Looking back at 08; thinking about 09
Like Macro Man, I went back and looked at the things I was planning to watch in 2008. My list wasn’t exactly prescient. I didn’t warn of a risk that housing losses might bring about the end of the privately owned, highly leveraged US financial sector. But it also wasn’t totally embarrassing.
The Gulf opted for inflation (and negative real interest rates) rather than a revaluation — and now the pressure is off. So nothing much happened there. But Eastern Europe is proving to be Europe’s analogue to the US subprime crisis – though the initial trigger for the reversal in capital flows to Europe’s periphery was financial trouble in the US, not credit problems among Eastern Europe’s big borrowers.
Global reserve growth did peak. Some countries’ reserves are even now heading down, though not for the reason I would have expected. Global reserve didn’t fall because emerging economies decided to allow their currencies to appreciate. Rather it fell because private capital flows (and oil prices) went into reverse. As a result, the fall in reserve growth was tied to a fall in most emerging market currencies.
Losses on central bank reserves (and sovereign funds) did emerge as an issue. But the losses that became an issue weren’t losses from currency moves. Rather the losses sovereign funds took on their investments in the global financial sector emerged as a political issue – and those losses scared the world’s central banks. They incidentally had reason to be scared, as they were quietly taking on a bit of risk (kind of like the Reserve Primary Fund) both to eke out higher yields and to show that there wasn’t a need to take large sums away from central banks and hand them to new sovereign funds. Who would have guessed that the CIC’s investment in Blackstone would lead, indirectly, to SAFE’s decision to stop adding to its Agency portfolio? Talk about a bank shot. At the beginning of 2007 China was desperate to get a higher yield than Treasuries offered; at the end of 2008 China wasn’t buying much other than short-term T-bills that literally yielded nothing.
I certainly didn’t foresee that losses in the US and European financial sector would end up topping the (likely) total assets of the world’s sovereign funds. The losses in the financial sector were under-estimated by all (even Roubini, initially; his estimate of the size of the ultimate loss rose over time) while the size of the world’s sovereign funds (at least those with a mandate to take risks; the total size of sovereign funds can be inflated by counting stabilization funds managed by central banks) was almost certainly overestimated even before the recent market slide. And then the correlated slump in oil and global equities dramatically reduced their current and expected future size. The result: that the losses in the financial sector were so large that they effectively had to be backstopped by the taxpayers of the US and the major European countries. No one else – not even China – had a big enough balance sheet.
Nor did I contemplate the possibility that a banking crisis in the US might be good – at least in the short-run – for the dollar. And I don’t know many who predicted that oil would top $140 and fall below $40 over the course a calendar year.
What of 2009?
All leading indicators point to a sharp, synchronized global downturn in the first part of the year. But no doubt the year will also be marked by new surprises. My list of things to watch would include:
– The depth of the slowdown in the emerging world. China has slowed far far more rapidly than most expected. The major source of its downturn has been a slump in domestic construction. But falling exports are now starting to play a role. I wouldn’t rule out the possibility that its economy may contract for a quarter or two. Russia is in deep trouble even if oil bounces back to around $50. Its economy will contract if nothing changes. Some other oil exporters are in a similar situation. The Gulf (apart from Dubai) is in better shape, but even if is being squeezed a bit. Oil and gas importers in Eastern Europe aren’t faring much better. Ukraine looks set to fall off a Icelandic cliff. Some other Eastern European economies with large current account deficits may follow …
There isn’t yet consensus on the likely growth trajectory of the emerging world though. Jim O’Neill of Goldman remains rather optimistic. That is why, I suspect, that there is a greater chance that the emerging economies will surprise on either the downside or the upside.
– What happens to East Asia’s current account surplus? China’s trade surplus has increased in the last part of 2008, as imports have fallen more than exports. Korea’s current account should once again post a surplus. Chalk that up to a big fall in imports. Japan’s trade surplus by contrast seems to be shrinking — and the strong yen augers further trouble. East Asia is on one hand benefiting from a big improvement in its terms of trade. It imports a lot of commodities. Domestic demand in China is also falling due to a slump in construction – which impacts import volumes. And on the other hand it is being hurt by a sharp fall in its exports. The balance between those two forces is still a bit unclear. At this stage I would bet that Asia’s surplus rises — in large part because I am not convinced that China will do enough to stimulate its economy to offset what could be a sharp fall in investment. I hope I am wrong.
– What happens to the United States non-oil trade deficit? It was improving quite rapidly for most of the past two years, though a rising oil import bill kept the overall deficit up. But forward looking indicators suggest US exports are poised to fall. Imports are falling too – but a successful stimulus might eventually break their slide. At this point I am expecting the non-oil deficit to get worse not better in 09 as the US does more to stimulate its economy than the rest of the world … the overall deficit will still fall though thanks to the a big reduction ($250b?) in the United States oil import bill …
– How are the world’s remaining current account deficits financed? Cross-border flows have collapsed. The oil exporters can finance deficits by selling off the assets they accumulated in 2007 and 2008. That though isn’t an option for most of Eastern Europe. The Balts, Romania and Bulgaria all have large current account deficits and most also seem determined to maintain their currency boards (Romania is an important exception; it never had a currency board). Bringing their external accounts into balance consequently requires a huge contraction; avoiding that contraction requires a huge amount of financing. It is also a live question for the US, as the improvement in the United States non-oil balance may stop. If China continues to run a large current account surplus it almost has to be the main source of financing for the US. If the Eurozone is taken as a whole, there may well just be one big deficit and one big surplus in the global economy. But that financing could come either from hot money outflows or from continued Chinese reserve growth …
– What happens to Treasury yields. Short-term bill rates are effectively zero. The ten year yield is now a bit above 2%. It was close to 4% not so long ago. The Fed wants to keep it down. Low long-term rates would help support home valuations, and thus potentially reduce the scale of the mortgage restructuring that the US needs to bring household debt in line with home prices. Some increase in yields wouldn’t be a bad thing. It would indicate that the flight to safety has abated, and investors aren’t buying Treasuries simply because they aren’t convinced anyone else will give them their principal back. It could signal that investors are willing to keep money in the banks – and there is enough demand for bank lending that the banks want the funds. All that wouldn’t be bad. A big increase in yields though would be a problem … as it would suggest that the United States external deficit limits its ability to run a stimulative macro-economic policy. Bad as things are in the US, they would be worse if the US current account deficit had to swing into surplus quickly to finance (net) capital outflows.
– Whether or not the banks have all come clean and are valuing all their assets at realistic levels, or whether there is still more trouble to come … and whether or not a second round of bank recapitalization/ purchase of troubled assets will be needed.
What have I missed? Dani Rodrik — who is always worth reading — puts more emphasis on the nature of the policy response in the advanced economies, and I would guess that Paul Krugman would as well.
And what might emerge as an issue in a way that surprises many?
Genetically modified seeds.
http://geoeconomicsindia.blogspot.com/2009/01/what-is-dr-brad-setser-missing.html
Protectionism. Plain and simple. Do the governments of world rally together in 2009 for the benefit of all or does each government in turn pursue parochial policies that serve to protect national industries at the expense of their neighbors and trading partners? Sadly, I think we all know the answer. It’s being written right now in Russia, China, the U.S., Vietnam, etc. etc.
BusinessWeek Quotes Michael Pettis supporting an US Trade War with China. It’s all China fault that US manufacturers aren’t globally competitive in almost every labor intensive industry. Not a sentence about trade barriers by the US government that prohibit high-tech exports to China where Americans still retain some comparative advantage (ie. supercomputers, semiconductors, machine tools, satellites, carbon composite materials, aerospace parts, etc). General Motors receives billions of US taxpayer dollars to pay exorbitant executive salaries to incompetents, but Michael Pettis complains about some Chinese government export programs for sock and shoe manufacturers. Even Businessweek admits that the Chinese government hasn’t broken any WTO trade laws. The Chinese should boot Michael Pettis from Beijing for slanderous remarks.
http://www.businessweek.com/magazine/content/09_02/b4115019705175.htm?chan=top+news_top+news+index+-+temp_global+business
Beijing University finance professor Michael Pettis goes so far as to liken China’s tax-rebate move to the Smoot-Hawley Tariff Act of 1930, the U.S. law that sharply hiked tariffs to protect American manufacturers. Smoot-Hawley is widely blamed for a wave of global protectionism that helped usher in the Great Depression. Back then, America was the world’s workshop and suffered from huge overcapacity at a time of global contraction. “China is in the same position today,” says Pettis. “So far, China is acting like it thinks it can export its way out of this problem. I am very, very worried.”
This is slightly long but the topic - The Reserve Currency Status of the US Dollar - is quite complicated:
In my humble opinion there is a significant risk that the US dollar will lose its reserve currency status. However my view is that at worst this can happen gradually over a period of time rather than in a sudden manner.
