indeed global) financial system right now. The administration, in my view, was far more guilty of understating the potential for deep trouble over the past year.

The New Yorker’s Nick Paumgarten recently noted that in this case the pros are more scared than the amateurs:

Often, the media exaggerates the significance of the ups and downs of the financial markets, while the sophisticates in the marketplace take them in stride. Not this time. Last week, the most farsighted market players were flabbergasted, even as they comprehended that they were witnessing a capitulation to some kind of greater truth—that Wall Street had got caught up in a pyramid scheme of its own devising.

I agree. It is quite rare for an economist at a major bank to make as dire a warning as Tim Bond of Barclays Capital did recently (via the FT):

As the freeze in the money markets persists, credit is rapidly becoming either completely unavailable or punitively expensive. This presents the world with an immediate risk of a surge in defaults as borrowers are unable to refinance. Needless to say, without an ability to lend, an economic depression threatens, as defaults erode bank capital and lending ability further. The countdown to a dramatically bad economic outcome is therefore running at very high speed. Unchecked, the current crisis would turn into a self-reinforcing vortex of defaults, bank capital contraction and deep recession within a matter of weeks.

The FT’s Alphaville isn’t normally as pessimistic as say Dr. Roubini, but Alphaville still noted that absent action from the US government: “a systemic crisis could well be realised.” A run on the shadow financial system isn’t as visible as a run on a bank, but if not checked, it can have a similar impact.

Why the worry?

A host of indicators suggest that markets remain distressed — and that banks are hoarding cash rather than lending to each other. Look at the TED spread. Look at the moves in the LIBOR-OIS spread — a measure of risk aversion — recent moves were, at least if the past is a decent guide to the future (it generally isn’t, but that is a different topic), a one in almost 7000 year event. These are all measures of much more the banks have to pay to borrow.

Or look at a plot of the 3m t-bill relative to the 10 year Treasury (the data is through yesterday). Most of the time, the 3m t-bill is less volatile than the 10 year Treasury; it tends to move with the fed’s target rate for short-term funds. Recently though its yield has swung wildly as investors have — depending on the moment — piled into the safest dollar asset around.


A plot showing the effective fed funds rate also provides — I think, though I am not fully sure — indirect evidence of distress. Usually the Fed has little difficulty meeting its target rate. But not recently. Effective fed funds has moved around even more than the 3m T-bill.


All sorts of indicators suggest a lack of confidence in the health of a set of financial institutions that are central to the United States financial system.

The details of Paulson’s proposal can be debated — and they have been. But I at least do not doubt that there was a real need to develop a new approach to managing what increasingly looks like a systemic crisis in the US financial system. There are a broad set of institutions that have effectively made the same bad bet (levered long US housing credit) on a large scale. A scale measured in trillions, not billions. The increase in outstanding mortgage debt in the US since 2004, counting commercial mortgages, is in the order of $5 trillion, according to the Fed flow of funds. That means there are many weak institutions looking to get rid of the same bad bet — not just one. And it has created a real problem.

We in the US need to make sure that we learn the lessons of the recent crisis and don’t allow ourselves to get into this kind of difficulty again. But the errors of the past cannot be undone magically either.

UPDATE: It looks like WaMu will join Lehman in defaulting on its bonds. JP Morgan is buying the deposits, but — as I read the New York Times coverage — not all of Wamu’s debts. Maybe now all the obviously weak institutions have failed, and the financial system can right itself. But I increasingly suspect the overall system lacks enough capital — and even it weathers the current storm, it will be vulnerable to any additional shock.


  • Posted by fatbrick

    I won’t be so negative, Brad. US still has a strong fundemental, seriously. Resources, technology, and judiciary system, I think they are pillars.

  • Posted by gillies

    perhaps you would like to list, for those of us who are untutored in economics, all of the various ways in which pyramid schemes can end ?

  • Posted by gillies

    sorry to be obsessed with this image – but i found the reference : june 2004. three u s helicopters airlifted $1.4 bn. into kurdistan (where presumable there were no safe banking arrangements). total currency 15 tons. thus 5 tons per helicopter. thus new clean $100 dollar bills weigh in at approximate value $100 000 000 to the ton.

    perhaps such a concrete image has use as a thought experiment – what kind of world would you live in when banks dont trust banks ?

    print it. hoard it. COD (cash on delivery) “do not ask for credit as a refusal may offend.”

  • Posted by Dave C..

    Brad, please see the Letter from 190 Top U.S. Economists:

    The taxpayer bailout of politically-connected Wall Street banks is complete nonsense. The “Armageddon scare tactics” of Paulson and the Bush Administration are utterly detestable. The bailout plan is an absolute disaster. The United States has now plunged to the overt corruption levels of Nigeria and other banana republics. Over 190 Top U.S. Economists slam the Taxpayer Bailout as absurd, corrupt and unworkable in an open letter.

