Revised Baseline Scenario: February 9, 2010

Caution: this is a long post (about 3,000 words).  The main points are in the first few hundred words and the remainder is supportive detail.  This material was the basis of testimony to the Senate Budget Committee today by Simon Johnson.

A.    Main Points

1)      In recent months, the US economy entered a recovery phase following the severe credit crisis-induced recession of 2008-09.  While slower than it should have been based on previous experience, growth has surprised on the upside in the past quarter.  This will boost headline year-on-year growth above the current consensus for 2010.  We estimate the global economy will grow over 4 percent, as measured by the IMF’s year-on-year headline number (their latest published forecast is for 3.9 percent), with US growth in the 3-4 percent range – calculated on the same basis.

2)      But thinking in terms of these headline numbers masks a much more worrying dynamic.  A major sovereign debt crisis is gathering steam in Europe, focused for now on the weaker countries in the eurozone, but with the potential to spillover also to the United Kingdom.  These further financial market disruptions will not only slow the European economies – we estimate growth in the euro area will fall to around 0.5 percent Q4 on Q4 (the IMF puts this at 1.1 percent, but the January World Economic Outlook update was prepared before the Greek crisis broke in earnest) – it will also cause the euro to weaken and lower growth around the world.

3)      There are some European efforts underway to limit debt crisis to Greece and to prevent the further spread of damage.  But these efforts are too little and too late.  The IMF also cannot be expected to play any meaningful role in the near term.  Portugal, Ireland, Italy, Greece, and Spain – a group known to the markets as PIIGS, will all come under severe pressure from speculative attacks on their credit.  These attacks are motivated by fiscal weakness and made possible by the reluctance of relatively strong European countries to help out the PIIGS.  (Section B below has more detail.)

4)      Financial market participants buy and sell insurance for sovereign and bank debt through the credit default swap market.  None of the opaqueness of the credit default swap market has been addressed since the crisis of September 2008, so it is hard to know what happens as governments further lose their credit worthiness.  Generalized counter-party risk – the fear that an insurer will fail and thus bring down all connected banks – is again on the table, as it was after the collapse of Lehman. 

5)      Another Lehman/AIG-type situation lurks somewhere on the European continent, and again G7 (and G20) leaders are slow to see the risk.  This time, given that they already used almost all their scope for fiscal stimulus, it will be considerably more difficult for governments to respond effectively if the crisis comes.

6)      In such a situation, we should expect that investors scramble for the safest assets available – “cash”, which means short-term US government securities.  It is not that the US has anything approaching a credible medium-term fiscal framework, but everyone else is in much worse shape.

7)      Net exports have been a relative strength for the US economy over the past 12 months.  This is unlikely to be the case during 2010.

8)      In addition to this new round of global problems, the US consumer is beset by problems – including a debt overhang for lower income households, a soft housing market, and volatile asset prices.  The savings rate is likely to fall from 2009 levels, but remain relatively high.  Residential investment is hardly likely to recover in 2010 and business investment is too small to drive a recovery. 

9)      On a Q4-on-Q4 basis, the US will struggle to grow faster than 2 percent (the IMF forecast is for 2.6 percent).  This within year pattern will likely involve a significant slowdown in the second half – although probably not an outright decline in output.  The effects of fiscal stimulus will begin to wear off by the middle of the year and without a viable medium-term fiscal framework there is not much room for further stimulus – other than cosmetic “job creation” measures.

10)  The Federal Reserve will start to wind down its extraordinary support programs for mortgage-backed securities, starting in the spring (although this may be delayed to some degree by international developments).  The precise impact is hard to gauge, but this will not help prevent a slowdown in the second quarter.

11)  On top of these issues, there is concern about the levels of capital in our banking system.  The “too big to fail” banks are implicitly backed by the US government and for them the stress test of early 2009 played down the amount of capital they would need if the economy headed towards a “double-dip”-type of slowdown; the stress scenario used was far too benign.  In addition, small and medium sized banks have a considerable exposure to commercial real estate, which continues to go bad.