The recent debate around the reserve currency status of the US dollar must be examined in terms of different dimensions that impact this status and also from the perspective of various private and state actors who influence it.
George Soros in his March 2008 book “The Credit Crisis of 2008″ predicted the end of an era and the collapse of the US dollar. He recounted that in January 2008 he went massively short on the US Dollar and long on the Indian stock market. Both the positions were losers and his firm,according to the book, “took it on the chin”. Marc Faber, Jim Rogers, Peter Schiff and perhaps Stephen Schwarzman are other US dollar bears.
If any other country on earth had been in the same macro economic situation as the United States was in 2008, its currency would have been subjected to a massive speculative attack from private currency speculators. This would have begun with a tremendous build up of short positions on the currency in the forex derivatives market. The fact that the US dollar escaped a successful attack from currency speculators in 2008 does not neccessarily augur that it will indefinitely retain its unique role in international trade as well as its exorbitant previlege to run painless fiscal deficits.
In 2008 several state actors have openly indicated a policy shift in the composition of their central bank foreign exchange reserves. Iran’s President Ahmedinijad made a self congratulatory speech in which he claimed that his decision to shift over from the USD to the EUR as the Iranian reserve currency was apt both from an investment perspective as well as from a political perspective. The German Foreign Minister Peer Steinbruck gave an interview in which he predicted that future forex reserves would move towards a combination of the US dollar, the Euro, the Japanese Yen and the Chinese Renminbi. Nicholas Sarkozy of France indicated that “the US Dollar is not the only currency in the world” in his statements prior to the G-20 summit. Though Japan continued to maintain strong support for USD denomination of international trade, Japan made a request to the US Treasury to issue Yen denominated debt securities to the Bank of Japan.
Given the political enmity with Venezuela’s Chavez and Russia’s Putin, those two countries will probably welcome any chance to ensure the demise of the US Dollar.
The only prominent supporters of the US dollar are emerging market economies like China and India. These countries are compelled to peg their currency to the US dollar since significant percentages of their population is directly dependent for their employment on a sustainable profitability of their export sectors.
Trade protectionism is another aspect which impacts the US dollar. Given Obama’s recent focus on data from manufacturing and unemployment statistics in some of his comments, there is widespread speculation that the new administration is likely to pursue protectionist policies. If the level of export demand for emerging market output becomes unsustainably low due to protectionism the remaining state supporters of the US dollar reserve currency status will change their view.
If the Obama Administration does not resort to severe trade protectionism it is quite likely that 2009 will see the US dollar gradually weakening against major world currencies, rather than undergoing a sudden collapse.
However in this analysis we have to recognize that a lot depends on the relevant emerging market economies wishing to sustain employment levels in the medium term. In the longer term, it is difficult to see how or why a country like China, for instance, would want to continue the policy of accumulating US Treasury bonds in lieu of real goods.
Brad,
Your outlook relies on a view that global trade as a % or GDP will remain static. For instance, you see the U.S. stimulus propping up non-oil imports; in turn, that means the Chinese surplus also remains high.
A different scenario grows out of the GD experience, where global trade plunges. Some of that contraction was caused by protectionism, which we may or may not see this time around. But part was caused by the impermanence of European imports financed by borrowing (as Michael Pettis has pointed out). We face a similar situation today.
I think you are implicitly stating that public borrowing from the stimulus can prevent U.S. total credit from contracting and taking imports with it. That’s a tall order. Maybe that’s what we’ll get as the Fed will be the principal financier of the U.S. Treasury, and those newly-printed dollars will buy real goods from abroad. But how long will the suppliers of those goods continue to sell them at declining real prices?
At the end of the day, the assumption, “we cant have dollar inflation as long as there is high unemployment,” is kind of like saying, “nominal U.S. house prices never fall.” The latter assumption is so gargantuan in its implications that it drives just about everything else (as it did from 2003-2007). By the same token, relax the assumption and the outlook yields all manner of possible black swans.
David — I didn’t intend to assume that trade stays constant as a % of GDP. I would expect both US imports and exports to fall as a % of US GDP, and Chinese imports and exports to fall as a % of China’s GDP. If us exports fall faster than US (non-oil) imports, the US non-oil deficit would still rise — and that deficit has to be financed.
Indian investor — India hasn’t consistently pegged to the $, tho it did intervene heavily to limit appreciation v the USD in late 07/ jan 08. More importantly, India actually has a fairly low share of its reserves in dollars. Lower than Russia I would bet, and well below China … so i wouldn’t lump the two together as big supporters of the dollar.
Moreover, india’s reserves have been falling for several months now.
It is not ‘protectionist’ to insist that foreign CBs cease currency interventions. They are contributing to unsustainable and dangerous global imbalances. A problem for the U.S. making this case is that uncle ben is now one of the biggest violators. We will have to wait and see if the ‘temporary’ swaps will be reversed.
As for those who view the euro as a viable alternative to the dollar, they may be in for a nasty surprise. the euro area is not an opimal currency area, and Germany may prove one of the most exposed (and adversely affected) economies in the growing economic slump.
One trend in 2009 is the growing importance of blogs and electronic media and the growing unimportance of traditional media.
What’s the point in reading what Michael Pettis has to say in a Businessweek article when you can go to his blog and ask him? Even worse, what is the point when the article doesn’t even link to Michael Pettis’s blog?
This is going to be particularly interesting when you start having major pieces of legislation start going through Congress. Just like Roosevelt was the first President to recognize the power of radio, Kennedy was the first President to realize the power of television, Obama is the first President to realize the power of the internet.
Also, it will make a difference in the relative strengths of national governments via international and corporate institutions such as the UN, IMF, WTO, or World Bank as national governments have incorporated the internet and new media into governance in ways that international and corporate institutions have not.
Alonby: Sadly, I think we all know the answer. It’s being written right now in Russia, China, the U.S., Vietnam, etc. etc.
It’s actually not. No one important is pushing for, or even seriously suggesting withdrawal from WTO, and without withdrawal from WTO, there are limits to the type and amount of trade protectionism you can get.
The type of trade protectionism you see is very seriously limited. Now there is a huge amount of capital protectionism, and that will likely increase.
Predictions for 2009
http://globaleconomicanalysis.blogspot.com/
Looking ahead in 2009 here are some things I see as likely.
Obama will pass a stimulus package of $850+- billion but $300 billion will be “tax relief” amounting to $19 a week at most. $19 a week per household is not going to stimulate much of anything but it will add to the budget deficit. People will use that money to pay down bills, which is exactly what they should be doing with it.
The first 3-5 months are going to be extremely weak on the jobs front with 400,000 or more jobs lost each month. Obama is going to need to create 2-3 million jobs just to counteract job losses in first half of the year. There is no way he is going to create jobs that fast given implosions in state budgets and retailers.
In 2009 consumers will continue to retrench, housing will continue to decline, and as many as 100 small or regional banks will implode over falling commercial real estate prices. The Fed may arrange shotgun marriages with these banks instead of letting them go under.
I am sticking with a thesis that says we are currently in a sucker rally in the stock market that will end soon after inauguration or moments after Obama signs a new stimulus package. My target is 600 on the S&P but 450 is not out of the question. However, it is better to think of this in ranges and that range would roughly be 450-700.
It is quite possible the lows in treasury yields are in. Unlike 2008 where I was constantly beating the drums for lower yields, 2009 could be different. Here are the facts: 3 month and 6 month yields hit 0% and the 10 year came close to hitting 2%. Could there be lower yields still? Yes, quite easily. Is it worth playing for other than as a hedge or part of an overall investment strategy? No.
There is no reason to proclaim an end to the trend of rising foreclosures and falling home prices. Rising unemployment will seal the fate in 2009. The bottom is not in.
I see 2009 as depending on whether or not the Congress and the President re-focus attention on the forgotten issue of toxic assets. Unless the financial industry faces the reality that created our problems, I expect all stimulus packages, regardless of size or content to fail.
This is very much a fairness issue, in my mind. No way taxpayers should be expected to make whole those who made bad choices regarding bets on sub-prime mortgages.
Now that the dust has settled a bit, the first action should be to allow firms to go bankrupt, regardless of size, or provide some other universal reduction in the size of the bills not paid - anything to clear up the bank’s balance sheet without the banks receiving more money from the Fed.
DCJ:”I am sticking with a thesis that says we are currently in a sucker rally in the stock market that will end soon after inauguration or moments after Obama signs a new stimulus package.”
If I may offer my own guess, I think the rally will continue somewhat longer (not necessarily in one smooth movement), but will end in new lows by the end of the year.
1. January-Rally on negative news. Analysts remain delusioned.
2. February: Shocking medicare fraud which will move markets lower arrive after the 1st week. S&P starts downtrend from 950 level.