    Click above to see the Letter from 190 Top U.S. Economists to the Speaker of the House of Representatives and the President pro tempore of the Senate.

    What is it that Paulson knows that 190+ economists don’t? After all Paulson was telling us all how safe the US Banking system was just a couple weeks ago.

  • Posted by gillies

    so bernanke seeks a helicopter drop, in physical terms, by 1,500 helicopters each loaded with 5 tons of $100 bills.

    the mood of the voters could turn drastically. the electorate might offer bernanke and paulson a golden parachute with no strings attached . . . obama might win all 50 including alaska . . .

    the situation may move faster than the helicopters can get take off clearance.

  • Posted by manch

    I am reading Michael Pettis’ “Volatility Machine”. His main thesis is that most financial crises in the development world could be understood in terms of the countries’ capital structure. A badly designed structure can add volatility to any shocks, be they internal or external.

    I wonder if anyone has analyzed the capital structure of US? I know, US is the antithesis of developing countries. But unlike yesteryears’ superpowers, US is the biggest debtor in the history of the world. Will the aggregate capital structure of the entire country add volatility? Or reduces volatility?

  • Posted by Cedric Regula


    Uncle Bruno tinks dey hafta use B-52s.

    Merrill estimated da deficit at $900B next year. Den adding da $700B gives a $1.6 Trillion deficit.

    If der are 150 million workers in da US, dat would be $10,667 per worker. Including da ones dat don’t pay hardly any taxes now because dey make less than $20,000.

    But der is no linkage between government spending and tax increases in da US anymore, so everyone is brainwashed inta think’n higher taxes is somthi’n dat happens in da distant future.

    So it will be be a big shock next year when we find out we can’t borrow it all.

  • Posted by Cedric Regula


    Our capital structure is “Leverage, Leverage,Leverage”

    You are seeing da problems wid dat now.

  • Posted by T. Aldrich

    I just don’t get this whole thing. I don’t know finance, so I’m flying half blind anyway, but to start with, the “discussants” (e.g., Paulson/Bernanke, and the whole flock of economists weighing in — Krugman, Thoma, the Vox guys, to some extent the FT bunch) slide seamlessly from commercial banks to the “shadow banks” and from attentuated lending to the non-financial sector to the threat of systemic panic in the financial sector, so that you can’t usually tell what problem they think they’re talking about.

    I can see an attenuated lending problem with the commercial banks, and I maybe can see the threat of panic in the shadow sector, but I can’t see the cross products. I thought we had commercial banking protected from panic, and I just don’t see how the pyramid scheme in the financial sector is all that important to the flow of funds to the non-financial sector, but maybe that’s what I’m missing.

    You ought to keep going with the numbers thing you started yesterday. My back of the envelope stuff runs along these lines: If toxic home mortgages are the root of the problem, there are about $11 trillion home mortgages altogether. Commercial banks hold $3 plus trillion directly, and the GSE’s and their pools hold $5. I assume the takeover of Fannie and Freddie secured the latter.

    Then there is about $2 trillion funded by ABS securities, of which there are about $4 tril total, mostly showing up in Fed’s bookkeeping as corporate bonds. There you kind of lose track of the ownership, because there is about $11 tril total of corporate bonds, and they don’t distinguish ABS within that.

    But if you look at the ownership of the $11 tril corp bonds, you get:

    Non financial sector $ 2T

    Insurance reserves, pension funds, mutual funds $ 3.5T
    (I take these to be front-line agents of the non fin sector, and distinctly not part of the pyramid scheme)

    Rest of the world ~$ 3T

    Commercial banks $ 1T plus

    And then we have money market funds $400 billion, and the broker-dealer/funding corp group for $ 650 billion.
    This is where I surmise the possibility of panic lies, noting particularly that the broker dealer/funding corps are heavily funded with commercial paper and repos, and the money market funds are big suppliers of this kind of funding.

    But surely there is a way to handle this problem without turning the world upside down.

  • Posted by Joe Rotger

    If credit default swaps out there account for $62 trillion, and we give a moment to the thought that they should have never been created, nor allowed in the first place, then we have a better picture of how bad things can get.

    Not created, nor allowed, because
    * risk valuations were never going to be true, it was in the best interest of S&P and Moody to give away higher ratings in order to enlarge their very competitive portfolio of clients…
    * the insurer taking the short side of the CDS bet, never put up with the necessary collateral to cover the risk, which is the at the root of the problem…
    * the seller and buyer of the CDS were too greedy and far removed from the transaction to realize that the insurance policy was deficient due to insufficient backing…

    This last point, very similar to what occurred with Freddie Mac and Fannie Mae, which were too far removed from the origination of the mortgage, hence, the field bank was careless in weighing in the financial fitness of the mortgagee, as long as he was able to pass along the loan.