12)  Undercapitalized banks tend to be fearful and curtail lending to creditworthy potential borrowers.  This may increasingly be the situation we face in 2010.

13)  Emerging markets are also likely to slow in the second half of the year.  Twice recently we have assessed whether these economies can “decouple” from the industrialized world (in early 2008 and at the end of 2008).  In both cases, emerging markets – with their export orientation and, for some, dependence on commodity prices – were very much caught up in the dynamics of richer countries’ cycle.

14)  The IMF projects global growth, 4th quarter-on-4th quarter within 2010 at 3.9 percent, i.e., the same as their year-on-year forecast.  We expect it will be closer to 3 percent.

15)  Over a longer time-horizon, we will probably experience a global economic boom, based on prospects in emerging markets.  With our current global financial structure, this brings with it substantial systemic risks (see Section C below).


B.     From Greece to the US: The Globalized Financial Transmission Mechanism

1)      The problems now spreading from Greece to Spain, Portugal, Ireland and even Italy portend major trouble ahead for the US in the second half of this year – particularly because our banks remain in such weak shape.

2)      Greece is a member of the eurozone, the elite club of European nations that share the euro and are supposed to maintain strong enough economic policies.  Greece does not control its own currency – this is in the hands of the European Central Bank in Frankfurt.  In good times, over the past decade, this helped keep Greek interest rates low and growth relatively strong.

3)      But under the economic pressures of the past year, the Greek government budget has slipped into ever greater deficit and investors have increasingly become uncomfortable about the possibility of future default.  This impending doom was postponed for a while by the ability of banks – mostly Greek – to use these bonds as collateral for loans from the European Central Bank (so-called “repos”).

4)      But from the end of this year, the ECB will not accept bonds rated below A by major ratings agencies – and Greek government debt no longer falls into this category.  If the ECB will not, indirectly, lend to the Greek government, then interest rates will go up in the future; in anticipation of this, interest rates should rise now.

5)      This spells trouble enough for an economy like Greece – or any of the weaker eurozone countries.  Paying higher interest rates on government debt also implies a worsening of the budget; these are exactly the sort of debt dynamics that used to get countries like Brazil into big trouble.

6)      The right approach would be to promise credible budget tightening over 3-5 years and to obtain sufficient resources – from within the eurozone (the IMF is irrelevant in the case of such a currency union) – to tide the country over in the interim.

7)      But the Germans have decided to play hardball with their weaker neighbors – partly because those countries have not lived up to previous commitments.  The Germans strongly dislike bailouts – other than for their own banks and auto companies.  And the Europeans policy elite loves rules; in this kind of situation, their political process will move at a relatively slow late 20th century pace. 

8)      In contrast, markets now move in a 21st century global network pace.  We are moving towards is a full-scale speculative attack on sovereign credits in the eurozone.  Brought on by weak fundamentals – worries about the budget deficit and whether government debt is on explosive path – such attacks take on a life of their own. We should remember – and prepare for – a spread of pressure between countries along the lines of the panic that moved from Thailand to Malaysia and Indonesia, and then then jumped to Korea all in the space of two months during 1997.

9)      The equity prices of weaker European banks will come under pressured.  Fears about their solvency may also be reflected in higher credit default swap spreads, i.e., a higher cost of insuring against their default.

10)  US Treasury and the White House apparently take the view that they must stand aloof, waiting for the Europeans to get their act together.  This is a mistake – the need for US leadership has never been greater, particularly as our banks are really not in good enough shape to withstand a major international adverse event (e.g., Greece defaults, Greece leaves the eurozone, Germany leaves the eurozone, etc).

11)  We subjected our banks to a stress test in spring 2009 – but the stress scenario was mild and more appropriate as a baseline.  Many of our banks – big, medium, and small – simply do not have enough capital to withstand further losses.

12)  As the international situation deteriorates – or even if it remains at this level of volatility – undercapitalized banks will be reluctant to lend and credit conditions will tighten around the US.

