Baseline Scenario, April 7, 2009

Baseline Scenario for 4/7/2009 (9am): Post-G20 Edition

Peter Boone, Simon Johnson, and James Kwak, copyright of the authors.

This long-overdue (and hopefully widely-awaited) version of our Baseline Scenario focuses largely on the United States, both because of the volume of activity in the U.S. in the last two months, and also because the U.S. will almost certainly have to be at the forefront of any global economic recovery, especially given the wait-and-see attitude prevalent in Europe.

Global Economic Outlook

The global economy remains weak across the board, with no significant signs of improvement since our last baseline. The one positive sign is that some forecasters are beginning to recognize that growth in 2010 is not a foregone conclusion. The OECD, for example, now forecasts contraction of 4.3% in 2009 for the OECD area as a whole – and 0.1% contraction in 2010.  This is broadly with our previous “L-shaped” recovery view.

Even that forecast, however, expects quarter-over-quarter growth rates to be positive beginning in Q1 2010. (This is not a contradiction: if growth is sharply negative in early 2009, then quarterly rates can be positive throughout 2010, without total output for 2010 reaching average 2009 levels.) While most forecasters expect positive growth in most parts of the world in 2010, those forecasts seem to reflect expected reversion to the mean rather than any identified mechanism for economic recovery. The underlying assumption is that at some point economic weakness becomes its own cure, as falling prices finally prompt consumers to consume and businesses to invest. But given the unprecedented nature of the current situation, it seems by no means certain that that assumption will hold. In particular, with demand low around the globe, the typical mechanism by which an isolated country in recession can recover – exports – cannot work for everyone.

U.S. Outlook

Like the global economy, the U.S. economy only looks worse than it did two months ago, with unemployment up to 8.5% and no real indicators of an incipient recovery. (See Calculated Risk’s March summary for all the dismal details.) The causes of economic weakness are largely unchanged and widely known:

  • De-leveraging by consumers (paying down debt, voluntarily or involuntarily), leading to reduced consumption and increased saving
  • De-leveraging by companies, leading to reduced investment
  • Reduced supply as well as demand for credit, constraining even those who want to borrow and spend
  • Continuing falls in real estate prices

This combination of reduced spending and reduced credit has sharply depressed aggregate demand, creating a classic vicious cycle where reduced demand leads to reduced economic activity which leads to reduced spending power via increased unemployment and reduced corporate profits. In addition, concerns about financial system solvency are constraining the ability of financial institutions to supply the credit needed by the economy.  There will likely be a rolling wave of defaults and debt restructurings in the US and around the world over the next couple of years; this is hard to avoid and constitutes a major reason why the recovery will be slow compared with previous recessions.

The Obama administration’s responses to date can be grouped into three broad areas:  the financial sector, the real economy, and monetary policy. In each case, the administration has made great efforts that either are yet to pay off or will not pay off.

Financial Sector

The core problem is that large segments of the financial sector are insolvent, or that many market participants believe that large segments of the financial sector are insolvent. In either case, the problems are situated on the asset side of financial institutions’ balance sheets. Although banks have taken hundreds of billions of dollars of writedowns on toxic assets, the fear is that they will need to write down hundreds of billions or over a trillion dollars more as those assets continue to deteriorate in value.

In the early phases of the crisis, concerns focused on structured securities (CDOs, CDOs-squared, etc.) that experienced disproportionate losses as default percentages on underlying assets increased. However, as the crisis has spread from the financial sector into the real economy, increasing default rates are taking their toll even on plain-vanilla assets, such as whole mortgages. (Along the way, the financial sector has moved from a liquidity crisis to a solvency crisis.) Because banks’ assets are sensitive to macroeconomic conditions, it is difficult if not impossible to put a bound on their expected losses as long as there is uncertainty about how long and deep the current recession will be.

The core problem today is that there is a gap between the current book value of assets and the real value of those assets, at least as perceived by many market participants. That gap is large enough to threaten the capital cushions of at least some banks. Many people have suggested solutions to this problem, ranging from outright government takeover (followed by balance sheet cleanup and privatization) to cheap government credit insurance.

However, the Obama administration’s proposals so far have been relatively modest, perhaps due to unavoidable political constraints. The overall strategy has been to:

  • Insist that the banks are fundamentally healthy, and that the market prices of their assets are artificially depressed due to a lack of liquidity in the market
  • Continue providing just-enough capital on an as-needed basis to keep banks afloat, while avoiding any more aggressive measures, as was done in Citigroup’s third bailout

Note that this strategy is not internally illogical: if you believe that asset prices will recover by themselves (or by providing sufficient liquidity), then it makes sense to continue propping up weak banks with injections of capital. However, our main concern is that it underestimates the magnitude of the problem and could lead to years of partial measures, none of which creates a healthy banking system.

The main components of the administration’s bank rescue plan include:

  • Stress tests, conducted by regulators, to determine whether major banks can withstand a severe recession, followed by recapitalization (if necessary) in the form of convertible preferred shares
  • The Public-Private Investment Program (PPIP) to stimulate purchases of toxic assets, thereby removing them from bank balance sheets

The stress tests have two main problems. First, they are no longer credible, because the worst-case scenarios announced for the stress tests are no worse than many economic forecasters expect in their baseline scenarios. Second, the administration has as much as said that the major banks will all pass the stress tests, making it appear that the results are foreordained. It is possible that the stress tests will be used to force banks to sell assets as part of the PPIP, which would be a good but unexpected consequence.

We also do not expect the PPIP to meet its stated objective of starting a market for toxic assets (both whole loans and mortgage-backed securities) and thereby moving them off of bank balance sheets. In essence, the PPIP attempts to achieve this goal by subsidizing private sector buyers (via non-recourse loans or loan guarantees) to increase their bid prices for toxic assets. Besides the subsidy from the public to the private sector that this involves, we are skeptical that the plan as outlined will raise buyers’ bid prices high enough to induce banks to sell their assets. From the banks’ perspective, selling assets at prices below their current book values will force them to take writedowns, hurting profitability and reducing their capital cushion.

As long as the government’s strategy is to prevent banks from failing at all costs, banks have an incentive to sit the PPIP out (or even participate as buyers) and wait for a more generous plan. Again, the key question is how the loss currently built into banks’ toxic assets will be distributed between bank sharedholders, bank creditors, and taxpayers. By leaving banks in their current form and relying on market-type incentives to encourage them to clean themselves up, the administration has given the banks an effective veto over financial sector policy. There is a chance that the PPIP will have its desired effect, but otherwise several months will pass and we will be right where we started.

Ultimately, the stalemate in the financial sector is the product of political constraints. On the one hand, the administration has consistently foresworn dictating a solution to the financial sector, either out of deep-rooted antipathy to nationalization, or out of fear of being accused of nationalization. On the other hand, bailout fatigue among the public and in Congress, aggravated by the clumsy handling of the AIG bonus scandal, has made it impossible for the administration to propose a solution that is too generous to banks, or that requires new money from Congress. As a result, the administration is forced to work with a small amount of remaining TARP money, leverage from the Fed and the FDIC, and the private sector.

The Real Economy

With each month, the outlook for the real economy gets worse. It is particularly disturbing that economic forecasts are being revised downward every month as well. However, the administration has at least partially delivered on two major policy measures necessary to help restart the real economy.

The fiscal stimulus package signed in February should help, but it is simply too small given the size of the problem. After deducting the fix to the Alternative Minimum Tax (alternative for stimulus purposes), the package was only about $700 billion, of which a large part was in tax cuts of questionable impact. This will partially compensate for falling private sector demand and improve the economy from where it would have been otherwise, but it cannot be expected to turn around the economy on its own. In an ideal world, the administration would be planning a second stimulus package as a contingency measure for later this year. However, given that the bill passed with zero Republican votes in the House and only three votes in the Senate (those votes bought with major concessions), it seems unlikely that the administration will be able to get Congress to commit another half-trillion dollars anytime soon.

The housing plan announced in early March is also a positive step, albeit one that should have been implemented months before, by the previous administration. The housing plan relies heavily on cash incentives to loan servicers and second-lien holders who are willing to modify mortgages. However, only time will tell whether those incentives are sufficient to actually change servicers’ behavior on a large scale. Again, this is far better than nothing, but whether it is enough to counteract the ongoing free-fall in housing prices remains to be seen.