    In conclusion, there’s $62 trillion in company debt default insurance, which could gradually come due as the economy slows down, because more and more companies would not be able to service their debts, forcing them to execute their CDS (or debt insurance policies) to cover their debts… and the insurers (investment banks and others) do not have the funds to cover these debts.


  • Posted by Flabbergasted in Palo Alto

    How bad is it?

    On Tuesday, I stopped by Wells Fargo to pay my installment of credit line. (Interest only!) I am almost maxed out at about 60% of what looks like the value of my house. I was invited for a talk by a friendly guy who has helped him before. I expected that he would tell me the bad news (“No more money for you buster. Shape up and start repaying.”)

    Instead, he volunteered to increase my limit by about 120K.

    That’s scary! In February 2007, he had offered to raise by by 150K. 🙂

  • Posted by obey

    Following up on Aldrich’s numbers, I have a question for those who aren’t sick of the what-I’d-do-with-700bnUSD game.

    If the core of the credit crunch difficulties lies in this tranch of 11 tn corporate loans, why does Treasury not simply start selling credit default insurance until the price of credit gets back to manageable levels. It would require the tax-payer risking some funds, but nothing of the magnitude of the Paulson plan. The required insurance fund would surely be able to get a good price for the insurance given it was backed up by the tax-payer, and could in large part be self-financed.

    The idea is to deal with the crisis by tackling the problem of a lack of confidence in debtors compounded by the absence of viable insurance through the CDS market. Due to the interdependence of the market participants, either no insurance is offered or if it is, the insurer is no more viable than the debtor. Bringing the government into the market as an insurer of last resort provides the stability to bring the creditors back into the market.

    Do tell me if this is ridiculous…

  • Posted by Cedric Regula

    obey:Do tell me if this is ridiculous…

    Me an’ Uncle Bruno tinks so, but it’s nada yous fault for tink’en dat way.

    Uncle Bruno tinks that a even bigger problem dan high leverage is insuring high leverage. Uncle Ponzi never even thought of dat, an Uncle Bruno can’ta believe anyone really went for da deal. But dey did to da tune of 62 Trillion. But having da feds step in as insurer of last resort has da same problem we gots now. Da feds an’ da taxpayer don’ta have da collateral anymore to back up da insurance. So it’s just more smoke an’ mirrors.

    Uncle Bruno dont’a know much ’bout CDS but he had an unusual cheery thought. He’s tinking like if’n yous buy car insurance, don’ta have a accident, then find out your car insurance company went bankrupt, all yous out is da price of da policy, an’ yous can probably live wid dat.

    Be kool if da CDS market worked dat way???

  • Posted by dunnage

    Fine. I’m not concerned with tomorrow’s regulations. I’m not concerned about exec. compensation.

    I want equity for the taxpayer or no deal. Equity in every move that Paulson makes. And I mean for real with oversite seeing to it. Hell, the man hid $$$$$$ under a bed at G.S.. Equity.

  • Posted by Cedric Regula

    Joe Rotger:

    Right on view of da situation, but one minor correction. Da $62T in CDS was written against da $11T in residential mortgages.(as reported in RGE). Confusing, I know. Uncle Bruno tinks da FBI should busy demselves wid dat one an’ leave us along. He’ll even mail ’em all der bugs back, no charge.

    Corporations are thought to be in generally good shape, outside of financials and casinos.

    Greenspan did estimate the total global derivitives market to be 5 times global GDP, or about $250T.

  • Posted by KnotRP

    “lack of confidence in debtors” is not the problem.

    I have a relative carrying $1.1M worth of pay option home loans, making minimum payments (and recently stopped paying on one since the renter lost his job and stopped paying), while he and his wife make less than $100K a year.
    The math just doesn’t work out. period.
    I am *quite confident* they won’t be able to make the lender whole. Or even half.

    See the difference between a confidence (liquidity) problem and a solvency problem?

    There is no amount of credit you can extend to
    him that will make his ability to pay improve.

    The Fed’s “hold-to-maturity” plan is hogwash.
    The housing behind that $1.1M could probably recover something under $500K if sold any time in the next 10 years. The only thing that…ahem….”helps”…would be total recklessness leading to a destroyed dollar.
    Then, maybe, the houses are worth $1.1M again….but maybe they end up worth $10M.

    The losses cannot be recovered.
    This is about loss shifting.
    If the losses are moved from the imprudent, to the prudent (where the money is), the prudent will learn an unintended and undesirable lesson from which the dollar will not recover.