13)  If the European situation spins seriously out of control, as it may well do in coming weeks, the likelihood of a double-dip recession (or significant slowdown in the second half of 2010) increases dramatically.


C.    Longer Run Baseline Scenario

1)      In terms of thinking about the structure of the global economy there are three main lessons to be learned from the past eighteen months.

2)      First, we have built a dangerous financial system in Europe and the U.S., and 2009 made it more dangerous.

  • The fiscal impact of the financial crisis was to increase by around 30-40 percent points our federal government debt held by the private sector.  The extent of our current contingent liability, arising from the failure to deal with “too big to fail” financial institutions, is of the same order of magnitude.
  • Our financial leaders have learnt that they can bet the bank, and, when the gamble fails, they can keep their jobs and most of their wealth. Not only have the remaining major financial institutions asserted and proved that they are too big to fail, but they have also demonstrated that no one in the executive or legislative branches is currently willing to take on their economic and political power.
  • The take-away for the survivors at big banks is clear: We do well in the upturn and even better after financial crises, so why fear a new cycle of excessive risk-taking?

3)      Second, emerging markets were star performers during this crisis. Most global growth forecasts made at the end of 2008 exaggerated the slowdown in middle-income countries. To be sure, issues remain in places such as China, Brazil, India and Russia, but their economic policies and financial structures proved surprisingly resilient and their growth prospects now look good.

4)      Third, the crisis has exposed serious cracks within the euro zone, but also between the euro zone and the U.K. on one side and Eastern Europe on the other. Core European nations will spend a good part of the next decade bailing out the troubled periphery to avoid a collapse. For many years this will press the European Central Bank to keep policies looser than the Germanic center would prefer.

5)      Over the past 30 years, successive crises have become more dangerous and harder to sort out. This time not only did we need to bring the fed funds rate near to zero for “an extended period” but we also required a massive global fiscal expansion that has put many nations on debt paths that, unless rectified soon, will lead to their economic collapse.

6)      For now, it looks like the course for 2010 is economic recovery and the beginning of a major finance-led boom, centered on the emerging world.

7)      But this also implies great risks. The heart of the matter is, of course, the U.S. and European banking systems; they are central to the global economy. As emerging markets pick up speed, demand for investment goods and commodities increases –countries producing energy, raw materials, all kinds of industrial inputs, machinery, equipment, and some basic consumer goods will do well.

8)      On the plus side, there will be investment opportunities in those same emerging markets, be it commodities in Africa, infrastructure in India, or domestic champions in China.

9)      The Chinese exchange rate will remain undervalued.  Our reliance on Chinese purchases of US government and agency debt puts us at a significant strategic disadvantage and makes it hard for the administration to push for revaluation.  The existing multilateral mechanisms for addressing this issue – through the IMF – are dysfunctional and will not help.  There is a growing consensus to move exchange issues within the remit of the World Trade Organization but, without US leadership, this will take many years to come to fruition.

10)  Good times will bring surplus savings in many emerging markets. But rather than intermediating their own savings internally through fragmented financial systems, we’ll see a large flow of capital out of those countries, as the state entities and private entrepreneurs making money choose to hold their funds somewhere safe – that is, in major international banks that are implicitly backed by U.S. and European taxpayers.

11)  These banks will in turn facilitate the flow of capital back into emerging markets –because they have the best perceived investment opportunities – as some combination of loans, private equity, financing provided to multinational firms expanding into these markets, and many other portfolio inflows.  Citigroup, for example, is already emphasizing its growth strategy for India and China.

12)  We saw something similar, although on a smaller scale, in the 1970s with the so-called recycling of petrodollars. In that case, it was current-account surpluses from oil exporters that were parked in U.S. and European banks and then lent to Latin America and some East European countries with current account deficits.

13)  That ended badly, mostly because incautious lending practices and – its usual counterpart – excessive exuberance among borrowers created vulnerability to macroeconomic shocks.

14)  This time around, the flows will be less through current- account global imbalances, partly because few emerging markets want to run deficits. But large current-account imbalances aren’t required to generate huge capital flows around the world.