3. March: Ides of March, a major commercial real estate firm files bankruptcy and a major U.S. bank fails (merges) going into the G20 Meeting in London. GM/F come back begging for more. Citigroup joins. Another level of Financial writedowns shock markets as credit card writedowns bring a new dimension on the Horizon. S&P closes March at 775, although right before the G20 meeting it reached 725.
4. April: Unemployment numbers weaken. U.S. posts 1st ever 750K job losses in the month of April. 5 Major retailers file bankruptcy and consumer sentiment reaches a shocking low.
5. May: Oil trades at new multi-year low of $27 barrel. S&P now trades at 680.
6. June: Markets rally slightly on better than expected jobs report coming in at 550K jobs lost. S&P moves back to 730 Level.
7. July: Markets trade flat. Oil moves back into mid 30’s.
8. August: China’s Q2 GDP comes in at 6.3%. Far worse than expected by most analysts. Although trading heads slightly lower the S&P
finishes August at 690. In this month another 900B of funds for the financial sector has been proposed by Senator Barney Frank. All the major U.S. financials are trading at record lows.
9. SEPTEMBER: Marks the first month of 1M U.S. jobs lost in U.S. History. The federal reserve and treasury have added hundreds of billions (if not Trillions) to the balance sheet and it is on SEPTEMBER 21st, 2009 that the United States Wakes up to read “U.S. Loses it’s AAA credit rating” on a downgrade from…Additionally GE’s credit rating is also downgraded. The S&P drops 150 points in September to close at 540.
10. October: Dollar begins massive downturn and breaks through 1.7 on the Euro. Another horrific jobs report of 900K lost jobs hit the wires. Although Congress is able to pass an additional massive Financial aid package the markets barely rally finishing October at 565 on the S&P.
11. November: Dollar to Euro ratio is now 1.81:1. Another major commercial real estate firm goes bust. Tensions become apparent in middle east as nations struggle with budgets as oil closes the month trading at $25. S&P drops to 550.
12. December: Some relief sets in sight this month as it appears the weaker dollar has aided some of it’s international companies. A better than expected jobs report of 650K lost jobs moves the market higher going into 2010. The S&P finishes 2009 at 578 and 1 euro nearly gets 2 U.S. dollars.
On this note, my advice is “sell in January and go away”.
@ Brad:
Thanks for clarifying. I stand corrected. India’s reserves and interventions are quite small compared to China’s.
I’d be happy to know the source of data for the currency composition of India’s forex reserves? I think the RBI reveals the currency composition of external borrowings on their web site but not that of forex reserves. My guess is that your source is BIS data.
The composition of india’s reserves can be inferred, in very broad terms, from the scale of the valuation gains that india reports on a quarterly basis in a document put out by the RBI called something like sources of accretion to the foreign exchange reserves. the split between currencies in the SDR basket and other currencies is also disclosed as part of the data india discloses on its reserves through the imf (see the reserves data on india’s imf country page)
predictor — europe is in trouble if euro is above 1.5 in a sustained way while europe is also posting bad jobs numbers/ big financial losses …
Bset-you are correct! As Paul Craig Roberts would note a collapsing dollar will indeed cripple the European economy. No way around it.
Big difference between EU-US is the consumer…Also all the firms on Park Ave took $$$ from TARP, except? Deutsche…
Standard of living will decline around the world (especially U.S.) and I could see aspects of regional protectionism arise (tariffs).
The crisis will be far more difficult than the situation the world faced during the 1930’s.
Also a note that the Eurozone is better integrated to deal with the crisis.
As George Osbourne has whispered, a collapse of the pound-sterling will provide UK the opportunity to join the EURO, as will Sweden and Denmark Spring2009.
2009 Alert: The Short Opportunity:
The Synthetic CDOs, or if you prefer, Credit Default Swaps - the primary instruments underlying the sCDOs - are the key to the house of cards coming down. What makes all this difficult to understand is the slicing up of the underlying CDSs and CDOs into tranches, and the repackaging of them into these sCDO instruments. This repackaging was ostensibly to spread the risk so no single failure could lead to a pandemic. However, there are clearly some time-bombs waiting to go off, and the higher-risk tranches seem to have gravitated into certain hands. Tribune Company was yet another of the time-bombs.
It is very difficult to determine who owns the sCDOs. But one way to simplify and give some transparency to the matter, help determine which defaults are likely to have the greatest impact, is to research which of the CDS-insured entities is holding the greatest amount of debt on their balance sheets. Those bankruptcies will cause the biggest shock-waves.
Another interesting thing to research would be to see which companies’ stocks tanked on the day the Tribune bankruptcy was announced.
I was interested in getting some reactions to my arguments about the likely global flow of funds in 09.
a general oberservation is that financing current account deficits in the private markets will he hard. But there is a risk here that i am inferring too much from the end of 08.
another argument is that the slowdown in the emerging world may be deeper than expected. that has a few implications:
a) in general, it suggests sustained commodity price weakness (helps commodity importers like the us/ hurts exporters)
b) it suggests that US exports will fall sharply as the dollar is a bit stronger and global demand is way way weaker.
c) if obama’s stimulus succeeds that implies more us demand and a less sharp fall in imports than otherwise would be the case.
d) a rise in the non-oil deficit from a faster fall in exports than imports tho only works if the financing is there — and who would supply the financing?
e) Asia and the eurozone, both of which benefit from low commodity prices, are the obvious answers. asia more than europe ..
f) but who in Asia? the official sector as intervention resumes (including say in japan, as Hale forecasts?)? private hot money outflows from China?
This general chain tho feels very much like i am expecting a repeat of 02-04 (but with a much worse global environment, so a rising deficit stems from a slower fall in imports than exports rather than a rise in imports .. ) — a rising us non-oil deficit financed by asia. and history usually doesn’t repeat itself.
what could i be missing?
The Fraud that went on between AIG and Wall Street Investment Banks needs deep investigation in 2009. Without first reviewing our past we cannot prepare for our future.
A provision in the $700 billion bailout bill permits the Fed to pay interest on the collateral it’s holding, which is simply a way to funnel taxpayer dollars directly into the investment banks.
Why do you need to know all of these details? First, you must understand that without the government’s actions, the collapse of AIG could have caused every major bank in the world to fail.
Second, without the credit default swap market, there’s no way banks can report the true state of their assets – they’d all be in default of Basel II. That’s why the government will push through a measure that requires the suspension of mark-to-market accounting. Essentially, banks will be allowed to pretend they have far higher-quality loans than they actually do. AIG can’t cover for them anymore.
And third, and most importantly, without the huge fraud perpetrated by AIG, the mortgage bubble could have never grown as large as it did. Yes, other factors contributed, like the role of Fannie and Freddie in particular. But the key to enabling the huge global growth in credit during the last decade can be tied directly to AIG’s sale of credit default swaps without collateral. That was the barn door. And it was left open for nearly a decade.
There’s no way to replace this massive credit-building machine, which makes me very skeptical of the government’s bailout plan. Quite simply, we can’t replace the credit that existed in the world before September 15 because it didn’t deserve to be there in the first place. While the government can, and certainly will, paper over the gaping holes left by this enormous credit collapse, it can’t actually replace the trust and credit that existed… because it was a fraud.
And that leads me to believe the coming economic contraction will be longer and deeper than most people understand.
Since there seems to be near unanimity here with regards to an extended deep downturn I’ll take the other side of the bet.
The big surprise will be that Ben Bernanke is in fact correct in his assessment of how to avoid an extended collapse as per the 1930’s. He is doing exactly as he said he would do and that is to monetize assets for as long as is necessary to bring down the cost of capital and raise the nominal price level to a point where it makes sense for economic actors to make investments thus producing more economic activity.
He rightly understands that mal-investment is better than no investment. On a micro basis that means it is better for someone to be out working sub-optimally than not at all.
Another consequence of monetizing long term mortgage paper will be to reduce mortgage rates to a point where vacant housing will cash flow as rental property. This will stem the decline in nominal housing prices.
We just saw a mini version of this after the stock market crashing in 2001-2003 and will see it again. The big question seems to be where will all the newly created capital flow. Last go round it was residential construction, this time it is most likely going to be energy infrastructure.
From a long term investment standpoint I would favor copper over oil (electrification of transport), and anything linked to infrastructure. Finance will be out for a long time as risk capital will be hard to come by. This will however raise the return on that capital and it could be a very good time to invest in M&A, private equity and the like because the deals will be fabulous.
I believe that the bottom is in for the S&P and we will see very very strong annualized returns over the next 10 years simply because the pendulum has swung way to the cheap side and the public is going to take a long time to get things way overheated again.
Please add the following to your “Thinking About 2009″ list: realizing that the US housing crisis had absolutely nothing to do with subprime mortgages and everything to do with letting markets regulate themselves.
