Where Do We Go from Here?

(Which is, of course, a song from the great Buffy episode, “Once More, with Feeling.”)

After the last week, it was a relief to have a relatively slow news day, at least compared to the preceding days, to catch our breath and take stock of things (and get over my cold). American and European policy makers decided they needed to use overwhelming force to stop the panic in its tracks. It will take some time to see if they used enough; the credit markets have certainly not opened up, although some indicators have gotten marginally better (the TED spread is slightly down; T-bill yields are slightly up).

There are two directions things could go. First, it is possible that the credit markets will not come unstuck, and even more force will be required; blanket loan guarantees (for all bank obligations) and large recapitalizations (more than 3% of assets) would then be called for. Second, and more likely, we think, credit will gradually start flowing again. But even in that case, the global economy will be far from out of the woods. Here are the top issues that will still need to be faced:

  • Implementing the Paulson plan, including both bank recapitalization and, if still included, asset purchases. This will require dealing with all of the issues of governance and pricing that we have commented on previously.
  • Containing the damage of falling housing prices and foreclosures. Asset prices do need to fall to reasonable levels – trying to prop them up at artificially high levels will only hurt the economy in the long run – but limiting an overcorrection and limiting the collateral damage have to be priorities.
  • Stimulating the real economy. Even if the credit crunch eases in, say, the next few weeks, the last month has already done significant damage to the global economy (which was already in the midst of a slowdown). For starters, just think of all the uncertainty and anxiety that have been generated in the last month, and the impact that will have on spending and investment by consumers and businesses. The fall in the stock market will also add to the negative wealth effect of falling housing prices.
  • The international dimension and emerging markets. We could be moving to a situation where core banks in wealthy countries are considered safe, while banks in emerging markets are still considered shaky. This could trigger a repeat, on a larger scale, of the emerging markets crisis of 1997-98. And severe economic dislocation can always have political consequences as well.
  • Update: How did I forget … financial sector regulation?

These are some of the major issues we will be thinking about over hte next few weeks and months (and possibly years). Let us know what else you think should be on the agenda.

4 thoughts on “Where Do We Go from Here?

  1. James,

    Now they we’re in the process of recapitalizing banks, helping homeowners to keep values from dropping too far and stimulating the economy are the remaining “too dos” in the BS’s “Plan B” if memory serves.

    As someone who follows Congress, I’m particularly concerned with the stimulus package and what you think it should look like. Should it be tax rebates, increased government spending or both?

    Thanks for the very informative site.

  2. hi,
    first of all thanks for having started this blog. I find it very helpful in trying to work out what is going on (got a bit of an economics background, but know more about politics – as I am student of political science).
    What I’d like read about here are socalled Alt-A mortgages.French economist Frédéric Lordon wrote in LeMondeDiplomatique that “the value of all circulating subprime papers amounts to 855 billion dollars, but the Alt-A-titles make up around 1000 billion.” Furthermore he points to the category “Option-ARM” (Adjustable Rate Mortgages)- saying we need to worry in particulary about mortgages issued in late 2006/early 2007 (Bloomberg also wrote that in a an article dated September 2008).
    Addition number provided by Mr. Lordon in the article are:
    “Fannie” holds 340 billion dollars worth
    Bank Wachovia: 122 billion billion
    Washington Mutual (WaMu): 53 Milliarden, of which 13 % are up for re-shuffling next year

    Can you verify those numbers? thanks.

    As I’m based in the heart of Europe I’d be interested in reading entries here on Hungary/Ukraine or Serbia which all have asked the IMF now for assistance. Not sure there are more readers who would be interested in that.

  3. DCLawyer, thanks for the question. We’ll be reviewing some potential stimulus packages over the next couple weeks. Seen solely from the perspective of minimizing the recession (as opposed to other considerations such as distribution), a major criterion has to be the speed with which the stimulus makes it into the economy, and the proportion of the stimulus that will actually make it into economic activity (as opposed to being saved). This is why tax rebates to lower-income people are attractive. Extending unemployment benefits is also good, because the recipients are likely to spend the extra money quickly. To take a somewhat silly opposite example, lowering capital gains taxes – whatever its other merits – is unlikely to help, because not that many people have unrealized capital gains, and the people that do tend to have a lot of money and so their tax benefits may not flow into the economy.

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