15)  This is the scenario that we are now facing. For example, savers in Brazil and Russia will deposit funds in American and European banks, and these will then be lent to borrowers around the world (including in Brazil and Russia).

16)  Of course, if this capital flow is well-managed, learning from the lessons of the past 30 years, we have little to fear. But a soft landing seems unlikely because the underlying incentives, for both lenders and borrowers, are structurally flawed.

17)  The big banks will initially be careful – although Citigroup is already bragging about the additional risks it is taking on in India and China.  But as the boom progresses, the competition between the megabanks will push toward more risk-taking. Part of the reason for this is that their compensation systems remain inherently pro-cyclical and as times get better, they will load up on risk.

18)  The leading borrowers in emerging markets will be quasi-sovereigns, either with government ownership or a close crony relationship to the state. When times are good, investors are happy to believe that these borrowers are effectively backed by a deep-pocketed sovereign, even if the formal connection is pretty loose. Then there are the bad times – remember Dubai World at the end of 2009 or the Suharto family businesses in 1997-98.

19)  The boom will be pleasant while it lasts. It might go on for a number of years, in much the same way many people enjoyed the 1920s. But we have failed to heed the warnings made plain by the successive crises of the past 30 years and this failure was made clear during 2008-09.

20)  The most worrisome part is that we are nearing the end of our fiscal and monetary ability to bail out the system. In 2008-09 we were lucky that major countries had the fiscal space available to engage in stimulus and that monetary policy could use quantitative easing effectively.  In the future, there are no guarantees that the size of the available policy response will match the magnitude of the shock to the credit system.

21)  Much discussion of the Great Depression focuses on the fact that the policy response was not sufficiently expansionary.  This is true, but even if governments had wanted to do more, it is far from clear that they had the tools at their disposal – in particular, the size of government relative to GDP is limited, while the scale of financial sector disruption can become much larger.

22)  We are steadily becoming more vulnerable to economic disaster on an epic scale.

By Peter Boone, Simon Johnson, and James Kwak

70 thoughts on “Revised Baseline Scenario: February 9, 2010

  1. Why is the political power of the “too big to fail” banks so opaque, e.i., where are the news stories about representatives and senators taking big money from these titans?

  2. Simon: A great deal of thought and energy went into this article. Thank you for your public service. I just hope that some of the myopic politicians in the US, UK and EU read this and follow some of your advice. I am not hopeful. The situation is further complicated by Tea Party populist sentiment in the US which constrains political will by the uninformed opinions of the right expressed in their strident cries of NO NEW TAXES.

  3. The underlying dynamic is extremely poor. The quality of GDP growth is very low. It hasn’t been that long and already the world is teetering on the edge of another financial crisis. Europe? China? USA? Can anyone say that none of these face possible implosion?

    My question is this: who’s left to bail others out?

    Are sovereign credits now a greater risk than corporates?

    Here’s a great commentary by Markit:

  4. Executive compensation cannot be controlled within these too big to fail corporations. They manage such huge amounts of capital that if we didn’t pay them they could just as easily steal it.

  5. I don’t understand why the US hasn’t used bank bailout money to start it’s own organization that lends money directly to business instead of hoping the banks will do it if we give them the money.

    Also I don’t understand why we (government) keeps hiring the same guys that got us into this mess. What are we hoping will change?

    Aren’t our agricultural and manufacturing capability matters of national security? We should be able to produce the goods and food we need.

    If we lose our middle class don’t we risk public unrest and/or need more control of the population, either through propaganda (mass media) or force? What are we fighting for if not freedom and the opportunity to succeed? Am I missing the point or is this really scary? Elizabeth Warren for President!

  6. Mr.Peter Boone, Simon Johnson, and James Kwak wrote:

    “22) We are steadily becoming more vulnerable to economic disaster on an epic scale.”

    February 10, 2010 6:52AM – Perth Now – excerpts

    “EUROPE’S top central banker Jean-Claude Trichet yesterday cut short his visit to Australia as fears intensified in global bond markets that Greece, Portugal and Spain would default on sovereign debt this year and trigger a new financial crisis… But the outcomes of those high-powered meetings have been kept secret by participants, which included Mr Trichet and representatives from 24 central banks.