In addition, the Obama administration took a harder line on GM and Chrysler, rejecting their restructuring plans and giving them new, tight deadlines to work out deals with their workers and creditors (GM) or with Fiat (Chrysler). In order to pressure bondholders to make concessions, the administration is trying to signal that it is willing to let the auto companies go into bankruptcy. But from a political perspective, they seem to be in a no-win situation. A Democratic administration that lets GM go bankrupt could face a revolt from one of its core constituencies; but bailing out the auto industry will only increase bailout fatigue from an increasingly resentful Non-Bailed-Out Majority that no longer identifies with autoworkers.

Monetary Policy

With the economy still stalled and the executive branch struggling with political constraints, the Federal Reserve has seemed increasingly willing to step into the breach. As an independent agency within the government, armed with emergency powers under Section 13(3) of the Federal Reserve Act, the Fed is the one actor that can, to some extent, simply take matters into its own hands. And although everything the Fed does is wrapped in gradualist language to cushion its impact on the markets, the Fed does seem to have embarked on a new, more aggressive phase of monetary policy.

Until late in 2008, the Fed’s primary role was to provide liquidity, in the form of short-term lending to financial institutions. Since then, however, it has expanded its role in at least two directions. The Term Asset-Backed Securities Loan Facility (TALF) puts the Fed in the position of deciding where to allocate credit across the economy. And the recent decision to start buying long-term Treasury securities means that the Fed is using new approaches to create money. While there is a debate over whether this constitutes “quantitative easing” or just “credit easing,” this represents a major expansion of the Fed’s role, which we discussed in our recent Washington Post Outlook article. These actions may help create moderate inflation and prevent the onset of sustained deflation; there is also a danger that inflation will be substantially higher than expected.

Regulation

Since virtually no one is happy with the current situation, there has unsurprisingly been discussion of how the financial sector should be changed in the future. Treasury Secretary Geithner outlined his proposals in Congressional testimony, with an emphasis on the need for centralized monitoring of systemic risk, and for the power to take over any financial institution that could bring down the system as a whole.

One of the root causes of the crisis, and of the difficulty in resolving it, has been the political power and ideological influence of the financial sector, which we discuss at length in our Atlantic article. Our preferred solution is to have smaller banks. Early indications, however, are that the Geithner plan will go a different direction – allowing large banks, but giving regulators new powers over them.  The resolution authority currently being sought by the Administration – and which we support – may have unintended consequences, some of which could ultimately prove positive if handled in the right way.

On a worrying note, the Financial Accounting Standards Board recently caved in to banking industry pressure (transmitted by the House Financial Services Committee) and relaxed the rules implementing fair value accounting. In some circumstances, financial institutions will find it easier to ignore market transactions and use internal models in order to value assets on their balance sheets. We think that fair value (“mark-to-market”) accounting has played a small role, if any, in the crisis. However, the full impact of this rule change will not be known until we see how it is applied by batteries of lawyers on Wall Street and in Washington; for one thing, it could change banks’ incentives to participate in the PPIP. And the fact that the financial industry, at this moment in history, still has the power to get its way in Washington is disturbing.

U.S. Summary

On balance, we believe that the Obama administration, and Fed Chairman Bernanke, are making every effort to combat the financial and economic crisis. However, some aspects of the response, most notably the fiscal stimulus, have been underpowered. And a combination of ideological and political constraints has hampered the administration’s efforts to rescue the banking system. For these reasons, we still do not see the mechanism that will cause the economy to turn around.

In this context, we interpret the recent stock market rally as indicating that the economic decline is slowing; it does not necessarily denote that rapid recovery is just around the corner.  We would also emphasize that credit markets are pricing in a substantial risk of default for some leading brand names, both in financial services and manufacturing – as the system stabilizes and bailouts become harder to justify, the probability of default for large companies may continue to rise.

International Issues

The lead-up to the recent G20 summit exposed some of the tensions between the U.S. (and the U.K.) and Europe when it comes to economic policy. To generalize for a moment, Europe (led by Germany and France) favors less fiscal stimulus spending, more fiscal discipline, and lower inflation risk; the U.S. favors more stimulus and more expansionary monetary policy, at the risk of higher inflation.

We favor the U.S. position, for a simple reason. Not only is the current global recession very severe, but it is unlike any we have seen before, and therefore we cannot rely on historical patterns to tell us when and how the recession will end. In that context, and with unemployment climbing virtually everywhere, it makes sense to do more rather than less to turn the economy around. The European position is that their more advanced social welfare systems will both limit human misery and provide an automatic fiscal stimulus, both of which are true. However, European economies are just as vulnerable as ours to a prolonged period of deflationary stagnation – a risk that, unlike Ben Bernanke, they seem willing to take.

Given this divide in opinion, there was no chance for a meaningful resolution at the G20 summit. However, the G20 did have some notable achievements. First, increasing funding for the IMF to $1 trillion gave it the capacity to actually bail out multiple mid-size economies, which may become necessary as the recession progresses. Second, by eliminating Europe’s de facto control over the IMF (and the U.S.’s de facto control over the World Bank), the summit gave other members of the G20 more of a stake in helping develop and support concerted international solutions to the economic crisis. While this could take months or years to pay off, it is an important first step.

————————————————————————————–

Further coverage of the crisis and policy proposals (a partial index)
Background material
Financial Crisis for Beginners primer, includes material on “bad banks” and the Swedish approach to cleaning up the banking system: http://baselinescenario.com/financial-crisis-for-beginners/
Deeper causes of the crisis, an ongoing series: http://baselinescenario.com/category/causes/

Previous editions of Baseline Scenario:

More on Europe

The European crisis, why the Europeans are not coping, and what to do about it

http://baselinescenario.com/2009/02/22/the-choice-save-europe-now-or-later/

http://baselinescenario.com/2009/01/05/eurozone-hard-pressed-2-fiscal-solution-deferred/

Our original European stabilization fund proposal:

http://baselinescenario.com/2008/10/24/eurozone-default-risk/

More on current US and global topics

Strategies for bank recapitalization

Global fiscal stimulus: http://baselinescenario.com/2009/01/21/global-fiscal-stimulus-should-it-be-an-obama-priority/

Citigroup bailout (the second round): http://baselinescenario.com/2008/11/27/international-implications-of-the-citigroup-bailout/ and http://baselinescenario.com/2008/11/24/citigroup-bailout-weak-arbitrary-incomprehensible/

Policy recommendations from October/November 2008

“The Next World War?  It Could Be Financial” (October 11, 2008): http://baselinescenario.com/2008/10/12/next-up-emerging-markets/

Pressure on emerging markets (October 12, 2008): http://baselinescenario.com/2008/10/12/next-up-emerging-markets/

Pressure on the Eurozone (October 24, 2008): http://baselinescenario.com/2008/10/24/Eurozone-default-risk/

Testimony to Joint Economic Committee (October 30, 2008): http://baselinescenario.com/2008/10/30/testimony-before-joint-economic-committee-today/

Bank recapitalization options (November 25, 2008): http://baselinescenario.com/2008/11/25/bank-recapitalization-options-and-recommendation-after-citigroup-bailout/

84 responses to “Baseline Scenario, April 7, 2009

  1. Pingback: Global Crisis Orientation « The Baseline Scenario

  2. You’ve stopped making predictions about the depth of the recession or the shape of the recovery. Loss of confidence in your ability to predict? Unwillingness to post bad news, or to take the blame if your predictions turn out too rosy? Or what?

  3. Pingback: The Swamp Report » Baseline’s new outlook, perception or reality?

  4. Paris Biltong

    “One of the root causes of the crisis, and of the difficulty in resolving it, has been the political power and ideological influence of the financial sector” (as exemplified, inter alia, by Lawrence Summers).
    There is something else that matters politically and ideologically. The rescue/bailout – in the broader sense – suggests that the consequences of risk-taking must be assumed by all. In other words, risk must be spread as widely as possible. Everyone has to willingly pay for AIG’s “errors” and for those of Citicorp, General Motors and the others, as we would if they had been struck by some calamity. There have even been suggestions that the Madoff “victims” should be entitled to some kind of compensation at the expense of the population at large. The underlying assumption for such an approach is that everyone benefits from the good times and everyone should likewise pay for the bad.
    While this is pretty much what happens in ordinary circumstances, there is now a shift toward “socialized capitalism,” based on the notion of “solidarity”, dear to the European left, which underpins social security, universal health care and the like. Pushed to the extreme, there is no more risk-taking and there can be no reward for risk takers, so that returns on investments must be distributed fairly (such as to each according to his needs). At that stage, there isn’t even the need for taxes to set off losses, as those merely cause distributable returns to decline.

