Economic Crisis

This post grows out of some discussion Freddie and I have participated in over at The Confabulum  re: Conor’s post about potential bank nationalization.

Bank nationalization,were it to occur, would undoubtedly be the result of a failure of all the attempted re-capitalization plans (either from Europe or the TARP in the US,etc.).

I’m convinced that TARPy legislation in whatever guises around the world is bound to fail.

Here is Cassandra on this point (h/t Yves S. of Naked Capitalism):

this is The Big One, we’ve smacked head-first into the boundary of the maximum amount of debt that can be assumed by households, corporates and governments in our economy and be reasonably sustained with the fruits of our labour, and investment. Actually, I would posit that we long-ago pierced any reasonably sustainable threshold, and only through sheer inertia and the fortuitiousness of pulling of rabbits-out-of-hats have we lasted this long. But it is the anchoring of popular belief in faith and absent solvency from days long passed combined with the extrapolation a series of non-extrapolatable macro income streams which could cause any sensible human being believe or have believed that the boundary lay somewhere in front of us and not far behind us.

Cassandra calls this situation “Peak Credit”.  If Cassandra is right–and evidence continues to pile up that she may well be, including China (China!!!) in a recession–then here is her prediction of what transpires:

So IF what we are currently witnessing, commonly termed as The Credit Crunch, is in fact, an expression of what I will term Hubbert’s financial equivalent – “Peak Credit” phenomena , and IF as I posit, we long ago untethered the financial wagon from the real economic train, what does this mean?

Many things, but first and foremost, that we are at a major and painful inflection that will impose a real Kunstleresque austerity upon Americans converging their desires with their means. In a word, this means “revulsion”, a somewhat arcane and long-forgotten term for large-scale write-downs and/or economy-wide elimination of outstanding debt(s).

As further proof, check out this post by Yves from Naked Capitalism [who is indispensable to understanding what is going on] which shows that banks that received TARP money gave out LESS loans.  And this is completely logical once we understand this is not a credit crisis but a solvency one.  (Cassandra’s point as well).


But that aside, why should we expect that the TARP would lead to more lending? First, there should be less lending, independent of the economic contraction. We know now that TONS of credit was extended to people who shouldn’t have gotten it at all or should have been granted much less than they got. Those balances NEED to shrink, ideally by paying them down, although a fair bit will be via defaults and writedowns…

Now offsetting that to a fair degree is that a lot of businesses are dragging out payments, which puts financial stress on their vendors. They could really use more financing now, if you assume that the business itself is viable and the customers won’t default on their obligations. But banks aren’t set up to do that level of credit investigation. If you fit in the right box on their grid, great, otherwise, you are toast.

The whole depressionary enchilada in other words is baked in the oven of knowledge about the amount of debt loads institutions hold–who holds the debt, what levels, who is trustworthy, who is not, etc.

Any money a bank gets from the government is going to be hoarded to protect their financial backsides because they don’t know how much debt they are actually holding.  But they can guess that’s a helluva lot more than they think it is and they better hold whatever small change they get from the taxpayer in that likely scenario.  Also, they have to realize at this point that a whole bunch of these debts are just going to be written off, so if there is a mass financial Jubilee, (tip o’ the Bowler hat to John Robb) they have some cash on the far side of the leveling.

Nicholas Nasim Taleb says the banks will become public utility companies (like electric, gas, and water).  Whether those are fully nationalized or rather public-sponsored or publicly sanctioned private monopolies which are massively regulated, seems the inevitable outcome of all this debt unloading. At best it means that the injection of liquidity into the banks has only staunched total arrest and complete hemorrhaging (i.e. mass runs on banks).  It has not in any sense brought recovery.  There is way too much more debt (“bad blood”) to be leeched out of the global finance body.

But perhaps my brothers in the League will have alternative theories as to how this could play out or would indulge in some discussion of how to prepare for and give a better spin to (as human life) an “austere” age.  If that is in fact to be the case.

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7 thoughts on “Economic Crisis

  1. I’m just not qualified to render an opinion on the various economic effects of what nationalization would mean versus buyng up bad assets. What I can say is that I think that there is resistance to nationalization based on the idea that such a thing is an affront to capitalism/the free market, and my point to Conor is just that a government underwriting a bank’s balance sheet is no less an affront to the market than nationalization. If there are sound economic and pragmatic reasons for not nationalizing, then I support not nationalizing. But I do think for a lot of people who, like myself, lack the background in economics necessary to meaningfully sort the economic consequences, there is a kind of psychological resistance to terms like “nationalism”. But we long ago crossed into territory decidely far from our free market ideals.