Do you really believe that the doubling in housing prices in the major metropolitan areas followed by the Case-Shiller index was due to subprime mortgages? This is a not a rhetorical or hypothetical question. Understanding the true reason for housing price bubble is essential to crafting long term solutions to this crisis.
@ Brad:
Thanks a lot for the information about inferring the currency composition of India’s forex reserves.
david_in_ct
Bernake and Paulson are absolutely wrong in their economic assessment of the US Economy. The Federal Reserve exclusively panders to the narrow economic interests of Wall Street finance capital to the detriment of society. In Paulson’s eyes, all that ails the United States is a “lack of consumer confidence”. Paulson and Bernanke want banks to lend in order for Goldman Sachs to once again reap enormous paper profits from subprime CDO and MBS securities. For what? Do we really need more? Houses? Condos? Pizza Huts? Home Depots? Lowes? Nail salons? Strip Malls? Walmarts? And if irresponsible banks did lend that money and new shopping malls were built, who is there to buy? What would happen then? Is the Federal Reserve balance sheet unlimited to bailout Wall Street banks? What about the problems that will create? Can problems be postponed forever?
“Spending now will only borrow from future production. The United States has been doing that for decades and all we have to show for it is an exodus of manufacturing jobs from the United States to China, and a housing bubble of epic proportion. The United States has borrowed itself into oblivion. Consumers have finally seen the light and are attempting to save in spite of horrible economic policy by the Federal Reserve encouraging them to do otherwise”, writes Mish Shedlock at his Global Economics blog.
There are two things to separate here.
One is how we got here and the other is what to do.
I am no fan of fractional reserve banking backed by a federal reserve which targets the price of money/credit rather than the quantity. I have posted here several times that I favor a system whereby base money is created algorithmically and that banks can not loan it into existence. The power of money creation is far too great to be put into the hands of apparently unregulated institutions.
That being said we are where we are. If the Fed sits by and does nothing and allows the entire financial system to implode we will have a horrendous economic downturn with the potential for extreme social damage. Anyone hoping/advocating for the economy to ‘cleanse itself’ in this fashion has about the same insight into the system as did 14th century monks that advocated bleeding and dung poultices for virtually any and all ailments.
Or they are talking their short book hoping to make a bunch of money while millions of peoples lives are turned upside down.
As for the idea of “‘Do we really need more? Houses? Condos? Pizza Huts? Home Depots? Lowes? Nail salons? Strip Malls? Walmarts”
the answer is yes. Except that it will be electric cars, cleaner energy, greater worldwide literacy, new medicines and everything else that people want for themselves and their children.
MRein: And third, and most importantly, without the huge fraud perpetrated by AIG, the mortgage bubble could have never grown as large as it did.
I think this is incorrect. AIG and CDS’s played rather marginal role in the mortgage mess. Without AIG and CDS, you’d still get as large a problem.
david_in_ct: Since there seems to be near unanimity here with regards to an extended deep downturn I’ll take the other side of the bet.
We need to define “extended” and “deep”. My best guess is 9-10% unemployment lasting another 12-18 months. That’s by far the worst recession since the Great Depression, but the good news is that we seem to have avoided the sort of systemic financial collapse that led to the Great Depression.
DJC: For what? Do we really need more? Houses? Condos? Pizza Huts? Home Depots? Lowes? Nail salons? Strip Malls? Walmarts?
I don’t know. If we can’t think of anything better to do, I propose that we start building strip malls on the moon. Maybe writing competitions and big, big prizes for people that can come up with the best poetry.
The trouble with the “paradox of thrift” is that if you shut down the economy because there is nothing to buy then everyone loses their jobs which causes the economy to contract which means that there is nothing to buy then everyone loses their jobs etc. etc.
david_in_ct: Except that it will be electric cars, cleaner energy, greater worldwide literacy, new medicines and everything else that people want for themselves and their children.
DJC: Wall Street Investment Banks won’t finance “pie in the sky” programs for clean energy or breaththrough medicines. Pandering exclusively to finance capital, the Washington Consensus ideologically opposes any “industrial policy” that attempts to organically grow “real economic wealth”. Financial manipulation is the name of the Ponzi game.
Barak Obama merely represents a different side of the same coin. The Obama administration is stacked with Robert Rubin cronies that intend to ruthlessly consolidate the country’s economic wealth of the nation into an Oligarchy cabal.
During the 1998 Asian Economic Crisis, the Indonesian economy was raped and pillaged by Robert Rubin and Hedge fund crony associates. Millions of women and children were left destitute while Indonesian energy assets were privatized to Wall Street banks. Under the banner of Neo-liberalism economics, the same ruthless treatment awaits the American people.
Twofish,
Bernanke and Paulson desperately want more lending and less US savings rate. If it is even possible to have less than the current 0% national savings rate, I have just the solution. Let’s all apply for taxpayer bailouts as banks. General Motors, Ford, and Chrysler are now registered as legal bank entities to receive US taxpayer bailouts. If everyone is approved as a bank, lending is sure to pick up. Then we can sit back and bailout the economy while getting rich lending each other with bailout money. Whoops, didn’t we just try that with subprime and Alt-A loans?
http://globaleconomicanalysis.blogspot.com/
“If the Eurozone is taken as a whole, there may well just be one big deficit and one big surplus in the global economy. But that financing could come either from hot money outflows or from continued Chinese reserve growth …”
Don’t hot money outflows associate with reserve contraction? So net reserve growth required for financing is just less?
DJC: Bernanke and Paulson desperately want more lending and less US savings rate.
I’ve never heard Bernanke and Paulson express the opinion that they want less US savings. They do want more lending right now, because banks are taking any cash they have and just stuffing it into treasuries since they think that next year is going to be bad.
Also no one said anything about more *consumer lending*. I don’t think that Bernanke or Paulson have any preference for whether the lending goes to consumers or businesses.
DJC: I have just the solution. Let’s all apply for taxpayer bailouts as banks. General Motors, Ford, and Chrysler are now registered as legal bank entities to receive US taxpayer bailouts.
Sure thing. The next step is basically a massive Federal program to give cash to people.
This is a silly thing to do when you are near full production, but we are nowhere near full production.
DJC: . Whoops, didn’t we just try that with subprime and Alt-A loans?
Actually no. The problem was that people were loaned money rather than just given it.
Also just because something is stupid to do at one point doesn’t mean that it is stupid to do at another point.
Dumping large amounts of water on a house causes a huge amount of damage, and it is pretty dumb to do it normally. However, if the house is on fire……
People have even been known to intentionally start forest fires in order to keep an existing fire from spreading, even though starting a fire is how the problem started.
So just because a policy was unwise or even totally stupid in 2005 doesn’t mean that it shouldn’t be done now.
Twofish,
There isn’t any economic reason for banks to lend money to either consumers or businesses. If banks are compelled to lend by the Federal Reserve, it will merely result in financial losses for the US taxpayer since almost every subprime debt security has been guaranteed by Paulson’s US Treasury. The US Shopping Mall economic model is history. We don’t need lending for anymore McMansions, Office buildings, Box department stores, or corporate welfare programs at AIG and General Motors. Both service and manufacturing sectors of the US Economy are already overloaded with record levels of debt. It is impossible to reflate a collapsed debt bubble.
TwoFish,
Here’s how it worked: Say you’re a major European bank… You have a surplus of deposits, because in Europe people actually still bother to save money. You’re looking for something to maximize the spread between what you must pay for deposits and what you’re able to earn lending. You want it to be safe and reliable, but also pay the highest possible annual interest. You know you could buy a portfolio of high-yielding subprime mortgages. But doing so will limit the amount of leverage you can employ, which will limit returns.
So rather than rule out having any high-yielding securities in your portfolio, you simply call up the friendly AIG broker you met at a conference in London last year.
“What would it cost me to insure this subprime security?” you inquire. The broker, who is selling a five-year policy (but who will be paid a bonus annually), says, “Not too much.” After all, the historical loss rates on American mortgages is close to zilch.
Using incredibly sophisticated computer models, he agrees to guarantee the subprime security you’re buying against default for five years for say, 2% of face value.
Although AIG’s credit default swaps were really insurance contracts, they weren’t regulated. That meant AIG didn’t have to put up any capital as collateral on its swaps, as long as it maintained a triple-A credit rating. There was no real capital cost to selling these swaps; there was no limit. And thanks to what’s called “mark-to-market” accounting, AIG could book the profit from a five-year credit default swap as soon as the contract was sold, based on the expected default rate.
Whatever the computer said AIG was likely to make on the deal, the accountants would write down as actual profit. The broker who sold the swap would be paid a bonus at the end of the first year – long before the actual profit on the contract was made.
With this structure in place, the European bank was able to assure its regulators it was holding only triple-A credits, instead of a bunch of subprime “toxic waste.” The bank could leverage itself to the full extent allowable under Basel II. AIG could book hundreds of millions in “profit” each year, without having to pony up billions in collateral.