    One of the key players in the meetings was the general manager of the Bank for International Settlements, Jaime Caruana, who is scheduled to speak in Melbourne today.

    In a speech given yesterday at a symposium organised by the Reserve Bank of Australia, Mr Caruana said that some central banks were not properly equipped to maintain financial stability in their banking systems.”

  7. In the long-run section, I don’t believe you mentioned the baby boom.

    This year will mark the 65th anniversary of the end of WWII. Sovereign debt, “to big too fail”, and emerging markets are the stories of the day, but it’s hard to ignore the fact that the retirement of the baby boom is starting now.

  8. Peter Boone, Simon Johnson, and James Kwak wrote:

    “13) If the European situation spins seriously out of control, as it may well do in coming weeks, the likelihood of a double-dip recession (or significant slowdown in the second half of 2010) increases dramatically.”

    Berlin looks to build Greek ‘firewall’ – – Feb 9 2010

    “Financial markets surged on Tuesday on hopes of a European rescue plan for Greece, as officials in Berlin admitted it was looking at how to construct a “firewall” to prevent the debt crisis spiralling out of control.”

    A German government official said that the steep decline in the euro and pressure on bond prices had forced Berlin to ”take a significant step” in how to deal with the crisis.”

  9. A few words on Bernanke & Geithner’s bailouts.

    When the $hit is getting ready to, and wants to, and needs to hit the fan don’t stand in the way or you’ll regret it later.

    James K. Galbrailth put it this way –

    “In this op-ed, Professor Galbraith said the bailout plan of September 2008 wasn’t necessary, and any rescue could have been handled by expanding existing programs: “Now that all five big investment banks – Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs and Morgan Stanley – have disappeared or morphed into regular banks, a question arises.
    The point of the bailout is to buy assets that are illiquid but not worthless. But regular banks hold assets like that all the time. They’re called “loans.”
    With banks, runs occur only when depositors panic, because they fear the loan book is bad. Deposit insurance takes care of that. So why not eliminate the pointless $100,000 cap on federal deposit insurance and go take inventory? If a bank is solvent, money market funds would flow in, eliminating the need to insure those separately. If it isn’t, the FDIC has the bridge bank facility to take care of that.
    Next, put half a trillion dollars into the Federal Deposit Insurance Corp. fund – a cosmetic gesture – and as much money into that agency and the FBI as is needed for examiners, auditors and investigators. Keep $200 billion or more in reserve, so the Treasury can recapitalize banks by buying preferred shares if necessary – as Warren Buffett did this week with Goldman Sachs. Review the situation in three months, when Congress comes back. Hedge funds should be left on their own. You can’t save everyone, and those investors aren’t poor.
    With this solution, the systemic financial threat should go away. Does that mean the economy would quickly recover? No. Sadly, it does not. Two vast economic problems will confront the next president immediately. First, the underlying housing crisis….The second great crisis is in state and local government.””

  10. “20) The most worrisome part is that we are nearing the end of our fiscal and monetary ability to bail out the system. In 2008-09 we were lucky that major countries had the fiscal space available to engage in stimulus and that monetary policy could use quantitative easing effectively. In the future, there are no guarantees that the size of the available policy response will match the magnitude of the shock to the credit system.”

    Or better yet, we the people will elect someone who will NOT engage in such stupid ideas. NO more bailouts for the banking system. Plus, it will be time to end the ability of the spoiled and rich to inflict their losses on the working people thru fewer hours or lower wages.

  11. Somebody is going to have to explain to me again how we can remediate our faltering labor markets without resorting to some sort of protectionism. I see little here that suggests how we will regain our balance, become more productive in substantive ways, and re-enter a healthy cultural competition with other nations.

  12. The article describes what can only be said to be a house of cards, ready to go off the cliff at the slightest drop of a paperclip or some distant hiccup in a computer.