  • Posted by Michael

    Tsk, Tsk, Tsk

    How pathetic it is to watch the rabidly ideological American free-market “anything goes” debt-worshipping populous (from the government, through Wall Street, to Main Street) freak out when the free market tries to rebalance itself toward a sustainable equilibrium.

    The Reaganomic model of zero regulation, maximum debt, maximum leverage “trickle-down” overfeed-the-wealthy was eagerly adopted by all parties, and the debt-and-leverage-stimulated 25-year expansion was noisily held up as proof of American superiority (even arrogantly called “The Great Moderation”). The rest of the world bought the scam and fed wetly at the trough, including the Russians and the Chinese.

    As any objective student of free-market capitalism can predict (see Hyman Minsky 1988, for example), with no internal or external constraints the free market players (right down to the homeowners seeking infinite leverage with their no-down payment mortgages) will ALWAYS substitute income/savings with leveraged debt as a means to faster, better, bigger, more economic growth. If natural steroids help us develop muscles, why not inject ourselves with more and more synthetic steroids?

    Anybody with an I.Q. in triple digits knew this rubber band could only be stretched so far, and many have predicted during the last decade the contraction or breaking of the band. Obviously a contraction would bring slower growth – and that is unacceptable in the Glorious American Victory Through Leveraged Debt paradigm – but a sudden breakage would be much, much worse.

    All the pigs at the trough ignored and insulted the level-headed economists and politicians who warned about aggregate debt reaching 350% of aggregate GDP, with the rate of credit creation and the degree of leverage accelerating. More and more cheap credit was and is being poured forth to prevent a credit contraction, and now we are at the breaking point – manifested by credit still being cheap (6% mortgages and car loans), but the credit markets themselves are frozen with almost no loans being made. That’s what happens if you artificially try to force rates of return into permanently negative territory – no one wants to loan at all (especially at the end of the 25-year binge when default becomes the order of the day).

    The biggest of the bigwigs are panicking as they look over the precipice they have created by preventing a natural, gradual credit contration to equilibrium, and they finally see the total credit crash and “economic Armaggedon” (the breakage) about to hit. They’re scaring the greedy, economically unsophisticated American (and World) populace to death – which will add to the velocity of the economic contraction.

    They’re still not listening to objective free-market economists, who clearly are warning that using more government borrowing to funnel obscene amounts of bailout cash to Wall Street is just adding to the unstable over-indebtedness problem that is trying to self-correct; the rubber band is just being stretched further, and it is definitely starting to break.

    Gloom and Doom?

    Well, the recessions/depressions at the end of credit binges are always experienced as Gloom. But, if we keep on this path, the “unthinkable” (you know, like housing prices going down, Bear Stearns/Lehman Brothers/Merrill Lynch/AIG suddenly folding, etc) may take place: The creditors who hold our government debt (and will have to loan us even more as we give trillions to Wall Street) – China, Russia, Japan, and the Gulf Sheiks – may get sick of losing money by subsidizing us, and they may stop buying Treasuries that pay a negative real return. Then the crash of the Glorious American economy will make the Great Depression look like a dimple.

    That’s Doom.

  • Posted by Cedric Regula


    Exactomundo. Amazing how many people here get it.

  • Posted by Cedric Regula


    Yup. Da feds tink dey can force feed cheap credit down da consumer’s troat an’ grow GDP.

    Supply siders tell da feds cutting taxes will help grow GDP an “grow da deficit shut”, so’s da feds can spend all dey want.

    Corporations say dey can outsource jobs to da turd world an keep inflation low.

    So’s yous sees sumthin wrong wid dis picture?

  • Posted by Twofish

    Aldrich: I can see an attenuated lending problem with the commercial banks, and I maybe can see the threat of panic in the shadow sector, but I can’t see the cross products. I thought we had commercial banking protected from panic, and I just don’t see how the pyramid scheme in the financial sector is all that important to the flow of funds to the non-financial sector, but maybe that’s what I’m missing.

    The basic problem is that you are looking at the asset part of the equation and not the liability part. Typically what a banks balance sheet looks like is that for every $1000 in assets, it owes about $900 to depositors. So on the one had you have $900 owed to depositors, and then on the other hand you have $900 in loans, $20 in cash, and $80 in securities. They only have enough cash on hand to pay out deposits, and if you have lots of people wanting cash, they sell securities, and if things get really bad, they trade loans with the Fed for cash.

    Under normal conditions, most people pay their mortgages, and you don’t have a problem. The trouble is that suppose the loans are not worth $850 instead of $900. You still don’t have a problem because you still have enough worth to pay your depositors. Now suppose all of a sudden your securities are worth $40 instead of $80. You now have barely enough assets to cover what you owe to depositors. If you suddenly have a run on banks that pushes loan values or securities down, you have a big mess.