It was a fraud. AIG never any capital to back up the insurance it sold. And the profits it booked never materialized. The default rate on mortgage securities underwritten in 2005, 2006, and 2007 turned out to be multiples higher than expected. And they continue to increase. In some cases, the securities the banks claimed were triple A have ended up being worth less than $0.15 on the dollar.
Why executives from AIG, Goldman and other players are not on trial facing prosecution is beyond me. Anyone care to explain? Fraud is fraud, and it’s very evident to me the way this game was played.
The most likely consequence for global capital flows in 2009 is that they will shrink much further and disappear altogether. The Obama administration clearly has a choice between domestic policy and foreign policy.
A domestic focus would imply a large fiscal stimulus spending with little or no protectionism. This policy will result in a recovery across the world.
A foreign policy focus would imply that the Obama administration should catalyze further economic contraction across the world with a view to impose certain desirable policy changes on foreign governments.The only way to accomplish this is to combine a domestic fiscal stimulus with a high level of protectionism. Domestic employment levels will improve rapidly with protectionism while foreign employment levels will collapse. Domestic hyperinflation has to be countered then with price regulatory interventions rather than monetary or fiscal policies.
Henry Paulson’s comments on re adjustment portend the imminent arrival of a protectionist Obama administration.
Indian investor -
Agree with much of what you say, but question the terminology. Would it be ‘protectionist’ to discourage foreign cb’s from intervening in currency markets? Such policies are producing some serious international imbalances.
MRein: Why executives from AIG, Goldman and other players are not on trial facing prosecution is beyond me. Anyone care to explain? Fraud is fraud, and it’s very evident to me the way this game was played.
DJC: Former Goldman Sachs CEO Hank Paulson was the largest drug-dealer in AAA-rated subprime garbage. Does that ring a bell why no one gets prosecuted for financial fraud, but instead get an US taxpayer bailout?
At least once in a while, some high ranking Chinese officials get the death penalty including a former Vice Mayor of Beijing for corruption, the former FDA Chief for bribery, and a former China PLA General for espionage for Taiwan.
I think the surprise will come from Asia. On December 13, there were two articles and a video on Reuters about a meeting in Fukuoka, Japan. The video showed the leaders of China, Japan, and South Korea together. They were all smiling.
http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE4B70ME20081213
They are up to something, but we will have to wait to find out what it is. Meanwhile there is this from Japan:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aFgHlh.Dn4Lc
I re-red all the above posts. The two by MRein are the most impressive.
However, I cannot believe, without additional evidence, that all the major banks in the world would have failed if AIG had been allowed to go under.
Many of the international banks would have failed. I doubt that all would have. And even if they had, new ones would arise to take their place.
No one know the distribution of these “toxic assets” among the various financial institutions. That is why I think Mr. Rein should be questioned.
The first action of the Obama administration should be to issue an order to cease propping up AIG or any other financial firm.
In the previous post, the word “private” should be added before the word firm in the last sentence.
Twofish is frequently right but he is totally wrong when he says the problem would have been the same without credit default swaps and other derivatives.
Anon — yes, hot money outflows from china substitute for reserve growth. more hot money outflows = less reserve growth. Both imply the buildup of china’s claims on the world but in the case of hot money outflows the buildup comes from private chinese savers.
i have to say the intellectual capacity on this board beyond the typical forum on the net.
if i were an editor of the Wall Street Journal, Fund Manager or even student Brad’s useful information and then the feedback is 5 star.
unfortunately after reading these posts I feel entire system is terribly flawed. If comments from all of you, including at times those of the admin Bsetser are true it looks like 2009 could be far worse than 2008.
i believe that the future is not predictable, in detail. i believe that the future can sometimes be predicted in outline, but this is really the identification of cycles or trends already in place in the present.
for those making predictions for 2009 and beyond i would like to draw their attention to these observations :
1 that $40 dollar oil should not be considered ‘low’ without recollecting what $40 dollar oil felt like on the way up, not so long ago.
2 that the phrase ‘collapse of the dollar’ should not be used casually, except by people with ambitions to make a lot of money (dollars ?) from gold.
3 that the conclusion ‘collapse of the dollar’ should not be suggested without stating what it is that the dollar collapses against - and how that entity itself (e g the euro, the yuan) manages to avoid collapse.
4 that predictions including the phrase ‘the euro’ should always be qualified as to which current members of the euro club will still be in it by the time spoken of.
5 that the geopolitical and geofinancial policies of japan should not be taken as a given. that all bets might be off if these change radically.
6 that the term ‘bailout’ be understood to mean bailout of the banks’ reserve ratios - that to understand it as some kind of charity to the banks’ clients that the banks unexpectedly refuse to pass on - is to allow yourself to be taken in by political window dressing.
7 that ’shovel ready’ public works projects depend not only upon government stimulus packages, but the ’shovelreadyness’ of the waiters, hairdressers, estate agents’, hedge fund managers, travel agents, pet groomers, and tarot card readers who are currently being thrown out of work.
8 that capitalism is in rude health, and is a self correcting system. when you hear that ‘capitalism’ has collapsed - understand it to mean that more monopolies, illusions, scams, and currency and interest rate manipulations (all anti-capitalist in spirit) have collapsed.
9 that as capitalism is essentially an ecosystem of independent financial organisms (from individuals to large corporations) central direction, even dressed up as a ‘rescue’, is to be treated with suspicion, from whatever source it emanates.
10 that there is nothingthat you can drop from helicopters that can make leverage fashionable again in this generation.
Bset-
any comments from the notes from Mrein?
“Twofish is frequently right but he is totally wrong when he says the problem would have been the same without credit default swaps and other derivatives.”
*i counterargue with Twofish. We also believe that without the issuance of CDS by insurance giants (mainly AIG) the credit crisis would not have reached the level we are witnessing today.
DJC: There isn’t any economic reason for banks to lend money to either consumers or businesses.
Yes there is. Businesses and consumers don’t operate on a cash basis, and couldn’t without returning to something close to barter.
MRein: Why executives from AIG, Goldman and other players are not on trial facing prosecution is beyond me. Anyone care to explain? Fraud is fraud, and it’s very evident to me the way this game was played.
Because stupidity is a defense to fraud (it really is). All you have to do to avoid being convicted of fraud is to convince the jury that you were and are an idiot. Also having a lawyer and accountant sign a piece of paper saying what you are doing is legal is also a defense against fraud.
This leads to some very perverse incentives.
Also without European money, the mortgage bubble still would have popped. Most of the money that came in went through the Middle East and China. Without a CDS, the German Landesbanks may not have been burned as much, but someone else would have.
DJC: We don’t need lending for anymore McMansions, Office buildings, Box department stores, or corporate welfare programs at AIG and General Motors.
But we need lending for *something*. The trouble is that if you cut off all lending for everything, then you have no economy to speak of.
DJC: Both service and manufacturing sectors of the US Economy are already overloaded with record levels of debt.
China managed to do with it with a much larger debt/GDP ratio than the United States had.
DJC: It is impossible to reflate a collapsed debt bubble.
It’s how we got out of the Great Depression. You are dead if the debt is in a currency you do not control, but if you do control the currency, and everyone owes everyone else money, you just swap bad debt and start fresh, which is more or less what China did in the late 1990’s.
“Most people never understood how AIG was the linchpin to the entire system. And there’s one more secret yet to come out…
AIG’s largest trading partner wasn’t a nameless European bank. It was Goldman Sachs.
I’d wondered for years how Goldman avoided the kind of huge mortgage-related writedowns that plagued all the other investment banks. And now we know: Goldman hedged its exposure via credit default swaps with AIG. Sources inside Goldman say the company’s exposure to AIG exceeded $20 billion, meaning the moment AIG was downgraded, Goldman had to begin marking down the value of its assets. And the moment AIG went bankrupt, Goldman lost $20 billion. Goldman immediately sought out Warren Buffett to raise $5 billion of additional capital, which also helped it raise another $5 billion via a public offering.
The collapse of the credit default swap market also meant the investment banks – all of them – had no way to borrow money, because no one would insure their obligations.
To fund their daily operations, they’ve become totally reliant on the Federal Reserve, which has allowed them to formally become commercial banks. To date, banks, insurance firms, and investment banks have borrowed $348 billion from the Federal Reserve – nearly all of this lending took place following AIG’s failure. Things are so bad at the investment banks, the Fed had to change the rules to allow Merrill, Morgan Stanley, and Goldman the ability to use equities as collateral for these loans, an unprecedented step.”
DJC: Wall Street Investment Banks won’t finance “pie in the sky” programs for clean energy or breaththrough medicines.
Wall Street is extremely non-ideological. It will finance whatever makes money. If there is money to be made in clean energy or breakthrough medicines, it will be financed.