    The house of cards is archaic, a relic of the 17th century; it is dysfucntionl and fast becoming obsolete, or is obsolete, whichever.

    Americans, Euros, Brits and Canadians should demand that the house of cards be left to implode and be thrown verily into the wastebin of history … with an interugnum provided in which new economic schemas can be developed and implemented, modern systems that are capable of serving needs effectively with a minimum of political interference and tomfoolery.

    Adapt or die.

    Our choice.

    The Model T is about to cack on us.

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  14. Well Said,

    This is what needs to happen and is so painfully obvious. I feel this is the elephant in the room that no one wants to discuss. While we gripe and moan about the symptoms and the usual players, there’s really a vacuum in public debate about the alternative systems that need to be developed. This current one is archiac and outdated. People such as Jacques Fresco have written extensively on resource based systems that address global needs instead of only monetary profit. Its time to change.

  15. Here in Europe we ‘need US leadership’ like we need another foot. Why not get your own house in order before you try pushing in here?

    Your article is notable for its ignorance of Europe. I really loved the bit about “the elite club of European nations that share the euro”. I feel more elite by the minute. Guess people also do in Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.[2]. That’s 327 million ‘elite’ Europeans.

  16. If domestic-oriented private industry remains crippled in the US, we will see a resurgence in hard-right nationalist politics.

    Right, the only US companies doing well are those who export a lot. But they are a minority.

    Domestic-oriented businesses are in bad shape, as is unemployment, and this means political reaction.

  17. Sorry, but did you guys just say you wanted the global financial system to disintegrate overnight? This would indeed usher in a new system, just as the fall of the Roman empire ultimately led to the renaissance. Unfortunately the transition was brutal, chaotic and deadly.

  18. Stefan wrote:

    “Somebody is going to have to explain to me again how we can remediate our faltering labor markets without resorting to some sort of protectionism.”

    President William McKinley wrote:

    “Under free trade the trader is the master and the producer the slave. Protection is but the law of nature, the law of self-preservation, of self-development, of securing the highest and best destiny of the race of man.”

  19. This is very depressing. A case of plugging leaks in the dike when the entire dike is in danger of collapsing.

    The multi-trillion dollar question is how to flush all this bad debt out of the system without causing more harm to the world economy.

  20. “The situation is further complicated by Tea Party populist sentiment in the US which constrains political will by the uninformed opinions of the right expressed in their strident cries of NO NEW TAXES.”


    On the contrary, the so-called populist sentiment is precisely a reaction against the uninformed opinions of the left (and I include both the current and previous administrations in this category) that have led us to where we are today, especially the bizarre distortion of Keynesianism that calls for robbing the Treasury to prop up GDP statistics by fueling excessive consumption and bailing out corporate fat cats.

  21. “Here in Europe we ‘need US leadership’ like we need another foot. Why not get your own house in order before you try pushing in here?”


    Do we have to remind you yet again of the state Europe would be in without US leadership? We bailed you out of two World Wars, protected you through the Cold War, and continue to provide the comfortable security umbrella that allows you to spend your resources elsewhere while whining about American militarism.

    As the eurozone implodes over the next few months, you will no doubt avoid looking in mirrors and instead pin blame on Californians who bought second residences in Las Vegas.

    Yes, you need US leadership.

  22. It does seem that the billions in bonuses would be good first drops into the bucket.

    A second useful thing would be recognizing what the debt purchased — one example is a great improvement and increase in the housing stock during the bubble. It breaks my heart when I see a foreclosed or short-sale house on the market where the pipes have frozen or other damage occurred. Mismanagement of the assets at the base of much of the debt further the losses.

  23. I am with you and have been saying that for a long time. Trickle down is a myth perpetuated by those at the top. If we don’t rekindle the manufacturing base in this country and create more than low paying Walmart jobs this is all more of a farce than it already is.

    The reason the big corps don’t care about jobs is that they have figured out how to mine the retirement wallets of said boomers. If you have 7 trillion dollars to steal, why do you need to manufacture anything when chinese slaves will do it for nothing?