    That is obviously not the intended scenario, but unless the system’s fairness is vastly improved, sharing risks is not going to be politically acceptable. Objections to bonuses and other forms of executive compensation (what they call, here in France, “les stock-options”) are symptomatic of the fundamental and recurring problem caused by growing income and wealth disparity. That issue should be addressed seriously and not merely dismissed as a populist, knee-jerk reaction. Whether this can be done without radical changes in the economy (e.g. nationalizations, government controls, etc.) remains to be seen.

  5. “On balance, we believe that the Obama administration, and Fed Chairman Bernanke, are making every effort to combat the financial and economic crisis. However, some aspects of the response, most notably the fiscal stimulus, have been underpowered.”

    I agree that the Fed is “making every effort” and, in fact, is probably doing more than anyone expected it would or could do…but we’re largely passed the role monetary policy can play in this Great Recession.

    OTOH, I think the Obama Administration’s response–especially the Geithner Plan for the financial sector–is not only underwhelming, it’s mis-directed. It will not “fix” the banks in any sense of the word and there is a huge risk–almost 100%–that the US taxpayers and national debt will take a tremendous hit in pursuing this policy.

    When it is recognized that this policy is a costly failure, the Obama Administration will necessarily turn to where it should have started: pre-privatization, nationalization, or whatever other label one wants to put on it. Given your earlier support for this kind of approach to solving the banking crisis, I find this assessment driven more by partisanship than scholarship.

  6. First, thank you for taking on the task of explaining the economic crisis to people like me – people who are not economists and find themselves stunned at the magnitude of the problem.

    However, some questions were inspired by the following paragraph:

    “The core problem is that large segments of the financial sector are insolvent, or that many market participants believe that large segments of the financial sector are insolvent. In either case, the problems are situated on the asset side of financial institutions’ balance sheets. Although banks have taken hundreds of billions of dollars of writedowns on toxic assets, the fear is that they will need to write down hundreds of billions or over a trillion dollars more as those assets continue to deteriorate in value.”

    1) I keep reading about banks who claim to be healthy, claim to have accepted TARP funds only because Paulson made them do it. (Northern Trust is one example – several of the CEOs who recently appeared in front of Congress also made this claim.) All that makes me wonder if there is a foundation of truly healthy banks that exist today within this economy. Did Paulson’s solution – flood the industry with money/indiscriminately throw billions at banks without regard for whether or not they needed it – did this approach actually add fuel to the fire? Would a more focused approach to addressing just the diseased banks been more effective?

    2) Perhaps you’ve answered this in detail elsewhere, but whenever I look at the appalling amount of toxic debt on the books of these institutions, I am incredulous. More than a trillion dollars in toxic assets! How did such highly paid executives let their businesses get to this point? Are you as astonished as I am by the reckless business decisions that got these businesses into such a hole?

    3) Is greed so ingrained in the business ethos that the only way to avoid this catastrophic scenario in the future is to act if businessmen are incapable of managing their businesses in a responsible manner? I.E. forgo the siren call of Reagan the De-Regulator and slap a host of rules surrounding the operations of American businesses? I realize some regulation is essential – but these people seem to have left their MBAs in a closet somewhere in favor of a more Darwinian approach to killing what they ate. Or maybe Darwin was the principle philosopher studied at the Ivy League programs. Though there appear to be few fit to survive these days.

    Again thank you for your analysis. I am new to your blog and will poke around for more info.

  7. Sharp, as always. One minor comment, mostly political:

    Although the Obama Administration may have challenges passing a second fiscal stimulus package through normal legislation, the normal budgeting process is _not_ vulnerable to the fillibuster. Peter Orszag appears willing to press Harry Reid to use that process, if needed. Obama has huge incentives to generate visible improvement prior to Q2 of 2010, when the midterm elections kick into high gear. Orszag and Romer have essentially promised this.

    Moreover, even without another stimulus package, the standard budgets are projected to run substantial deficits for at least 5 years – which are likely to be partially financed by the Fed in at least the short term.

    In light of this, are you more or less despondent than you were two months ago?

    —–

    Separately, one point in your baseline that doesn’t get picked up often is that the common projections of recovery in 2010 are based on models that predict spontaneous reversion to the mean (without trying to explain how this happens), simply because of the historical tendency for this to occur. This ignores key facts, that you note:

    1) This one is worse (already) than anything since the 1930s, and it’s global.

    2) Previous reversion to the mean may not have been spontaneous, but could have resulted from active policy response. The blind expectation of magical mean reversion may be killing the active policy response that is required to achieve mean reversion.

    The fact that the models keep being revised back on a monthly basis is scary – it means that the (unknown) factors that should be triggering an “automatic” recovery aren’t happening on schedule (and may not happen at all).

    On the positive side, it seems that US policymakers finally started to understand this in March.

  8. Reading about the contraction of the economy, inflation/deflation worries, accelerating job loss, and the latest IMF report of an estimated $4 trillion in bank toxic assets now just leaves me waiting for when, not if, the administration will be forced to nationalize.

    I lost my job in August 2001 and was out of work for 25 months, (after 34 years of continuous employment), and had to crawl back from that only to now see people getting chopped all around me these days. I think I have a form of PTSD that is making this current situation rather terrifying for me.

    David

  9. bobgreenfest

    For the most part your comments and analysis is insightful and on the money. Policy will not solve any of the financial crises that are occurring. As I discuss in http://www.bobgreenfest.wordpress.com when fear of action becomes less that the present fear of inaction and paralysis that’s occurring in all aspects of the market, then, and only then, will the world begin to correct itself. Based on today’s rules of the game, The World is Flat!

  10. Thanks for this comprehensive if desolate overview. I didn’t find a word of it reassuring (though quite a bit was enraging). I agree with statsguy that the projections of a recovery right around the bend always seem to be based on the notion simply that that’s how it’s supposed to happen. I’m always reminded of how until just recently the EIA and the IEA would project future oil production by extending the trend line of demand into the future and then assuming that the necessary production would magically appear. So wouldn’t be surprised to see the beginnings of recovery always just a year off.

    On the one hand, the administration has consistently foresworn dictating a solution to the financial sector, either out of deep-rooted antipathy to nationalization, or out of fear of being accused of nationalization.

    Yes, it must be one or both of these, neither of which are reality-based reasons. It’s either self-imposed corporatist ideology, or this utterly baffling obsession Obama has with appeasing the decrepit republicans.

    Either way it’s infuriating and disgraceful how the people so fervently expressed their will for Change, voted for change, and how nothing has changed. The exact same capital crimes continue to be compounded.

  11. >Yes, it must be one or both of these, neither of which are reality-based reasons. It’s either self-imposed corporatist ideology, or this utterly baffling obsession Obama has with appeasing the decrepit republicans.

    First off, caveat, I’m somewhat left of the Democratic party.

    Don’t leave out the Democrats. The money spent by the big financial institutions in campaign contributions was pretty evenly distributed – in fact, I don’t hear any major democratic politician decrying the administration’s strategy to leave the banks intact.

  12. “On the one hand, the administration has consistently foresworn dictating a solution to the financial sector, either out of deep-rooted antipathy to nationalization, or out of fear of being accused of nationalization.”

    The more simple explanation is that they are in bed with the big banks. why in the world do you fail to mention that? it undermines your credibility as well.

  13. Ed Beaugard

    So is Nouriel Roubini’s new-found confidence about the state of the world economy not justified? It seems not, so I’m not sure why he’s been in such a relatively sunny mood lately.
    Also, how do we know when we’ve reached the bottom part of the L-shaped depression if the economy will continue to contract over the next approx. 2 years?
    Where and when is the bottom to this crisis? Doesn’t a positive second-derivative mean anything?

  14. Bill Bradbrooke

    There is a tone of impatience in your summary.

    “…However, our main concern is that it (the Obama approach of gradualism) underestimates the magnitude of the problem and could lead to years of partial measures, none of which creates a healthy bank system….”

    Do we have a choice? On one hand legislators are being asked to end the financial crisis (and economic contraction) as soon as possible; on the other they are being asked to extinguish once and for all our culture of consumerism. These goals are not compatible in a short time frame.

    If the banking system were healthy today there is no acceptable domestic use for the volume of credit that it formerly generated. Former levels of output are only achievable in the short run by revitalizing the economy as it formerly was. This we are determined to avoid or so it would seem with the consumer now a net saver sitting largely on the sidelines. So a healthy banking system must mean a banking system that functions as de-leveraging continues. This does not spell a return to prosperity or even a sense of security for the average American.

    We are inventive and adaptable. We love our property and we love our freedoms. How do you propose to proceed any faster than we are presently going? Wholesale moves to seize anything are likely to produce a backlash. The value of whatever is seized, no matter what the pretext, is likely to retreat to zero. The world looks on and promptly sells all its dollars. That is certainly one very likely outcome of not “feeling our way as we go.”