DJC: Pandering exclusively to finance capital, the Washington Consensus ideologically opposes any “industrial policy” that attempts to organically grow “real economic wealth”.
So what the heck does the Washington Consensus do with Wall Street? Wall Street is extremely non-ideological. If socialism comes about, then Wall Street will figure out a way of profiting from socialism. If laissez-faire capitalism is the flavor of the deal, then Wall Street is made up of laissez-faire capitalists.
Sort of the like the Chinese government which is why the two get along so well.
Mrein: “Most people never understood how AIG was the linchpin to the entire system. And there’s one more secret yet to come out…
You are a bit slow to the game. Most people figured this out a few months ago.
Mrein: The collapse of the credit default swap market also meant the investment banks – all of them – had no way to borrow money, because no one would insure their obligations.
True, and the second the investment banks die, then that kills the money markets and the commercial paper markets. When those die then commercial banks, businesses, and households all go totally broke.
Really scary stuff.
Economics is not a morality play. Sure there might be some satisfaction in seeing someone who through stupidity or malice gets swept away by the tide, the trouble is that you are tied to them.
Whether an investment bank “deserves” a bailout is a secondary point. They probably don’t, but it doesn’t matter. The problem is that that if you try to make a moral point, you will end up shooting yourself in the head.
Unless, you have all your wealth in gold, and have guns and farmland somewhere, I’d be interested in knowing how you could end up crushing the investment bank system without crushing yourself in the process.
Mrein: Most people never understood how AIG was the linchpin to the entire system.
It actually wasn’t. AIG was one of many, many issuers of CDS, and most CDS issuers were much better run than AIG was. Because AIG was so badly capitalized, when things fell apart, they were the first to blow up, however if AIG was well capitalized, then it would have been another day or two before the second worst run insurance company would have started to go under.
Pumping money into AIG was important since that kept another set of dominos from falling. But if you take away the first domino, then some other company whose name no one knows would have blown up.
The problem is that unless you have a decent regulatory system then someone is going to be the dummy. If not AIG, then someone else.
Twofish: Wall Street is extremely non-ideological. It will finance whatever makes money.
DJC: I should have written that if Wall Street can’t make a quick quarterly profit, it won’t finance any program. Subprime AAA-rated bond securities made Goldamn Sachs CEO Hank Paulson enormously wealthly for a couple years before “blowing-up” the entire US financial system. Now millions of pension holders across State governments and corporations will retire destitute resulting from investments into “fraudulent” Goldman Sachs subprime bond securities. How is that for long term planning?
“Real Wealth” industrial production requires long-term investment capital which remains in ideological deficit on Wall Street. Wall Street despises Research and Development. When Boeing announced it would develop the 787 Aircraft, Wall Street punished the stock. Fortunately the Japanese government is willing to finance the Boeing 787 Aircraft development but at the expense of Boeing transferring wing design technology and production to Mitsubishi Aircraft.
Twofish: Wall Street will figure out a way of profiting from socialism.
DJC: Wall Street has profited enormously under Hank Paulson’s, “No Hedge Fund Manager Left Behind”. The $700 billion Taxpayer bailout of Wall Street is filling the pockets of Paulson’s cronies with billions. The United States is no longer a democracy but a kleptcracy. Privitizing the profits and socializing the losses to the American taxpayer is the name of the Paulson Ponzi game.
The trouble with focusing on AIG and CDS’s, is that you see the burning tree and miss the forest fire.
Suppose AIG didn’t exist and CDS’s were banned. You still have monoline insurers, SIV’s, structured notes, and about a hundred other problems. It so happened that CDS’s were the way that European banks managed to get subprimes listed as regulatory capital, but give me half a day, and I can think of twenty other ways.
So if that particular tree didn’t exist, it really would not have mattered. Also the problem with punishing the heads of AIG and the IB’s really doesn’t solve the problem.
DJC: I should have written that if Wall Street can’t make a quick quarterly profit, it won’t finance any program.
Yes it will.
DJC: Now millions of pension holders across State governments and corporations will retire destitute resulting from investments into “fraudulent” Goldman Sachs subprime bond securities. How is that for long term planning?
They won’t. The reason that investment banks got in so much trouble was that they made promises to state governments and corporate pension funds which someone is obligated to keep. The bailout of AIG was essentially to keep most of those funds solvent.
Let’s make this clear. *YOU* are the one that is in favor of bankrupting all those people. I don’t think that people that invested in pension funds should be punished for the misdeeds of others, but *YOU* do.
There are so many innocent people involved, that letting some of the guilty get away with huge sums of money, seems to be a rather small price to pay.
DJC: “Real Wealth” industrial production requires long-term investment capital which remains in ideological deficit on Wall Street. Wall Street despises Research and Development.
I guess that’s why they are one of the few places where physics Ph.D.’s can make a decent living doing something other than building bombs.
Twofish: If laissez-faire capitalism is the flavor of the deal, then Wall Street is made up of laissez-faire capitalists. Sort of the like the Chinese government which is why the two get along so well.
DJC: Excuse me, the Chinese economy is far from a laizze-faire Neo-liberalism economy. Still well over 40% of China GDP is state-ownership controlled. Actually the Chinese government under the Hu Jintal administration hasn’t given a “free pass” to Wall Street banksters. Forget about the US trade deficit, Hank Paulson’s greatest complaint is that the Chinese economy isn’t fully liberalized for Wall Street banksters to loot. In the self-proclaimed “socialist-market” economy, I can assure you that Chinese strategic industries including banking won’t be privatized to Western banksters anytime soon. In fact, due to the US financial crisis, Western banks are divesting their Chinese share holdings to repair their balance sheet back home.
Twofish: The reason that investment banks got in so much trouble was that they made promises to state governments and corporate pension funds which someone is obligated to keep. The bailout of AIG was essentially to keep most of those funds solvent.
DJC: Tell your fairy tale to the State Employees of New Jersey who have watched their State pension collapse in value from $60 billion to the current $40 billion. Thanks in part to Governor John Corzine, another former Goldman Sachs bankster, billions of dollars were invested in Lehman and Bear Sterns bonds which is de facto worthless today. The deceptive marketing of subprime bond securities as AAA-rated securities on par with US Treasury bonds isn’t capitalism; it was criminal fraud pure and simple.
Paulson complains that the China PBoC isn’t buying anymore of the Fannie Mae wastepaper. But give credit to the Chinese government, at least they were smart enough to avoid investing in Wall Street’s subprime garbage.
I doubt the Obama administration will indict the perpetrators but I think it’s fair that those involved with this AIG scandal should face trial.
We are not playing by fair rules if we do not hold accountable those who are responsible for today’s crisis.
What happened behind the scenes involving AIG and other investment banks sound like kickbacks (sense compensation was bonus) and a system of non-stop greed. I think it’s fair to say that Geithner threw Goldman a lifeline by arranging the bailout of AIG. Odd that Geithner now happens to be head of Treasury….
Oh I forgot, the #2 contributor to the Obama campaign behind was, any guesess???
Goldman Sachs $884,907
Brad Setser is right…FOLLOW THE MONEY.
DJC: Excuse me, the Chinese economy is far from a laizze-faire Neo-liberalism economy.
And neither is (or was) the United States.
DJC: I can assure you that Chinese strategic industries including banking won’t be privatized to Western banksters anytime soon.
No, but they will be run by imported Chinese banksters. If you look at who is rising in the Chinese economic system, a pretty large number of them worked for Western investment banks.
That’s really why China has come out ahead in a lot of its dealings with Western banks. They have people that know all of the tricks.
hot capital flow could, can and most certainly will turn cold - if someone thought someone else might think of any of them funny thoughts again
JamesBond: . I think it’s fair to say that Geithner threw Goldman a lifeline by arranging the bailout of AIG. Odd that Geithner now happens to be head of Treasury….
Do you have someone else in mind?
Either you have someone that knows something about banking or you have someone that knows nothing about banking. Anyone that knows something about banking has probably at some point in their career interacted with a bank at a high level, and Geithner is probably as distant from the banking industry as you can get, since he’s never worked in an IB.
If the government is preferential toward Goldman at the expense of all of the other banks, then this won’t work since all of the other banks will start screaming. One very good and valid question is whether the government is too preferential to the banking industry. If you think that bankers are evil parasites that have no social value, then yes. But I don’t think so.
Obama contributors….
—> Goldman Sachs $884,907
$800K is an extremely piddling small amount in the grand scheme of things. But Wall Street tended toward Obama because Bush was such a disaster for the economy.
Also if you are interested in following the money, then follow *YOUR* wallet. Where do you get your money from? Where do they get their money from? Keep going. You’ll get to Goldman-Sachs after three or four steps, and had they gone under, so would have you.