  24. Wow. Thanks for that. Old school Republican thinking is what we need, but other than Ron Paul….?

  25. Read Simon’s predictions with interest!
    I realize that Americans have to step in, but it may be little late for the looming European crisis!
    I think the Europeans simply lack the will power to save themselves….Where are you Maggie Thatcher when Europe needs you!
    I still think we will avoid the catastrophe of 1929, as eventually Bankers all over the world will work will be interesting to see what the Chinese do!
    Thank God we do not have a Treasury Secretary like Andrew Mellon and a Prez like Hoover, today!

  26. Indeed, a house of cards. What bothers me is not just how we can stablise the system or survive a crash … it’s how to radically restructure global banking and purge it of the worst perpetrators so that we never see a repeat of this nightmare. As far as I can tell little has been done in this direction, the worst culprits appear to still be running the madhouse. I’d have them joining Bernie Madoff in jail or, better still, swinging on the end of a rope (after a full trial, of course!).

  27. I can’t help but remember Asimov’s Foundation series (or was it the later sequels?) where the home world’s massive power generation systems failed because there was no one who knew how they worked anymore…..

    Anyway, to me the above issues make sense – but are at polar opposites to the deregulatory/libertarian/Chicago school line of thought. The problem seams to be political in that there isn’t anywhere close to a consensus that will pass both houses. But how people can think that letting banks run free is in our collective best interest is beyond me. Perhaps the operative word is “collective” (ohhhh noooeeesss – commies!!!!) People just aren’t thinking about true national interests anymore (or at least, not enough politicians are right now). Which means that the body public is getting snowed enough so that they keep electing people who are not looking at this problem in a constructive way.

  28. Yes, that’s true, but it doesn’t have to come with chaos and bloodshed. It needs to happen through the realization of human ingenuity to solve problems through technology. We have the knowhow and skills to become energy independent right now, the technology has existed for years. Why isn’t it happening? When you don’t accept the answers you’ve been given for your whole life, you start to find better ways to solve these problems and life becomes 100x better. This political system is not equipped to do anything but elect guys like Scott Brown with a nice truck.

  29. “A second useful thing would be recognizing what the debt purchased — one example is a great improvement and increase in the housing stock during the bubble. It breaks my heart when I see a foreclosed or short-sale house on the market where the pipes have frozen or other damage occurred.”

    Well said!

  30. “Much discussion of the Great Depression focuses on the fact that the policy response was not sufficiently expansionary. This is true, but even if governments had wanted to do more, it is far from clear that they had the tools at their disposal – in particular, the size of government relative to GDP is limited…”

    In today’s non-convertible floating exchange rate currency system any limitation on fiscal expansion is purely political, not economic. Governments sovereign in their own currency have most certainly not “already used almost all their scope for fiscal stimulus.” As long as there are real goods and services for sale the federal government can always purchase as much output as it wants. That’s not to say that governments should always exercise their purchasing power. It all depends on the state of the economy. But the idea that there is some absolute governmental budgetary constraint that exists independently of the state of the economy is deeply flawed. See here for a more detailed discussion of why the commonly cited debt to GDP rations considered to be “sustainable,” are really just bogus made up numbers:

    The only limit on the scope for fiscal stimulus is the possibility that nominal aggregate demand exceed real output capacity (in which case inflation would ensue). At this point in time it seems unlikely to me at least that inflation poses much of a threat. James at least has repeatedly expressed similar point of view. If inflation is not a threat then there is no excuse for the kind of analysis Dr. Johnson engages in above. It just shows how even intelligent, well-meaning individuals can become trapped by ideology.

  31. “12) Undercapitalized banks tend to be fearful and curtail lending to creditworthy potential borrowers.”

    Is the bigger danger that the undercapitalized banks _won’t_ lend or that they _will_ lend, thus building up too much risk? Or is it simply that the incentive structure rewards risky loans with a high probability of blowing up, but that don’t contribute to GDP growth in a meaningful way; but does not reward prudent lending to potential capacity-increasing growth-inducing projects?