  15. Pingback: More Good Writing That Is Not Mine « Taunter Media

  16. adios amigos

    Brad,
    Or, perhaps they are simply telling what is so obviously the truth: no one knows how this ends, how big it gets, or when it begins to recover. I respect the position offered by Mssr’s Boone, Johnson and Kwak. Anyone who says “OK, here’s how big it gets, and here’s where it ends”, knows very little. The truth is….no one knows, as we can’t predict accurately that which is clearly unknown.
    AA

  17. adios amigos

    Mr. Kwak,
    As shocking as this may sound, coming from me, I agree with everything you reflect in this post. Amazing! For once, I offer no insults, brow beating, or related pandering’s to the crowd. I believe you got this exactly right: It’s not good, we have no idea when it may be good again, the administration has no idea what they are doing or if their actions will do any good, the banks will be allowed to continue to lie, GM and Chrysler are probably going to tank, and it’s probably going to get worse ( but no idea how much worse) before it starts to turn around. Finally! The truth! Congrats.
    AA

  18. To some extent, all economists have to speak elliptically like the Chairman of the Federal Reserve. If they don’t, they end up like Krugman, out of favor with both parties…

  19. Previous baseline entries pointed out that the problem isn’t just the banks not making loans; the demand for credit has also drop significant. Businesses and individuals are simply tightening their belts and are not borrowing and paying off their debt.

    Recently, Krugman made the following point about bank reform during the Japan lost decade:

    “it’s hard, looking at the data, to see much role for bank reform in Japan’s recovery, such as it was.” – Krugman

    http://krugman.blogs.nytimes.com/2009/04/02/japans-recovery/

    Considering the lack of demand for borrowing and Krugman’s point about bank reform during Japan’s lost decade, I wonder how high a priority is cleaning up the banks relative to other efforts to turn around the economy? Ha, I know this is heresy!

    Is there a way to measure the percentage of reasonable loan applications being denied because banks are insolvent?

    Is there a way to measure if borrowers are paying higher interest rate because banks are unhealthy?

  20. Also worth mentioning
    Libor rates have fallen dramatically.
    And, because of their ability to borrow from the Fed at nearly no interest, banks are finding that lending can be very profitable.

  21. Steve in Cranbury NJ

    I wish your website could publish and interpret statistics on actual trends in US lending rates by each of the big segments of the financial industry:

    1. Commercial banks a) the top 20 and b) the rest
    2. Investment banks
    3. Commercial paper
    4. All the rest

    I’m not an economist, so my categories are probably not right. But you guys can fix this. IMO, we need to track this information to see if the administration and Fed programs are working to get lending restored.

    If there are no good statistics we can trend, then I ask, how can we know if these programs are working or not and why should we throw hundreds of billions against them.

  22. I strongly agree with Steve.

    Most of what I’ve read on this site has been qualitative analysis rather than quantitative analysis. Qualitative is fine to get a general idea across. However, we really need more than just “trust us, things are bad.” I apologize for exaggerating but my point is we need to see numbers to compare and put things in perspective. Numbers let us to check our views against reality.

  23. SolidBaseline

    Thank you for your informative writing and insight.

    To explain one thing:

    “the administration has consistently forsworn dictating a solution to the financial sector, either out of deep-rooted antipathy to nationalization, or out of fear of being accused of nationalization”

    The first reason “deep-rooted antipathy” is odd given the president’s well known political background and leanings. It ought to be meant sarcastically.

    Belief in the second reason, fear of accusation, has been publicly encouraged. The subject was addressed in a widely disseminated presidential talking point many weeks ago.

    It is a weak point: an agonizing fear of accusations of nationalization does not seem to be stopping the president and his party from other nationalization plans.

    The other plans, whether right or wrong, are a more radical step within the American context, while bank nationalization can be a smaller step: as you have pointed out, temporary FDIC takeover is a well recognized, establishment thing to do.

    And it cannot be disregarded that the president enjoys perhaps the most sweeping backing of the institutionalized news media in American history. That is not a backdrop for a paralyzing fear.

    The actual answer? You almost wrote it: replace the word “deep” with “shallow”.

    Rather than “deep-rooted antipathy to nationalization”, it is a “shallow” antipathy that was colloquially identified by the commenter tooearly above.

    As part of the recent White House financial disclosures, we now know that the head of the White House council of economic advisors is a multi-millionaire due in part to $5M for 16 months of work for hedge fund DE Shaw. In addition, Bloomberg reports he “earned more than $2.7 million in speaking fees from companies such as Bank of America Corp., Citigroup Inc. and Goldman Sachs Group Inc. that later received taxpayer funds in the economic bailout”.

    Private and private/public hybrid banks serve an important monetary function for politicians and their advisors.

    To the contrary, it is very hard to quickly become a
    multi-millionaire working only for pure government entities.

    Prior to becoming the president’s chief of staff, a political operative from Chicago was gifted with an “investment banker” position on Wall Street. He quickly collecting > $million to support his later election to Congress. As well, he was gifted with a very well compensated board seat on Freddie Mac (that was misreporting income during his tenure).

    It goes on an on…there being only a couple of current officials that spring to mind…we don’t mention the tens of millions of dollars to the political operative who was made head of Fannie Mae, for example.

    It is fine to mention several wrong reasons as long as the right one is included too. :-)

  24. AA is my hero!

  25. adios amigos

    Point well made, and one that I have made often and loud in this blog. It’s called corruption – plain and simple. There can be no recovery until trust is re-established, and that won’t happen until the corruption ceases. Especially in light of what just happened to the world economy. The opinion of we, the great unwashed, is that this mess can be boiled down to dishonesty ad corruption on VERY high places.
    My 2 cents.
    AA

  26. I much value your analysis for its clarity and balance, but I fault it for its credulity. Your analysis of the administration’s actions are based on an assumption of their sincerity and does not weigh the possibility of their duplicity, or the control of the administration by powers that would exploit it to the breaking point. I don’t mean to suggest a descent into paranoia, but rather a theory in which the remedial forces are paradigmatic, which is to say “sticky.” A theory based on sticky political forces would consider the possibility of sharp policy changes resulting from crises of civil unrest or exogenous insults (like the confrontational monetary, fiscal, or policy actions of other nations). What are the policy alternatives? What factions foreclose these avenues, and what power do they have? At what point will the propaganda machine lose traction, such as it did in New Orleans? Lacking the inclusion of these forces, which I consider increasingly likely as thing stretch to the limits of elasticity, your analysis seems Victorian.

  27. Thank you for this informative and provocative post. You have my support for your proposal to have smaller banks and the sooner the better. The large sums of money used to maintain “zombie” banks and dinosaur corporations would be an excellent source of funds to increase the fiscal stimulus and to provide more help to those who have lost their jobs and homes.
    I am also happy to see you point out the pitfalls in the economic forecast reports. In the US, there is considerable doubt that prices will actually fall and stimulate consumer demand. So, as you suggest, relying on this scenario to provide the cure is not the answer. Creating an environment where new and existing businesses which make innovative products for the world can thrive and grow would be a more proactive strategy.

  28. How can anyone judge what is really going on with the flow of capital markets with all the manipulation that is done in the name of monitary policy? Primary dealers are making their bets as usual!

    But for the rest of us, we are at the mercy of the banks since they basically run our government, and that means our country.

  29. Let's revoke the federal reserve act

    The bankers run all policy! We have no say because our government is owned by the banks….and conveniently, the Federal Reserve Act made it official–private banking system blessed publicly to spend all taxpayer’s future stream of income for bailouts!

  30. Unlike Tom, I don’t see anything provocative or particularly informative in this post.

    The Treasury, Fed, Obama, Congress, and friends are robbing the public for the benefit of their gangster and bankster pals. The fact is that more debt will not cure debt problems (i.e. we can’t spend our way out of this.)

    Everything off-balance-sheet should be left to those who played that game to sort out – with a hoard of litigators representing those taken-for-a-ride suing the greedy miscreants from now to kingdom-come.

    And Paulson, for being at GS when they were shorting the investments they were pawning on their clients, should be the first to be sent to prison, followed by hundreds more.

    I am truly sick of academics and politicians giving any credence whatsoever to this massive fleecing of the public. Period. By doing so, YOU are complicit.

    YOU ARE PART OF THE PROBLEM, NOT PART OF THE SOLUTION. START THINKING OUTSIDE-OF-THE-BELTWAY-BOX…but perhaps you can’t.