“If China continues to run a large current account surplus it almost has to be the main source of financing for the US. If the Eurozone is taken as a whole, there may well just be one big deficit and one big surplus in the global economy. ”
That is an accounting entity:
Govt. deficit (u.s.)=u.s. non govt.surplus+foreign sector surplus !!!
They get the dollars from us!!!!!!! They are not finacing us…we are financing their trade!!!
DJC: Tell your fairy tale to the State Employees of New Jersey who have watched their State pension collapse in value from $60 billion to the current $40 billion.
This is an old politician trick, when someone makes a general point, respond with a specific case that may or may not be typical or relevant to the general point.
DJC: The deceptive marketing of subprime bond securities as AAA-rated securities on par with US Treasury bonds isn’t capitalism; it was criminal fraud pure and simple.
It’s fairly clearly not criminal fraud. Whether it *should be* criminal fraud is another question, but as a legal matter, it very clearly isn’t, and any criminal defense attorney can go through the five elements to demonstrate fraud and show that they weren’t satisfied.
Twofish contues to argue that AIG (and by inference, all other private firms in a similar situation) cannot be allowed to FAIL because we are all interconnected.
He does not specify how close we are interconnected. In fact, he has no data AT ALL to justify the degree of interconnectedness.
I repeat, not all private firms will fail, not all pension funds will dry up if
AIG is allowed tofail. I say the Twofish assumption is simiply fear of the unknown.
That a shake out will occur is given. I say a shake out is needed. Without a shake out, we are forever confronted with ignorance ofwho hasthe toxic assets.
Bring on the known problem - failure of several private financial firms.
Convert the unknown to the known is a better statement, of the last sentence above.
jogerel is correct.
We are financing China’s Trade.
I realize that is reversing an assumption fundamental to Bester’s position. However, facts are facts.
Without the U.S. current account deficit, China would nothaave the dollars tosend back to the U.S.
Agree with Raymond to some extent. Twofish seems to continue promoting “fear of the unknown”.
He seems to admit that the actions of these executives (who graduated from top schools) were committed from “stupidity”.
I don’t believe that to be the case. If one’s salary goes from 500K to suddenly 15M in a matter of years don’t you look in the mirror and say “how’d i do this”.
Moral is at play. It should be in play. How 100-200 top guns on Wall Street basically packaged these securities and got a AAA rating from AIG to put the seal on the envelope is pure fraud.
As a matter of fact, TWOFISH, should know much better than say that these executives did this as “stupidity”, well is it not ironic then that soon after some of these securities were sold a few of these I-banks (Goldman) immediately shorted them????
A proper trial and investigation should be set up. MRein’s notes should be published in major publications and deserves attention.
Although 300M americans may not understand the complexity of what arose their pockets and networth have sunk while the executives who put the game together have run away with ten’s of millions and have exited the lights.
One of the crocked politicians in Boston is said to have the following on his tombstone : “He seen his opportunities and he took ‘em”.
That’s the way I look at this situation. A lot of people simply took advantage of their opportunities. Unfortunately, most of it was made legal by the Commodities Futures Modernization Act of 2000. That act insured that these now toxic contracts would be enforced in U.S. courts and that U.S. governmental and regulatory officials would have no information about these “private” contracts.
Look tothe Congress and our system established by law and custom and “consensus” for who is responsible.
I am going to try reposting this without the links. If it still goes down the memory hole, I guess I have been banned.
I think the surprise will come from Asia. On December 13, there were two articles and a video on Reuters about a meeting in Fukuoka, Japan. The video showed the leaders of China, Japan, and South Korea together. They were all smiling.
They are up to something, but we will have to wait to find out what it is. That is the nature of surprises.
Meanwhile there is this from Japan:
ReformerRay: I repeat, not all private firms will fail, not all pension funds will dry up if
AIG is allowed tofail. I say the Twofish assumption is simiply fear of the unknown.
You need to do your own research. Spend a day with the comptroller of the company that you work with, go to the bank where you have your money and start asking questions. Where does their money come from? Where does it go?
The connections are
CDS -> Investment bank -> commercial paper + money markets -> Industrial companies
I don’t see how I can make it any clearer. Again go to a factory and follow around the comptroller for a pay cycle.
Also, the economic system is very interconnected. This is normally a very good thing in that if one part is damaged, the goods and services move around the damage. The bad part is that if enough parts are damaged, then the system collapses.
Saying that some companies will be around after a systemic crash is like saying that some cities will be around after World War III. True, but pretty useless.
JamesBond: He seems to admit that the actions of these executives (who graduated from top schools) were committed from “stupidity.”
I’m not saying that. I’m saying that if you can show that they really believed what they said, then legally it’s not fraud. Now of course you could argue that it was obvious that they didn’t believed what they said.
Why? Because, no one could be that stupid. It’s obvious to everyone that they were peddling garbage. Unfortunately, that’s also a defense to fraud. If everyone knows you are lying, you can’t be convicted of fraud.
ReformerRay: That a shake out will occur is given. I say a shake out is needed. Without a shake out, we are forever confronted with ignorance ofwho hasthe toxic assets.
They tried that in 1930, and it didn’t work well.
The problem here is that in a shake down, good assets start becoming rotten assets. You have a decent honest person who is paying their mortgage on time, and that’s a good loan. They lose their house. The good loan suddenly becomes a bad loan. Banks holding those loans start going under. People lose their jobs. More good loans start turning bad, and the cycle goes all the way down, until someone says enough and you overthrow the government.
Right now we are on this sort of downward spiral. People that were paying their mortgages and credit card bills on time last year are losing their jobs, and they aren’t paying them this year.
defaults -> bad banks -> job losses -> more defaults
The good news is that the cycle is slow enough so that people can do things to break that cycle before things get too bad.
ReformerRay: Bring on the known problem - failure of several private financial firms.
The trouble is that there is not this piece of paper that says *THIS WILL BE A BAD LOAN*. It’s unlikely that there are any bad loans that will turn good, but it is certain that a lot of good loans right now will turn bad next year. If you set up a situation in which bad loans generate more bad loans, then it won’t stop until people have had enough and vote in new people who are either sane (US-1933) or not (Germany-1933).
Also one problem in finance is that you are dealing with other people’s money, and so there is this notion that if you do nothing wrong, then nothing bad will happen to you. Unfortunately, this isn’t the case.
Also subprime and alt-A are no longer problems.
They’ve all been written down. The problem now is prime mortgages, auto loans, credit cards. People are losing their jobs, which means they spend less, which means more people lose their jobs, which means……
Twofish persists in delying on an accurate generalization - that the U.S. economy is highly integrated. I counter that the degree of ibtegration between the parts vary with each part. To show that a collapse of AIG would bring down enough other firms to “ruin” the system (however that is defined), Twofish would have to identify the firms that are most connected to AIG and then trace out the % of connection those firms have toother firms, etc. If he could do that, which he cannot, we would learn that the influence of the failure of
AIG on the third and fourth order firms would be minimal because so many of those firms are dependent on firms othr than AIG. The complexity of the dependencies argues against any one firm being too big to fail.
The Lehman Brothers is the only data point available to us. Some thought that they were exporsed to 400 billion dollars of Credit Default Swaps. These swaps were settled sith 5.5 billion dollars changing hands.
The burden of prof should be on anyone who says the normal bankruptcy route should not be followed.
I apologize for the typos and misspelling above. I was so anxious to beat the addition I did not used the spell check. And I am obviously not a good typists.
The U.S. financial problem today is much more like the one Japan faced in 1990 rather than the one the U.S. faced in the 1930’s.
The Japanese banking system was at the base of their problems. The government refused to let the banks even report the extent of their bad loans. Sound familiar? Few banks failed but lending was curtailed because the banks were weak.
Twofish wants the U.S. to repeat the mistake made by Japan.
Perhaps Paulson was right to delay the collapse of AIG, given the fear in the air at that time.
However, a new policy is needed. One that declares that no firm is too large to fail. And that no new money will be made available to any financial firm. And that AIG will be pressured to pay back the government just as soon as posssible, in small amounts, but to begin returning the money.
This will be enough of a signal to begin the process of eliminating the toxic assets via bankrupcy.
The burden of prof should be on Twofish or Ppaulson or anyone else who claims that any firm is too large to fail.
ReformerRay,
Welcome to the lost decade! In 2015 the Dow Jones may still be at 5000…
Twofish does not understand the patient has cancer, bandaid here, bandaid there, the U.S. is Japan but in much worse shape than Japan because we have a deficit spinning out of control.
Socialism will be wanted by the people and easily delivered by the gov’t. If you want to make your money the next 20 years move to the emerging markets, that’s the place to be!
All empires decline, we are witnessing the slow but sure decline of United States.
Ray,
Maybe in a year or 2 when they finally figure out that the stimulus is ineffective and that the deficit is at a point foreigners say “sorry” you will get your wish and one by one the authority will just let the free market do what should have been done from the start.