    Put that’s not the worst part. The worst part is that if you go under, then this triggers a credit insurance payment, and if the people who are having credit insurance don’t have enough money to pay out the insurance, they go under, which triggers more insurance payments.

  • Posted by Twofish

    The way that this can spread to non-financials is this. Suppose you are a car company that wants to buy steel to make cars. You don’t have the cars yet, so you borrow money from the commercial paper market to buy steel. Once you turn the steel into cars, you sell the caars, and repay the loan.

    If banks stop making these short term loans, then you can’t buy steel, you can’t make cars, and there are no jobs. Right now people are still sort of lending is still going on because people thhink that there will be a bailout. If there isn’t then banks are going to find they are underwater, and the commercial paper market will just evaporate.

  • Posted by Twofish

    This has been basically what I’ve been feeling like over the last week

  • Posted by KnotRP

    Twofish — so tax payers front the money and GM gets the steel to overbuild yet more automobiles, even though they cannot move what’s on the lots now. Overproduction. Worse yet, overproduction by a substandard builder.

    Money isn’t being lent because no knows of a productive enterprise worth dumping money into at this time. Substituting governement malinvestment (or just shotgunning it) backed by taxpayers does not reflate an economy…it causes capital flight.

  • Posted by KnotRP

    I said it before, but I’ll say it again:

    This country is making a monumental blunder by ignoring the US consumer’s ability to pay (i.e. real wage growth x jobs)….the US consumer’s inability to generate income growth in a global economy *is* the lever moving us to insolvency.

    It’s a monumental blunder. If we don’t wake up soon, it will only be the first of many…

  • Posted by Twofish

    I give up.

    One of the things about being a Buddhist is that ultimately you find out that some things are totally out of your control. I happen to be of the opinion that if something isn’t done in the next week or so, we are going to be seeing a repeat of the 1930’s, but if people won’t listen, people won’t listen.

    Anyway I’ve been spending too much time trying to explain all of this. Time to disconnect, and just accept fate.

    Just make sure you hold a place for me in the soup lines.

  • Posted by Dave C.

    The US Taxpayer bailout is Irresponsible…

    U.S. to lose financial superpower status: Germany

    BERLIN (Reuters) – Germany blamed the United States on Thursday for spawning the global financial crisis with a blind drive for higher profits and said it would now have to accept greater market regulation and a loss of its financial superpower status.

    In some of the toughest language since the crisis threw Wall Street banks into financial disarray earlier this month, German Finance Minister Peer Steinbrueck told parliament the turmoil would leave “deep marks” on both sides of the Atlantic, but called it primarily an American problem.

    “The world will never be as it was before the crisis,” Steinbrueck, a deputy leader of the center-left Social Democrats (SPD), told the Bundestag lower house.

    “The United States will lose its superpower status in the world financial system. The world financial system will become more multi-polar,” he said.

    Steinbrueck, in one of the harshest attacks on U.S. policies from a G8 ally, denounced what he called an Anglo-Saxon drive for double-digit profits and massive bonuses for bankers and company executives.

    “Investment bankers and politicians in New York, Washington and London were not willing to give these up,” he said.
    The German views were echoed by leaders of governments from around the world meeting this week at the United Nations in New York. Many sharply criticized the George W. Bush administration’s financial record and warned that U.S. financial mistakes now threatened the global economy.

  • Posted by b

    Twofish: Just make sure you hold a place for me in the soup lines.

    Last I checked, China is hiring, everyone from scientists to bankers.

    Something tells me that this is hardly the end of the world. In the grand scheme of things this is only a “virtual” collapse. A plague, an epidemic, famine, those are real. This is all about virtual numbers in the CPU and on the hard drives of the computers.

  • Posted by pseudorandom

    Twofish: One of the things about being a Buddhist is that ultimately you find out that some things are totally out of your control. I happen to be of the opinion that if something isn’t done in the next week or so, we are going to be seeing a repeat of the 1930’s, but if people won’t listen, people won’t listen.

    I wouldn’t worry so much. A repeat of the 1930’s is unlikely mainly because everyone is trying so hard to avoid exactly that (Bernanke downwards). I am sure we’ll find whole new kinds of economic collapse!

    Painful as this is going to be, what was going on in the last 6 years especially was completely unsustainable. It had to end, so we might as well get it over with now. Who knows maybe we’ll come out of this with a leaner, more humble and deleveraged financial sector. That’s can only be good for the economy.

  • Posted by Dave C.