  31. now btraven is my hero!

    As if hank didn’t know what a win, short term and long term, getting rid of Lehman was i am not a human being–short term win the bet, long term, more market share for the other banksters! The icing on the cake was the brilliant idea to use taxpayer money 100% to pay all collateral and debts of AIG! BRILLIANT!!! that was the saving grace of Goldman— if anyone had the guts to call for a retroactive audit of GS and maybe even MS, it would be a good bet to wager that because of their winning the short bet and CDS’s bet on Lehman and subsequent cash that flowed through AIG saved their corrupted souls!

    For all the weeks that hank lobbied for the TARP, he could have taken that time to ask for the power to take into conservatorship AIG, and any bank that was next in line instead of passing on our children and our grandchildren’s tax dollars to the crooks that were going down without the scam that we were brainwashed to believe about how this money had to be spent.

    A TRIAL AT A MINIMUM, IS THE ONLY RIGHT THING FOR THE MAKERS OF THIS SCAM!

  32. let's rant!

    … fools seldom differ.

  33. Dear let’s rant,

    Sorry if i offended you.

  34. btraven:

    I think I am as angry as you seem to be about what the bankers and their toady politician friends have managed to do at our expense. However, I still have some faith that Obama plans to do the right thing, even though it is not obvious right now how that will happen. I don’t think there is any way to stop the runaway debt locomotive at this point. I think the best we can do is push to have the borrowed money diverted away from the banks towards helping those most in need and towards building the framework for a better system. In he end, I think the debt will go away via default.
    I am worried that not enough is being done to identify the crooks and hold them accountable. However, I have seen some recent reports that efforts in this direction are gaining steam so I plan to withhold judgement for awhile longer.
    Finally, I disagree that the authors of this post are part of the problem. I think they are performing a great service in many ways. I was particularly impressed with their Atlantic article and how eloquently they described the problems caused by the tight connections between Wall Street and Government. The mainstream media can easily dismiss as crackpots those who express views that suggest widespread corruption and conspiracy, even though they may be correct.
    Anyway, I prefer to retain some optimism at this point so I don’t sink into despair. I may be wrong and will gladly eat my serving of crow if and when the time comes.

  35. i hope the global economy will be better soon.
    by the way,a dating site:
    *****T allfinder.c om*****
    YOU may find your soul lover there.

  36. Ed Beaugard

    Err…that should be a negative second derivative, a decreasing rate of change(a good thing).

    Sincerely,
    Ed Beaugard

  37. Not a cheerful story but better to hear the real situation than a bunch of propaganda or fluff.
    Most of this economics is over my head but I check here to try to get a grasp on these important subjects.

    This may not be the best place but, I have a naive question for anyone who wants to answer.

    Introduction: I had a bunch of money invested in a sensible diversified way. In spite of that rational choice, nearly half of my money is now gone.

    Listening here and elsewhere I now have a grasp on how big manipulations, derivatives, bad bets, greed, lack of regulation and so forth took the world economy down in a short time. That sucks, but I sort of understand how the fools managed to screw us all for big short-term profits along the way.

    But here is my basic failure of understanding that I never heard anyone actually directly address:

    WHERE DID ALL THE MONEY GO?

    The best simplistic understanding I have is this. Some of it was siphoned off by the bastards that made it happen and a bit more by other big players. A good portion was removed from the field by those who pulled out in time and are still hoarding it in some safer form. Here is the part where I speculate because I never heard anything to confirm it. The majority of the money vanished because it never existed.

    Lots of it was based on assets or loans that were inflated or totally insecure. But I think a huge amount of it was created at the top by smoke and mirrors multiplication of things for things and mumble jumble of layers upon layers.

    Am I basically right? If so I am horrified that the whole world, not just Bernie’s clients was subjected to a Ponzi scheme.

    If there is a better or more complete (but understandable for the masses) explanation of where the money went, please help me understand.

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  39. If you are unwashed, that is easily solved, let me know where to send the soap.

    You keep talking about corruption. I question that wording. Corruption could possibly involve political influence that made certain things easier. But that is only one factor in the process.

    Pure greed and stupidity is a much more likely explanation in my mind for why those at the top of the financial system made such stupid choices.

    Tell me what role corruption played and why you think it is a big factor in our problems.

  40. I find it curious that you are now so apologetic.

    Weren’t you cheering those who wanted to see someone on a pike?

    …now a bit of an implied insult.

    and you are sorry?

    As I said… curious.

  41. Just a layman’s and citizen’s question: a lot of comments have blamed the precarious, risky situation before the downturn on the repeal of Glass-Steagall in 1999.

    Is there any serious talk in Washington about just reinstating Glass-Steagall, or some equivalent?

  42. Anne,

    I’m only going to respond to #3.

    I can tell by your writing that you may be smarter than me, certainly more informed academically.

    You mention — businessmen incapable of managing their businesses in a responsible manner. From the context, I have to think you are referring, actually, to bankers or Wall Street types. The ones who actually made a number of bad choices leading directly to our current economic catastrophy.

    In my mind their trade, these certain ones, though a form of business, has evolved more into a form of speculation or pure gambling with the huge assets provided by others, rather than what most people would think about hearing the term businessman.

    These particular “businessmen” found themselves in this in this god-like position of power where they had huge amounts of chips (money) provided by the house. The house stake grew largely due to “lack of regulation”.

    These “businessmen” would place bets with the house money. Only safe ones. But the odds are so good. Look at the numbers — this vs. that. The “businessmen” made money — the house happy — game riskier — everyone happier — **Game over**.

    Now, in my mind, real businessmen play a part in our current situation for a different reason related to Wall Street.

    I first noticed it back around the middle 80’s. Companies I worked for, rather than thinking about what was best for the company in the long term, started to focus on stock price. Was this driven by leaders vested interest? Could be.

    Now everything the company does is driven by how the numbers look on a quarterly basis. Is this any way to run a company? Yes for the stock market, no for the long term goals.

    Number, numbers. Short term, move it, sell it, off-shore, merge, reduce, consolidate. Wallmart.

    In my opinion we have killed the golden goose and the last of its blood fertilized this last bubble. My question is, do we have enough of a real economy left to sustain a recovery without artificial financial smoke and mirrors?

  43. All very social and fine pointed. Nicely written.

    I have no idea what France’s economy looks like on an average day.

    Here in the US, I’ll venture my own uninformed perspective.

    I worked in electronics, computers, technology, most of my life. It was a very good and satisfying way to earn a living and it produced good stuff that others could use.

    Throughout my career, there was always a way to be smart and get a little more, do a little more, keep working, do good.

    In the 80’s I noticed a trend where the company started focusing on quarterly results to keep the stock market happy. This, I think, is frequently not good for long term goals.

    Competition increased, I left.

    But many other companies seemed too be focused on the stock market or extremely short term gains.

    Quickly most of the US innovation was squashed, production ceased, the good companies merged into mega tyrannies.

    I have thought for a long time that I was watching a shell game in motion. No new money, just slide it around.

  44. Erich Riesenberg

    I never understood the phrase “real economy” in the same way I never understood companies refer to themselves as “players” in an industry. Now it is clear that in the “real economy” there are consequences while the “players” get lots of do overs.

  45. Thanks, I’m glad to hear that.

  46. Thank you XRAY. I am not academically informed at all – just a writer/small business owner struggling to reconcile how so many exceptionally highly paid and well-educated business people felt it appropriate to turn their business into a craps game. Thank you for your answer.

  47. out of nothing

    All the money went back to the same place they came from when the time was good!

    Sorry, I couldn’t help myself:p But I do have a point here. Have you wonder why didn’t we ask where the money came from when our assets are increasing in value? I am serious about that is where the money has went back to.

  48. Tom – I hear you, but I have zero hope at this point in time. Maybe that’s a good thing, as hope was the last thing out of Pandora’s box.

    If you toss a frog into a pan of hot water, it leaps out.
    If you place a frog into a pan of cool water and heat it up slowly, it will stay there and die.
    We are being cooked.

    Go back and research all the statements of Bernanke & Paulson starting last year — “everything is contained,” blah, blah. They are either liars or ignorant. At this point, since they haven’t confessed to being clueless after making one incorrect assertion after another, I take them as intentional liars. The latest joke is “the stress test” charade — just more smoke and mirrors.

  49. Charles Toney

    A practical view –

    The current financial crisis on Wall St.is simply a supply & demand problem. There is just no demand for stupid investments, even esoteric ones. The investing public is saying quite clearly (by selling the stocks & bonds of the major Wall St. banks & by not giving them any more deposits to invest), that there is no demand for the major Wall St. bank’s services. Which is simply investing other people’s money while confiscating millions & billions of these other people’s dollars in salaries & bonuses. While providing no benefit whatsoever to the U.S. economy which produces their lavish life styles..