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  2. good point. if the left wants to make some longer term hay out of this crisis then they are going to have to get at that resistance. one way is by showing that the right-wing ideology of late that claimed the mantle of free-marketdom was far from. Paulson’s bailing out of his Goldman Sachs buddies (while leaving his rival Lehman to fail) being a classic example.

    I’m not really sure Obama is that guy though. He’s instinctively more market-oriented. Cass Sunstein called him “University of Chicago liberal.” But we’ll see. If it gets as bad as I’m worried it might, then he’ll do whatever he thinks he has to do to prevent collapse.

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  3. Rapid fire. Three long posts in practically as many minutes…. :)

    I think nationalization could easily play out as a short-term fix, wherein nationalization is temporary and results in re-privatization. More on that later…

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  4. Nationalization is a bad word, especially when it is best read as “orderly bankruptcy” in usage.

    I am very interested in the long-term hay the left, myself included, can make out of this crisis. Two points, and I hope Freddie takes them in his response:

    1) I don’t think there is room for a “free-marketdom was far from” for liberals. Dividends were cut and financial institutions given free rein, there was an increased financialization of capitalism, with profits going less to workers and more to stock buybacks and executive salaries – and the whole thing collapse.

    I don’t think arguing for a more purer market is a good move for the left – a good liberal line is that markets are great, but need a strong referee to keep the whole thing from turning into a madhouse.

    2) More importantly for the left, we need to frame the 2001-2008 bad credit period as Americans racing to stand still while trying to get access to health care and education and stability under a period of intense inequality.

    There’s a natural tendency to think of all this bad debt as a Wall*E critique of lazy Americans buying too large TVs or immigrants and payday loan sharks swindling each other. I don’t think that is the (whole) case – I think it is far more that much of what has worked for middle Americans is being unwound, and can use the crisis to put a more liberal agenda of shared prosperity (cynical maybe, but I actually do believe this cause->effect).

    But I’ve already written too much.

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  5. I have a post in process on this that will go in greater detail on a few points above but I wanted to comment on rortybomb’s post:

    1. The cutting of dividends did not give Wall Street free rein. That was done by a combination of a) the SEC, who in 2004 allowed the Wall Street i-banks to relax leverage requirements, allowing them to lever up like hedge funds, b) the Fed, who cut the fed funds rate down to 1% and held it there for a year, which not only flooded the market with liquidity but also, indirectly, made investments like mortgage backed securities and CDO’s attractive, c) absolutely no one in our government taking note of the mess that was being made in the subprime mortgage business going back as far as 2003, and d) the lack of any sort of regulations that would have helped foster transparency in the credit derivatives markets (this I place directly on Greenspan’s shoulders).

    2. Paul Krugman has already beaten you to that with his arguments of wage stagnation (or something to that effect). I’m sure there have been others as well but I do not recall them off the top of my head.

    The Left already has enough to make hay about with idiot politicians and Alan Greenspan trumpeting the “self regulatory” aspects of free markets. I don’t believe in “self regulation”. I believe that people, if given the opportunity, will act in their self-interest with little regard for others. This can have catastrophic consequences. Limiting this is important.

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  6. I look forward to reading that post.

    1 – I think #1 is a great summary. By dividends, I just meant the more overall idea that an increase of the financialization of the economy and a deference to financial markets both in rhetoric and in policy, tax and otherwise, hasn’t seemed to pay out for the working and middle class – it would be one thing if 2001-2008 were champagne years for the median earner, but the data doesn’t play that out.

    As opposed to, say, inequality, market collapse is hardly an issue for just the Left to get in arms about. But it’s important to be rigorous with why self-regulation breaks down – Eugene Fama would agree with you about traders “act[ing] in their self-interest with little regard for others” but he thinks markets are always perfect, for lack of a better word. Is it just a few bad apples, or is it in the very nature of a financialized economy?

    2 – Ha! I wish I was that original of a thinker. Krugman is great, but my argument is cribbed from Elizabeth Warren’s work moreso. Speaking of, I wondered recently if, given it’s large correlation with bankruptcy and money troubles, the most appropriate response to an “austere age” would be having less kids. I wonder if there are a lot of second and third children that won’t be born cause of the credit crunch – something that should worry people concerned about demographics issues, and perhaps not just social conservative ones.

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