Let the incompetent implode and the competent excel.
There is the productive economy of material objects (cars, oil wells, electronics, food, clothing, etc) and services (teachers, policemen, firemen, carpenters, mechanics, nurses, maybe even lawyers and economists, etc. Then there is FIRE (finance, insurance, real estate). FIRE’s necessary job is to create a monetary system with the least transaction costs and allocate the surplus wealth that the productive and service economy creates to those that would create the most new wealth or better the quality of living. However FIRE has slipped its leash (if it ever had one) and began to exist primarily to make money for itself and people who had more money than they needed - tail wags dog. It became so greedy that it killed the golden goose. It used its money and influence to buy favorable tax and regulatory environments. Instead of distributing the surplus wisely it used its creativity to conceive of more and more complicated ways to skim ever increasing amounts of money out of the necessary flow. Now we are in 2009 with the productive and service economy tanking because FIRE failed. The US has more mcMansions and strip malls,etc even car manufacturing plants than it needs. The world has more car manufacturing plants than it needs. There are more electronics factories than it needs. etc etc The money was not invested wisely so FIRE was not doing its job and needs to be reformed. How many would take a bet that this will happen in 2009?
the US has a much bigger military than it needs. Is Obama going to deal with this? In the present setup is there any way he could deal with this and stay alive? No, he is going to transfer troops from Iraq to Afghanistan because ?Pakistan actually does have nuclear weapons and is a Muslim nation. Oh wait, we are supposed to talk about whether the stimulus plan will work and make the global economy ok in the last half of 2009. When this fiasco was first beginning the way the Swedes handled their banking failures in the 90s seemed the way to go. Was it tried? Will the stimulus be invested wisely by Summers et al and Geithner et al and Congress? It would then have some value but what are the odds?
There is a war between inflation and deflation. Will the present deflation which is following the previous building inflation going to be followed by an even more virulent inflation fueled by the ‘powers that be’s’ attempts to show that deflation can’t happen with a fiat currency and hip honchos like Helicopter Ben. I don’t know. I would like to know if the FED is ‘pushing on a string’ as the Austrian oriented economists think.
Or ‘you can put all the money you want into banks but if businesses and consumers don’t want to borrow then you can’t make them as the Elliot Wave types think. Then there are the gold bugs waiting for the hyperinflation to happen. There are neo-keynesians who think that if the government takes up the slack then the sheeple will follow. Maybe there isn’t slack so much as a failed paradigm of consumerism without pay raises - productivity gains going only to the already rich. I think the rich elites got too greedy as they invariably do. Bubbles burst as is their nature. To fix the present mess there needs to be real changes that aren’t going to happen in 2009. Conditions will get much worse before something substantive will get done. FIRE failed. Then the ‘real economy’ failed. As a result there will be further failures in FIRE and as a result will cause further failures in the… 2009 will not be pretty. The volatility we see now will increase. The spinning top that is the global economy is slowing down. The wobbles will become more violent. The failures will happen more suddenly. Hopefully we will see the bottom in 2009 but the various stimulus plans might put it off until 2010.
ReformerRay: Twofish would have to identify the firms that are most connected to AIG and then trace out the % of connection those firms have toother firms, etc.
MRein has already done part of that. The $20 billion that GS had in AIG CDS. You then look at the firms that do business with Goldman to access the commericial paper markets.
ReformerRay: If he could do that, which he cannot, we would learn that the influence of the failure of AIG on the third and fourth order firms would be minimal because so many of those firms are dependent on firms othr than AIG.
Not in a systemic crash
A->B - you are dead
A->C->B - you are also dead
A->C->D->B - you are also dead.
The US only has four megabanks and had six investment banks and maybe about a two dozen primary broker dealers before this crash. Also there was Freddie and Fannie which was another point of failure.
ReformerRay: The complexity of the dependencies argues against any one firm being too big to fail.
If it was a distributed net, maybe, but it isn’t. It’s a hub and spoke model. Things even into a hub and spoke because under normal conditions, it turns out to be more efficient.
ReformerRay: The Japanese banking system was at the base of their problems. The government refused to let the banks even report the extent of their bad loans. Sound familiar? Few banks failed but lending was curtailed because the banks were weak.
And the banks were weak because the government refused to either let them go under or pump more cash into them. So as a result, the banks started “evergreening” loans, which is a bad thing. One other thing that people almost never mention is that a lot of the problems of the Japanese banking system started in the mid-1980’s when the government deregulated the banking industry in a big way.
Also, it’s unwise to just take one similarity and have this be the only main point. There are about fifty differences between Japan and the United States and fifty similarities, and it’s sometimes tough to figure out what the important differences are.
ReformerRay: Twofish wants the U.S. to repeat the mistake made by Japan.
Actually no, but we really don’t agree on what the “mistake” or “mistakes” were. The big mistake that I see is that the Japanese government didn’t inject enough capital early or quickly enough to prevent a deflationary spiral.
LostDecade: Let the incompetent implode and the competent excel.
The trouble is that when the incompetent implode they take the competent with them. Look at the 670,000 that got unemployed this month. How many of them really had anything to do with subprime mortgages?
If you are at a bank that did things wrong now you are looking at 60% layoffs. If you are a bank that did things right, you are looking at about 15% layoffs. The fact that you did everything you did right, is pretty cold comfort if you happen to be in that 15%.
In any case, we are pretty much done with the implosion phase for now.
ReformerRay: The burden of proof should be on Twofish or Paulson or anyone else who claims that any firm is too large to fail.
I’m sorry. You can kindly play Russian roulette with someone else’s life savings.
The thing to do is just regulate the hell out of the critical infrastructure so that any company is either too small to have a serious consequence if it fails, or is big enough so that it is quasi-nationalized and heavily regulated.
Also if people think that a firm is too large to fail, then you’ve already lost the game.
LostDecade: Twofish does not understand the patient has cancer, bandaid here, bandaid there.
So what do you suggest?
The first thing that any doctor learns and any economist should learn is “noli nocere.” Do nothing that makes the situation worse.
LostDecade: The U.S. is Japan but in much worse shape than Japan because we have a deficit spinning out of control.
That’s not true. The US has a debt / GDP of about 70%, Europe is about 80%, and Japan has a debt / GDP of about 160%.
The important thing about debt / GDP is to make sure that you spend your debt on things that will increase GDP. If you do that, then you can worry less about debt since GDP will grow. If all that money that had been plowed into houses and Iraq had gone into something like teacher salaries and nursing scholarships, we’d be a lot better off than we are right now.
twofish,
your solution of fixing the problem with temporary medicine won’t solve the patients problems. In order to solve his problems he’ll need to go “cold turkey”. If he doesn’t go “Cold Turkey” and continues getting temporary medicine it could end in a fatal situation (Default on debt).
Throughout history, Austrian economics provides a guide to market rule. In my opinion nothing can avoid a U.S. Depression, or worse yet Stag-Depression.
A few more things that were left out from the 09 post + comments:
1. capital controls will kick in
2. look up closely at the ACA (asian currency area)
3. nothing is said here about the ME central bank and their currency set up?
Plus an observation - this patient – besides all the bandages – is IMO starting to show serious signs of braindeadness too
Re-reading all the above posts is a good exercise.
For me, the key to the future is the action to be taken by the Federal Government to reduce the size of the toxic assets on the books of U.S. private financial firms.
Since no one knows the current size of the problem, no one knows to what degree the market is resolving the problem by actors selling positions to each other.
The infusion of more than 300 billion dollars from the public sector to the private sector should have strengthened the banks.
My conclusion to all this uncertainty is that now is the time to withdraw the public money and let the market determine which banks are currently strong enough to stand on their own (including AIG).
As he has done throughout the financial crisis, Twofish presents a false dichotomy between bailout and crash. The missing option is nationalisation with shareholder equity wiped out, for institutions that are too big or interconnected to fail. And, if there are still losses after equity has been used up, debt for equity swaps for junior creditors. The state should use its resources to allow orderly windups, not to prevent them. I cannot understand why firms are being given capital without the existing shareholders equity being written down to zero. I guess the US is too soft to make people face up to their losses, and so, as Ray says, it is repeating the mistakes that Japan made.
to my claim that FIRE is not doing it job and stealing money from the real econmoy I will give an excerpt from an interview of Kenneth Rogoff, former chief economist of the IMF 2001-2003:
“The financial services industry had been taking in 30 percent of corporate profits and 10 percent of wages despite representing only 8 percent of GDP (at its peak, and that is counting insurance). Why should a supposedly efficient financial system be soaking up so much of GDP? It is quite possible that a lot of what has happened to our overbloated financial system needed to happen anyway, albeit one would have expected the process to take five years instead of five days.”
So ‘they’ know this if going on. My view point is that the common man would be charged with embezzlement if he acted in this manner with Madoff being an extreme example.
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