    A supply & demand imbalance is exactly what happens to any company that goes bankrupt. There is simply insufficient demand for their service or product at current prices. The same with “smaller” banks.

    And what is one of the first things the bankruptcy courts & FDIC do to correct the supply & demand problems at these companies & banks? They get rid of the people who made the decisions that led to the supply & demand imbalance at their companies. The management.

    But now we have Mr. Geithner, Bernanke & Summers telling the investing public that they’re stupid & don’t know what they’re talking about. They tell us that there is still demand for the large Wall St. bank’s services. They tell us the supply & demand imbalances at these big banks have nothing to do with the decisions of the managements of these banks. And while the investing public has decided not to give these inept managements any more money to invest, Mr. Geithner, Bernanke & Summers have decided to give these inept people billions & trillions to make more stupid investments. Money they’re confiscating from we the taxpayers without our permission.

    But Mr. Geithner, Bernanke & Summers assure us that they will write some new rules to prevent these managements from making any more stupid investments.
    Yeah, right. Like they’re going to convince the investing public to keep buying whale oil after we hit oil.

    Charles F. Toney
    Plano, Texas

  50. xray

    i should have been more specific in my earlier post, I don’t agree with the last part of what btraven said when he said that he was ,

    “I am truly sick of academics and politicians giving any credence whatsoever to this massive fleecing of the public. Period. By doing so, YOU are complicit.

    YOU ARE PART OF THE PROBLEM, NOT PART OF THE SOLUTION. START THINKING OUTSIDE-OF-THE-BELTWAY-BOX…but perhaps you can’t.”

    But, i am guilty of agreeing with the rest, and for my own wish to see guilty parties exposed and corrected.

  51. My hat’s off to Peter Boone, Simon Johnson, and James Kwak. This is the most thorough and cogent recent analysis of the relevant conditions that I’ve seen.

  52. I agree. This is a very thorough and cogent analysis of the situation. I am quite happy to have happened upon this blog accidentally while looking for something else.

  53. Greed and the resultant sustaining of a wealth cycle increasingly created out of nothing tangible, word inventions, caused the current collapse. Wealth and power is a pyramid scheme and geometric in shape. Deals are made along the way by an ever decreasing amount of individuals, as the smaller, weaker and less ruthless are bought out of the cycle. This results in an ever increasing concentration of wealth and power with an ever diminishing agenda of self and peer aggrandizement. Call their bluff-pull out the rug!

  54. adios amigos

    X,
    “Corruption”, because without it, this mess would probably not have occured. Institutionalized corruption typically emerges when people in big places (IE: Gov’t, Heads of Large Corps) no longer have a fear of prosecution. They get to act with impunity. When elected lawmakers, heavily influenced by lobbyists from the financial services biz, passed laws that allowed them to leverage their balance sheets up to the stratospheric, idiotic, levels they allowed, knowing the probable result….it’s corruption. Are ya tellin’ me they actually thought 40X leverage was going to be fine and dandy? Thats not stupidity….that’s piracy, and all rubber stamped by Washington….when they changed the laws to allow it. There are no clear thinking business leaders that will ever look you in the eye and say “yes, 40x leverage is fine”. Thats lunacy.

  55. Economics Rock God!

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  58. Forgive my simplicity, but as I see it, (correct me if I am in error) this “liquidity crisis” started by a rather noble democratic administration’s attempt to get an over-abundance of Americans into home ownership. They influenced the lending institutions to make loans to allegedly high risk people. If the economy would have continued to grow, those people would have been able to make payments on their loans and in 30 years, they would have owned those homes. However, the prices of energy started to rise and in order to be able to drive to work the people paying off those loans and the corporations that employed them had to pay those high energy bills. This higher cost of energy made Americans seek a means to fund their excessive lifestyles (not reduce their spending). Simultaneously, as the economy started to slow (due to higher energy prices) the Federal Reserve lowered interest rates to stimulate the economy and put more money into circulation. The home owners found that more people could make payments on homes that had historically low interest rates and were willing to pay more than the property was actually worth because all they were concerned with was the payments they needed to make. The real estate markets escalated and suddenly, those that got in early saw a means to pay their bills with the equity increases in their real estate. They essentially used their homes as ATM machines. They re-financed and took out the money and spent it. They didn’t invest it into endeavors that created true wealth, they spent it on maintaining their relatively lavish lifestyles. The problem was that money was being spent that wasn’t ever really earned by a true wealth creation, it was just created by the magical ability of lending institutions to lend 9 times more than their actual assets that had previously been required to be earned by actual creation of wealth though productive labor. Then, entering the scene were a bunch of creative parasites who survive off of enterprizes that simply move and manipulate those monies that were magically created. They organized those money making mortgages into packages that they sold internationally and made additional profits on the pretend money, creating a pretend deriverative profit on already pretend increase in value of the underlying assets. The energy costs continued to rise and the corporations that produced actual wealth couldn’t keep up with the costs and had to stop employing people. Also, the money available from the equity sales ran out. Jobs were lost and people began to not be able to pay the payments they thought they would be able to make had they kept their jobs. So, they began to default on their mortgages. Mortgages that had been purchased by alot of people who were expecting to make long term money on the interest payments that would have been generated. Suddenly, they had to sell their houses to maintain their lavish lifestyles, but no one could afford to pay those artifically heightened prices and the real estate market collapsed. Since the basis of those values were created by magic, they could disappear as quickly as they appeared. And they did, in a very short time, the foundation-less card castle’s base began to collapse. Those little pieces of paper with God written on them givith and those little pieces of paper with God written on them taketh away, just as easily. For quite some time the solution to the underlying parasite problem was to simply create more paper with God’s name on it. As long as there were suckers out there who trusted in its value, the imaginary “money” was sustaining the artificial “economy,” even though what was being practiced was not, in any traditional definition true money nor real economy. Then, the rest of the world stopped buying the little pieces of paper. Unfortunately, the creator of those papers, instead of stopping the printing, decided to simply buy them themselves. And to further the smoke and mirror environment, the magicians decided to let the parasites themselves decide how much the mortgage assets were worth instead of requiring that it’s real value be assessed by virtue of the market’s price. So the pretend economy will look better on paper, a pretend solution has been proferred. Well, the real problems haven’t been solved. The only means to solve it is to generate more energy so it becomes cheaper for all those excess Americans as well as the rest of the world dwellers. There are just too many people vying for the limited true resources and assets remaining. Do you want answers to the problem and predictions? Ok, I’ll make my opinion known because I’m just a joker whose financial reputation doesn’t matter. Any endeavor that doesn’t have as its goal a reduction in population and production of sustainable, non-polluting energy will only be more smoke and mirrors. The people who own the current sources of energy (fossil fuels) will very soon begin to demand tangible goods and real assets for it,and will refuse to accept imaginary-valued paper. The Chinese, the Russians, and OPEC are going to force a movement away from the Federal Reserve Note as the currency of exchange for energy. They will require gold backed securities. This transition will become of notable substance within 3 years. The pretend paper will become less and less acceptable in commerce. If you haven’t noticed, there is an ever-increasing discrepancy between what the paper price of gold as published in the futures market and the actual money it takes to purchase the metal. This gap will become increasingly widened as time goes on. The U.S.Government will allow this to happen so as to allow inflation to erase the debt that it has been rapidly accumulating as of late. Massive inflation is not a future supposition, it is a foregone conclusion. If the U.S. Government doesn’t move to solve the sustainable energy problem and the over-population, there will be no solution to the economy’s failure because its origins rest in those realities, not the sleight of hand mistakes in the prestidigitation of pecuniary principles.

  59. “…getting lending restored”

    So what we need is more debt? With total debt (government, corporate, private) at over 350% of GDP, more debt is not the answer.

    More lending? For what purpose? To buy homes which are too big and still too costly relative to median wages? To expand production capacity for goods that will clog tapped out domestic and world markets?

    All Obama is doing is kicking the can down the road. More debt means more interest burden for the next decade and the next generation. It is unsupportable.

    How will that 350%+ debt-to-GDP ratio ever revert to the mean unless we have more GDP and less debt? Currently we have lower GDP and institutions taking on even more debt.