    Obviously Brad Setser supports the $700 billion taxpayer bailout for Wall Street Banksters when he earlier erased my comments below:


    190+ Economists Slam Bailout

    Over 190 top economists in the country have slammed this bailout on grounds of fairness, ambiguity, and long term effects.

    What is it that Paulson knows that 190+ economists don’t? After all Paulson was telling us all how safe the US Banking system was just a few weeks ago.

  • Posted by bsetser

    DC — your post ran afoul of the automatic filters, not me, it is now up.

    knot RP — the absence of real wage growth (and the rise in real debts in that context) is at the root of this problem.

    palto alto — interesting observation. maybe i am too swayed by the mood in nyc among the money center banks.

    2fish — i hear you. my initial post had a couple of obvious errors (a massively incomplete sentence and a graph that was too big) but no one took the time to highlight them, which suggests to me that no one read my post all that closely …

    manch — i think pettis would argue that the us created its own volatility machine in a new way, namely through the use of heavily leverage to support assets that were claims on a highly leveraged consumers. but i am also perhaps putting words in his mouth. he has been more inclined recently to see weakness in china’s financial system than weakness in the us.

    alrich — i plan to continue, but there are only so many hours in the day. i don’t have spreadsheets set up to analyze the us flow of funds, so further analysis will require a bit of time.

  • Posted by koteli

    To gillies and brad,

    With lots of appreciation, I suggest you ti listen to Joe Jackson:

    The man Who Wrote Danny Boy

    It happened one night
    At three in the morning
    The devil appeared in my studio room
    And he said I’m your pal
    And I’ll make you a deal
    Blow away your struggle
    And I’ll take your soul for a toy

    After rubbing my eyes
    I looked all around me
    At the half-finished drivel I’d worked on for days
    And I told him my dream
    Was to live for all time
    In some perfect refrain
    Like the man who wrote Danny Boy

    And I said if you’re real, then I’ll ask you a question
    While most of us turn into ashes or dust
    Just you and that other guy go on forever
    But who writes the history
    And who do I trust?

    He gave me a wink
    And he said it was funny
    How mortals would pour all their blood, sweat and tears
    Onto tape, onto paper
    Or into the air
    To be lost and forgotten
    Outside of his kind employ

    Then I thought I could hear a great sound in the distance
    Of whiskey-soaked singing
    And laughter and cheers
    And they’re saying, that song could bring tears to a glass eye
    So pass me the papers, I’ll sign them in blood
    And the smell of the brimstone was turned into greasepaint
    And the roar of the crowd like the furies of hell
    And I hear the applause and I hear the bells ringing
    And the sound of a woman’s voice from the next room

    Saying come to me now
    Come lay down beside me
    Whatever you’re doing you’re too gone to see
    You can’t hold onto shadows, no more than to years
    So be glad for the pleasures
    We’re young enough to enjoy

    So maybe I’m drunk
    Or maybe a liar
    Or maybe we’re all living inside a dream
    You can say what you like
    When I’m gone, then you’ll see
    I’ll be down in the dark
    Down underground
    With Shakespeare and Bach
    And the man who wrote Danny Boy

  • Posted by koteli

    As I know that Brad is not in the mood of reading poetry, let’s give him a bit of sauce, from Krugman (which with Yves Smith, Calculated Risk and some others quotes him very often).

    Paul Krugman says:

    September 25, 2008, 9:34 pm
    Madness on Pennsylvania Avenue
    I hate nights like this — the news kept changing as I tried to finish the column. But this White House meeting was obviously one for the ages:

    House Financial Services Committee Chairman Barney Frank (D-Mass.) angrily accused House Republicans — with the tacit support of Republican presidential candidate John McCain — of crafting an alternative to undercut Treasury Secretary Henry Paulson.

    Both McCain and his Democrat rival, Sen. Barack Obama, left without any joint endorsement. A beleaguered President Bush had to struggle to maintain order and reassert himself. And when Democrats left after the meeting to caucus in the Roosevelt Room, Paulson pursued them, begging that they not “blow up” the legislation.

    The former Goldman Sachs CEO even went down on one knee as if genuflecting, to which Speaker Nancy Pelosi (D-Cal.) is said to have joked, “I didn’t know you were Catholic.”

    I don’t even want to think about what tomorrow’s TED spread will look like.

  • Posted by slumlord

    Paulson is a smart man and he is politically savvy.

    No one is arguing about the need for a bailout, what people are arguing about is it’s terms. The idea that the same people who made this mess will handsomely profit from the bailout is politically unacceptable

    Apparently, according to Fed Governer Fisher, Bernarke has been telling Paulson to institute systemic reform of the banking system for a long time. The fact that Paulson choose to unveil his “rescue plan” when congress has a financial gun to its head would imply–to this impartial observer–the maybe the taxpayers welfare is not high on Paulson’s scheme of things.