    It’s incredibly out of fashion these days, but grandma thought you should first work to earn capital, save some, then spend. It worked for grandma. It would work for a nation, if we had leadership that hadn’t been “captured by the finance industry” as Simon Johnson’s Atlantic article put it. We need reduction of debt, to put the banksters out of their line of work and into a useful type of employment, like cleaning out public lavatories.

  60. xray,

    What’s happening has every appearance of corruption. Apply Occam’s razor. Or as Judge Judy once put it, “Don’t pee on my leg and tell me it’s raining.” If it looks like a duck, walks like a duck, quacks like a duck…

    William K. Black just called it fraud. (Check out last week’s Bill Moyers program, where he interviews Black — the video and transcript are on his website.) But it was fraud with a nod and wink from government. Fraud plus government refusing to act, even when warned by law enforcement that fraud on a scale apt to cause something worse than the S&L debacle, that my friend equals corruption.

  61. anne-
    Please excuse me/this. This is my first time reading the baseline-very impressive. The answer to
    your theory is not a crap game; but, pure greed/deception on most if not all (ceo, coo, cfo,
    hedge fund mgr’s i.e. These individuals jumped at
    the chance to deceive all of us for the buck$. They
    grabbed a few of the good ole boys -n DC to come
    along for the ride. It is a wonder/amazement how
    this great country sat by and did nothing. We are all (baaaaa!) sheep and now we are sitting around wondering why we are all in pins, why is there so much blood on the floors.

  62. Oh, man you are AWESOME! I can’t believe someone credible is actually saying what all of us average people are THINKING every minute we hear about this messed up financial crap! Dude, you deserve an award for saying publicly that bankers ALL SUCK xxx!! Dang, the only problem is that you’ll be on the hitlist for assassinations now by the all-knowing banking oligarchy. Let’s HOPE the Obama administration has the pelotas to stuff the bankers back into their box!!! Please keep up the effort for true disclosure!!!!

  63. I was laid off from Sun in ’01, worked fast food and took classes to get into the healthcare field but never got past the waiting list. I was outta work for over 5 years (shoulda got my Masters but nobody was hiring C.S people regardless) til I finally landed a job with the State just 4 months away from homelessness. I still can’t kick the underlying feeling of desperation, PTSD for sure. I can’t discuss current events with coworkers as they seem delusional or just don’t get it. It can’t happen here, right? What’s going to happen with the coming tsunami of homeless? Masses of migrant farm help? Oh boy…

  64. JustAnAverageCitizen

    My question is, how can the average person–with not a lot of time–convey to the administration that we DO want a change in cozy relationship between the financial industry and its regulators? I don’t mean writing sophisticated letters that reveal my (NOT) in-depth understanding of all the causes and effects. I’m looking for a way to express my desire for change in a practical way. I keep meaning to ask Bill Moyers the same question but, as I said, I don’t have a lot of time. And I would like a way to galvanize my neighbors and friends, as well. I would appreciate it if this site would either have such suggestions or direct me with an obvious link to one that does. Thanks

  65. Sudip Chahal

    I greatly enjoy and value reading your site and i stumbled on your brilliant Atlantic article “The Quiet Coup” from another website (from Greg Mankiw’s site). The only link to that article from this website is in the “For Beginners” section where it woould be easy to miss for longtime readers of the Baselinescenario.

    I would like to urge you to display a link to that article much more prominently -I am positive that each and every one of your readers will greatly enjoy and value that superb (even that praise feels inadequate) article. In my view it should be required reading for everyone (and i’m trying to do my part! :) to make that happen)

    Another suggestion / request would be for you to consider writing a book that elaborates and expands on the points you make in that article (The Quiet Coup).

    Thanks,

    -Sudip Chahal

  66. “We believe the Obama Adminstration…. is making every effort to combat this crisis” Huh?

    From an entrepreneur’s point of view you’ve got to be kidding.

    Raising taxes, stopping offshore drilling, imposing carbon taxes, Card Check, enacting a stimulus package with little stimulus and lot’s of new welfare, universal healthcare, suppressing free speech, imposing new Libby Ledbetter workplace rules, concurring with a proposed World reserve currency- the list goes on and on, and it makes most entrepreneurs puke and frightened. Why would any sane and decent individual invest in that kind of fascist/socialist controlled economy? There’s little upside, unless you’re a con artist or thief.

    You guys have been looking at your charts and numbers too long. You can’t quantify the huge effects of those kiind of socialist rules and moves. We’re headed into uncharted waters and we’re taking on water. Fast.

    Furthermore, the underlying reason for this collapse is a series of unwise and corrupt government interventions into the free market, starting with the CRA, Fannie and Freddie corrupts moves and continuing right through to Turbo Tax Timmy’s plans. Much of the regulatory bureaucracy is corrupt. Much of your “the Quiet Coup” stuff was spot on. Some was not. The rise of the Oligarchy is true. Concentrated power on Wall Street has corrupted our financial system. I still don’t understand why investment banks reserve requirements were allowed to be decreased- there was hardly any public discussion of a huge issue.

    What most people see as a ” free market ” does not necessarily mean a totally deregulated market. It means a sensibly and transparently regulated market that conforms with our Constitutional liberties.

    But a major problem with many pundits analysis, not just yours, is that there is no reason to believe the Obama Administration really wants to bring back a healthy free market and or even a healthy economy that would be recognized as such by most Americans. To the contrary, in their own words ‘ a crisis should never go to waste”. Obama appears to want to change the nature of our economy to a more centralized, socialist, command controlled economy and that kind of economy has always led to disaster and ruin every time it has been tried.

  67. FranklinPierce

    StatsGuy,
    You write (and think) very well. Please keep it coming.

  68. FranklinPierce

    In the near future we will see masses of homeless people and masses of empty foreclosed homes. If market forces were allowed to prevail, insolvent banks would have to sell these homes cheap – problem solved. But instead, zombie banks will sit on these houses and let them deteriorate. No one benefits except welfare queen bankers being paid billions to do nothing.

  69. FranklinPierce

    “this “liquidity crisis” started by a rather noble democratic administration’s attempt to get an over-abundance of Americans into home ownership”

    This is only one part of the problem. A much bigger part is gross irresponsibility and fraud in the big banks.

    To my mind, it started back in the 1980s with the Savings & Loan scandal. Despite billions in losses, those guilty were let off the hook. Analysts were surprised to discover that 90% of S&Ls actually obeyed the law, even though they could have got away with breaking it. The lesson was clear: obeying the law is for suckers.

    Fast forward to today: the numbers are reversed. Rampant fraud is the norm on Wall Street. All these complex “derivatives” are just a smokescreen to confuse the little people. How complicated does a mortgage have to be, after all?

    Try this link:

    http://www.pbs.org/moyers/journal/04032009/watch.html

  70. What will bring about a recovery? There will be some pent-up demand for things but not enough for a return to the good old days. The demand for goods, houses and services was stimulated by the baby-boomers, who also filled the needed jobs, and bought stocks etc. That stimulus is over and is not coming back anytime soon.

    You should really take a look a the demographics of this country. We will very shortly have about the same number of people entering the labor force as leaving it. No baby-boom-like demand. (but also less pressure on unemployment)

    Japans lost decade had more to do with a static or declining population that with the health of the banks. Russia is facing the same problem.

    Population growth has always been one of the reason for boom times, the other is technology. And what technology is about to save us? Alternative energy? Not if it is more expensive than present conventional sources.

    We are doomed to a long slow/no growth period. The only way out is exports, good luck with that!

  71. Duncan Phelps

    This is a plea and statements directed to the fall of 2009, when the last of the hold outs will find that the same experts that contributed to the US financial disaster and who are presently telling the dwindling number of believers who are still listening that the downturn has nearly bottomed—are AGAIN wrong!

    This plea is for someone to put together the legal team to charge 98% of politicians and top corporate leaders with conspiracy and embezzlement of US funds. It could start as something seemingly small like CIA sponsored torture charges or Bank of America arm twisting in the take-over of an insolvent firm—anything to lead on up and take-in/include the Big Elite.

    Purpose: To declare the usury financial institutions, including the private Federal Reserve, totally BANKRUPT. The bubbles will continue to burst: commercial real estate, credit cards, retirement funds, derivatives, etc.etc. This “too big to fail” BS is only perpetuating the true traitors and swindlers.
    We need to let the inevitable occur earlier rather than later. Don’t let the conspirators run the show any longer. Lets get on with raising the Phoenix. Only those who have been standing out in the open trying to expose the corruption for decades should run the show from now on. Put my name on the list to “call the shots” and replace those with no integrity. And I don’t mean that in a violent way. I’ll be one who is willing to be in service to The People for only room and board. Executive payouts are for the twisted where crime pays! Let us call and end to corporate-ocracy. It is bankrupt and has shown no-one is in charge who can give intelligent orders.
    A good part of the military is for a banana republic type takeover, but not like the JFK one in 1963! Martial Law is coming—either your way or my way! A declared default will allow The Black world and their projects to come-out of compartmentalized secrecy & the underworld and share new technologies and their money system based on production and mineral/agri wealth and takeover the present bankrupt-slave world currently empowering Elite usury-ists’ families. Cutting-edge production, wealth, and leadership can once more be attainable by the united States.

    So, sign me up—class action suit or whatever! I have been working for this day most of my life! I am no terrorist. Those “insiders” of 9-11, the War on Iraq & Afghanistan and pushing for an Iran War are the true terrorists.
    Let the New Order of the Universe (NOU) or Universal New Order (UNO) begin! Let the New World Order (NWO) default and be declared bankrupt.
    May the Force be with us…

  72. great analysis, excellent comments. should be among the best 3 economy blogs I found so far.
    what I believe is not discussed enough: the simultaneous impact of a number of significant trends making “recovery” as most understand it unlikely any time soon: energy and other resource scarcity plus the cost caused to states by aging populations. those two alone should force us to lower levels of average wealth in developed economies.

  73. tomaso spingardi

    the fact that excessive leverage and abnormally high risk propensity had pushed the world in a very high risk zone was clear to many people for years. let’s not forget that we were coming from LTCM and a quasi lehman collapse in 1998 and a capital crunch in 01-02. surely nobody could predict the exact timing or such magnitude of the crisis. but the lingering suspicion is that the top people were more tha aware of the situation but none of them, subject to competitive pressures, dared to stop first.

  74. Let the Billionaires fail? Give the country back to the people? Look at who is in Congress. The number of mega-millionaires or billionaires or millionaires representing billionaires is staggering. John McCain’s wife was worth a quarter billion. Kerry’s wife was worth over a billion. Anybody heard of Kennedy? Henry Paulson was a Democrat and Chuck Shumer represents New York’s Wall Street which is overwhelmingly Democratic and now in control. Summers and Geithner invented most of this mess under Clinton and the Republicans did little to stop it since their hedge funds were generating huge returns. Bill Gates is a Democrat along with GE’s Jeffrey Immelt who has set up a another company to make billions more off of cap and trade and has a division readying money losing windmills. The one thing every politician is good for is telling the masses what they want to hear to get elected so they can run to the trough with all the other little piggies. But hey, so you are scammed and lied to but would you rather be in a permanently depressed Cuba where the same thing goes on but at a lower economic level? So stop wasting your time in a pity party. Get some studies on economics, politics and investing. Then, either join the piggy party or enjoy a life of financially disciplined integrity, living a simple life of modest income and service. You don’t need a gold cup to enjoy hot chocolate. You don’t need a BMW to arrive. You don’t need a Harley to enjoy the breeze. And you pay nothing, absolutely nothing for salvation and inner peace. They are free for the taking.

  75. Let the Billionaires fail? Give the country back to the people? Look at who is in Congress. The number of mega-millionaires or billionaires or millionaires representing billionaires is staggering. John McCain’s wife was worth a quarter billion. Kerry’s wife was worth over a billion. Anybody heard of Kennedy? Henry Paulson was a Democrat and Chuck Shumer represents New York’s Wall Street which is overwhelmingly Democratic. Bill Gates is a Democrat along with GE’s Jeffrey Immelt who has set up a another company to make billions more off of cap and trade and has a division readying money losing windmills. The one thing every politician is good for is telling the masses what they want to hear to get elected so they can run to the trough with all the other little piggies. But hey, so you are scammed and lied to but would you rather be in a permanently depressed Cuba where the same thing goes on but at a lower economic level? So stop wasting your time here in a pity party. Get some studies on economics, politics and investing. Then, either join the piggy party or enjoy a life of financially disciplined integrity, living a simple life of modest income and service. You don’t need a gold cup to enjoy hot chocolate. You don’t need a BMW to arrive. You don’t need a Harley to enjoy the breeze. And you pay nothing, absolutely nothing for salvation and inner peace. They are free for the taking.

  76. Duncan Phelps

    Enjoy your hot chocolate ‘GotLife Too’ and do nothing to stop the OneParty Corporate-ocracy in this country and in 2 years most of us will be living like Cubans, and any children will be indebted to a living standard far below Cuba, if they are not swine-flu-ized 1st! I stood out against the War on Iraq and now must pay a 400% tax because not enough others are standing up against these scams, so presently I cannot afford to work to pay my share to the rich politicians and their welfare creations—you are no doubt paying “my share” even now. Hope you are not drinking that hot chocolate out of a paper cup, cause you need to have wiggle-room to down-size. I am down to drinking water!

  77. I’ve got 3 points :
    Point 1 : Nobody saw this coming :
    Well they did –see this Washington Post article by the former Governor of New York http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021302783.html – All 50 states saw this coming and tried to stop it. Washington saw it this coming and stopped the states stopping it.

  78. Point 2 : Crisis ! – What Crisis ? – what have we actually run out of ? I suggest that the problem we have is, at base, caused by us using a financial system that was invented in 15th C – pre-machine age –Venice and only survives on periodic financial asset booms : Tulip bulb booms, housing booms, stock market booms… – quite simply it’s not fit for purpose – what a merry-go-round we have to go through to buy a house built 100 years ago and to eat food that needs only one farmer and a tractor to feed thousands. I suggest that we use a modern financial system based on ideas like NEFS – NET Export Financial Simulation

  79. nobilityofspirit

    I would add this to the conversation: Captains Courageous of Commerce and Industry
    Touting the virtues of free enterprise, capitalist economy
    They would like us to believe
    They are the brightest and they know best
    They take the risks to them go the rewards
    From their efforts fall great, bountiful benefits to us all
    Economically, socially, materially we will be blessed
    De-regulate and let the invisible hand work its magic
    Look to them for leadership they know the way to prosperity
    They are examples to aspire to
    Honor, ethics, and morality we ask innocently
    Are in the way and in the end do not pay
    Charlatans, cowards and corrupt they deceive
    These courageous captains of commerce and industry
    They are the brightest and they know best
    They deserve great rewards for taking the risk
    What risk? They risk other people’s money
    When comes the call to stand tall in the box of responsibility
    Into the shadows invisibly they disappear
    They did nothing illegal and owe nothing in return
    Honor, morality and ethics just get in the way
    After all these courageous captains got their pay
    Like the Robber Barons of a Gilded Age
    They are protected you see
    Uncle Sam will lay the tab on you and me
    At the altar of free enterprise and the invisible hand they genuflect
    Then feed at the public trough with unrepentant hypocrisy
    True leaders with honor, a moral compass and nobility of spirit
    These courageous captain choose not to be
    This capital is not really important and does not pay materially
    They are privileged and protected from free market reality
    And the masses upon which they feed and tread
    Will pay the price and pick up the tab, naturally
    The guardians of the public trust in whom we should trust
    To protect us from immoral, unethical, unprincipled avarice
    Blind they become to these captains of commerce and industry
    Palms greased and pockets filled materially
    They dance with these captains on the backs of the masses
    A fog of moral malaise and ethical hypocrisy devoid of nobility of spirit
    Trickles down onto the masses and, yes, the masses see
    Cynically they follow these leaders and further erode society
    Surely if it is good enough for the captains and public protectors
    It must be good enough for me we say cynically
    Honor, trust, integrity, justice and responsibility
    Become fading, frayed threads in the fabric of society
    Lack of regard, respect, restraint, responsibility and
    The ends justify the means becomes the new reality
    And, yes, the masses will pay the price and pick up the tab, naturally
    Dale O. McCoy (Dec. 08)

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  83. Re: The King´s New Clothes

    I´d first like to say that both of you, Simon and James, are doing a fine job as concerned and knowledgeable citizens.
    However, I ask that you consider the following.
    1) You know from your time at the IMF (Simon) that politicians are gamers (many different shades, but gamers just the same).
    2) Banking is a commodity business and don´t let anyone tell you differently. The bankers of today (oligarchs) are gamers too.
    3) John Q. Public has bought (and or borrowed) into the game.
    4) There are two ways of learning: for the love of it or through pain.
    5) No one likes pain so it tends to be put it off for as long as possible.
    6) The king is naked but no one wants to be the one responsible for the pain, so the gamers play on.
    Two possibilities: We can dig up the character that made America great and do what´s right (and needs to be done) or we can continue in denial and allow the gamers to play on until…

    Keep up the good work.
    Andrew