    Assume crash positions; we are going down.

  • Posted by Jehu

    bsetser Says:

    knot RP — the absence of real wage growth (and the rise in real debts in that context) is at the root of this problem.


    If this is true, Brad, why isn’t Washington focused on real and permanent tax reduction for working families with that 700Bn?

    All it would take is a decision to stand down on military spending, and the like, and shift the expenditures to this end – that is an increase in income for working folk of at least $4000 a year, or about $75 a week.

  • Posted by Guest

    To Jehu:

    The Fourth Branch of Government

    The US government (and many others) is divided up into three branches: executive, legislative and judicial. This was a bit of an innovation when it was created since previously the concept of government as separate from power groups was not as clear.
    A traditional society had some version of a royal ruler who was assisted by courtiers and appointed ministers. Judges and the rest of the legal system was devoted to settling disputes between people, not matters of state. In addition there was frequently a strong religious sector with its own source of funds and hierarchy.

    As time went on and the excesses of royalty become burdensome to the large landowners various types of legislative bodies were introduced, their ability to promote policies at variance to the will of the ruler was not assured.

    The innovation in the US was to do away with royalty and to replace this executive function with an elected official. The judiciary was (eventually) given responsibility, not only for settling domestic issues, but oversight over the constitutionality of laws passed by the legislature. Laws required the agreement of the executive and legislative branches to be enacted (with rare exceptions).

    The small permanent military presence that was the norm for most of the US history no longer exists. The military sector is now a continuing presence in the power structure. We in the west are used to thinking of other states as having the military as a quasi-independent force in society. For example Burma is run by the military. In China the military owns various industries outright. In Pakistan Musharraf retained his military position after he seized power in a coup. In Lebanon the military is being called in to stop fighting between armed factions since the “government” can’t do the job.

    I claim that the military is now the fourth branch of government in the US. The idea that it is part of the executive branch and is headed by civilians is just a technicality. It commands half the discretionary federal budget. It has a permanent hierarchy which remains in place regardless of which party is in power. It has members of the legislature who are its supporters and ensure that funded is maintained. It has the ability to determine which information about its operations are released to the public and even to congress and the judiciary. It has continuing relations with military contractors who supply lobbyists that work on promoting projects that will benefit both the military and the contractors, as well as sending military spending to the districts of cooperative legislators. It has a propaganda arm which supplies (mis)information to the press and the general public. It has over a dozen spy agencies which can manufacture intelligence information that suits the long term goals of the military.

    There was no provision in the design of the government for a fourth power center and as a consequence the “checks and balances” that apply to the three branches of government don’t operate on the military. It’s like a cancer and appears to be unstoppable. It has already sucked much of the money away from social services and infrastructure maintenance and is now going after political dissidents using the cover of domestic security.

    As I’ve said before, the ability of spy agencies to uncover plots by unknown actors is extremely limited. That’s why things like the London transit bombings can occur even with heightened surveillance. Agencies can’t find small groups of first-time actors who are careful not to be obvious in their planning. What spy agencies can do is to track political groups which are not trying to be invisible. In fact most of them make a point of trying to get the public’s attention, since their purpose to change the political dialog. When these groups start to be heard or are on the verge of getting their message out it is easy to round them up or prevent them from being heard.

    We see this time and again as political rallies are broken up, especially when they coincide with events that will be covered in depth by the media. This happened at both the Democratic and Republican conventions during the last presidential cycle and in many less publicized cases since then. In a new twist people can be forced to turn over records of innocent activity (such as library or phone records) and even the fact that a subpoena was issued cannot be disclosed. This is the ultimate in an abridgment of civil liberties.

    It just shows to what extent the military sector will go to keep its operation free of interference or oversight. Generally when the military gets this strong it either takes over the government explicitly (as in Pakistan or Burma) or permits a powerless government to exist as a “democratic” cover as in Lebanon.

    One could argue that we have not reached this stage in the US, the president and his advisers forced a war with Iraq, not the military, but we really don’t know. What would have happened if the military had really opposed the idea of invading Iraq? After all most of the top brass thought that the toppling of the regime would be quick and easy. This would also improve their image and give them further justification for future expansion. The few critics of the plan were removed from the chain of command or were in other branches such as the state department and were marginalized. So did the president order the war or was he allowed to do so?

    If the existence of this fourth branch of government becomes widely understood what changes can be expected? There is little incentive for the existing military/industrial/congressional nexus that is profiting from the spending to push for change. The public is still in a state of heightened anxiety over an invisible threat which seems to exist without end and the worry about a decline in the standard of living as resources become scarce makes support of a muscular foreign policy popular even as people deny this is their preference.

    As the limits on political activity increase the ability of the small group that wants to see change to get their message out will diminish further and only the road of militarism will be discussed. We have seen this path before, it occurred in Germany every few decades through much of the late 19th and early 20th Century. It occurred with many of the colonial powers in an earlier age. In every case the lot of the common man became worse as essential services were sacrificed to the god of war.

    The US is already suffering from weakened social services, especially in health care, education and employment support. Recently we have seen key civil engineering infrastructure start to crumble and the government unable or unwilling to protect citizens from natural disasters. When the USSR became a hollow shell with an over-sized military it collapsed from within. Is this to be the fate of the US?

    By rdf

  • Posted by Alan von Altendorf

    Twofish wrote: “Suppose you are a car company that wants to buy steel to make cars. You don’t have the cars yet, so you borrow money from the commercial paper market to buy steel.”

    Suppose you are a going concern that makes and sells cars at a profit. Positive cash flow and surplus working capital from retained earnings give you plenty of dough to buy steel, design new products, etc. I don’t think you’ve ever been in business, have you? Biggest users of CP are running on empty (“Just In Time” transposed from the shop floor to the treasury function). Sigh. GE has been stripped of working capital at this point, trying to flip every penny of “excess cash flow.”

  • Posted by BMH

    @Cedric Regular
    There is an interesting post written by Robert Waldman on possible consequences of overinsurence of debt over at Angry bear
    I wonder what Unle Bruno would think of it.
    Best BMH

  • Posted by Rien Huizer


    A couple of things that would have made this uesful piece even better:

    1. There is never enough bank capital in a systemic crisis (i.e. enough to make gvt assistance redundant), becasue of th ambiguous nature of -especially US- gvt responsibility for the financial system. I say specially US bacause of the extreme level of ambiguity (it is not even certain that decidedly non-bank, and totally devoid of prudential regultion- entities like money mrket funds, are non-insured) and because of the global nature of USD based finance.
    2. For some reason there has ben much attention for the politics of a specific solution (i.e. one that leaves the dominance of US firms in global finance intact (a mercantilist implicit seondary goal) without focsusing on the problem. Systemic crises feed on themselves, but as appears from widely accepted literature on the great crash of 1929 (for instance Friedman’s Monetary History of the US, systemic crises appear lrger than they really are and solving them may be simply more expensive than leaving them alone (not that I would propose this on the basis of the very little I can observe)
    3. One would like to see a range of solutions, combined with a reasonable assessment of the consequences. This plan appears poorly costed and risks being still too little, as well as a feding frenzy for speculators and assorted white collar crooks..

  • Posted by T. Aldrich

    Twofish: Then I take it that what you are saying, in response to my earlier post, is that the fear here is of a crash (not just attenuated lending) of the commercial bank system.

  • Posted by Joe Rotger

    Cedric: The CDS $62 trillion is a Moodys figure from this article:

    “According to Moody’s Investors Service, some $62 trillion of debt was protected by CDS contracts at the end of 2007. That number exploded from $10.2 trillion in June 2005 and represents the face value of the underlying debt. The face value would have to be paid to CDS buyers if all the underlying debt were to slip into default.”

    My point is that there is at least that much fireworks under the shack that’s already on fire… If water doesn’t get here quick, this will be one hell of a new year’s.

    And, yes… In that same basement you’ll find some other very flammable stuff, like subprimes, credit card debt… and the like.

    So, it promises to be quite an unforgettable spectacle to experience, unless, you get too close, of course.

  • Posted by Nicole Tedesco

    If these institutions held so much “bad debt,” one has to ask, “Who has been holding the ‘good debt'”?

  • Posted by Joe Rotger


    The issue here is one of investment banks acting as insurance companies without the necessary backup.

    Liquidity has the characteristic of allowing much more boats (all kinds of companies) to float than without it.

    Once the liquidity tide started to ebb, then companies began to falter too, defaulting on their debts, triggering credit default swap calls on the redemptions of these insured debts.

    These were supposed to be covered by investment banks, AIG, and such, the sellers of these CDS, but, they don’t have the money to comply with their obligations –akin to Lloyd’s stating that they could not comply on an insurance call.

    As a consequence, the seller of CDS, the company that borrowed and the bank that so freely lent, are all in big trouble.

    In essence, bankers disguised CDS as financial instrument, which otherwise would’ve been considered an insurance policy on debts, to avoid the latter’s stricter regulations.

  • Posted by Joe Rotger

    I found this wonderful piece at the NYT which explains through the AIG undoing the general gist of the thing.

  • Posted by London Remortgages

    I for one am glad that the Bush administration is finally out, maybe this mess can be sorted out by the new guys in charge, it’s about time something was done.