    (Serious question for authors of the blog)

  32. Simon,
    as regards the Greek parts of your argument I would conquer with most of your interpretations. However, I think that one key issue about the virtues or challenges of an IMF-led or European Union-charged bailout of Greece has been ignored.
    Consider for a moment the hypothetical question if Greece were a so-caled ‘systemically relevant’ country. This classification was at the heart of justifying bail out programmes in the US and Europe during 2008 and 2009 for financial sector institutions.
    Governments and central banks found creative and hitherto unknown avenues to implement, let alone justify such bail outs of financial sector instituions.
    Returning to the hypothetical question, if Greece were labelled ‘systemically relevant’, e.g. for the euro zone stability, or political credibility of the EU, would some form of joint intervention not prevail, despite legal hurddles and treaty regulations?

  33. Americans are either aware of it and encouraged to support it by all the usual suspects (Rush, FoxNews, et. al.), or are angry and want it to change but don’t have options. What can they do? Vote out the Democrats and put Republicans in charge of Congress?

    I’m just going to keep watching Amerian Idol and wait or it all to blow over. Yeah, that’ll work.

  34. This situation is a lot simpler than you think.

    No business is too big to fail. Let the banks go under. It would have been painful, but amputations are the only thing that saves the patient sometimes. Instead, we’re letting the financial gangrene creep throughout the whole body with a kick-the-can-down-the-road debt policy.

    Increasing levels of well-meaning government intervention make the situation more and more complex. Credit default swaps would be a thing of the past if governments did not protect banks from the consequences of their actions. Let the undercapitalized banks fail and put their metaphorical heads on a pike as a warning to everyone else. People aren’t stupid and shareholders will demand change, and change will come. This top-down “we’ll bail you out but try to regulate you” is a near-fascist approach that was always doomed to fail.

    Get back to basics. Get the government out of it, not further in.

  35. The banks, media conglomerates, and various wealthy owners of this country will not present us with candidates that won’t bow to their whims. Every candidate that gets enough support to have a chance to win WILL be captured by massive financial interests, unfortunately. As a result, the ballot box is a useless weapon against this corruption.

  36. Socialization of losses, the greatest achievement of the HBO government to date…

    J.Stiglitz estimates at 11 trillion $ the cost of
    government support to the financial system.

    However the fovernment is stuck in the door, high time for regulation of the ‘casino’, if you want
    to stand a chance for the U.S economy to go bust.

  37. Not that I don’t completely disagree with you, but just a little food for thought…

    The top 20 US banks have about $3.6 Trillion in deposit. When TBTF fails then who covers those deposits? During the GD the average depositor at a failed bank got back something like $.40 on the dollar. Today the FDIC would pick up the other $.60. That’s $2 Trillion dollars. Even if only the top 5 banks failed you’re still talking $1.5 Trillion in FDIC liabilities.

    If I’m an elected official, $700B is starting to look mighty cheap.

  38. 700 Billion might look cheap to the completely short-sighted. What about the next 1.4 T or more when the lessons that are learned is we can put all our capital at risk and get bailed out when the scheme collapses, and big daddy gov’ment comes in and passes some regulations that make it worse instead of better?

    We’ve put the cancer on life support instead of the patient. Whether you think that’s a good idea or not, the patient is still going to die.

  39. Their power stems more from fear and ignorance than direct financial contributions. Fear and ignorance btw, are much more effective sources of power than money.

  40. great question and here is the answer. Without sounding to bitter. Because america runs off of 2 or 4 or 6 year projections. Why? Because every 2 or 4 or 6 years a politican wants to be re-elected and cannot anger the unions, the banks or any other source of votes or money. And mostly because it would make sense and save time.

  41. Here in the US, we’ve been talking about bankers privatizing gains and socializing losses ever since the crisis began. Isn’t that what’s going on in Greece right now? They know that a sovereign default within the eurozone would cost Germany and France more than a bailout, so they are not willing to take the politically unpopular steps necessary to fix their own problems, knowing full well that Germany or the ECB will step in and bail them out. What am I missing?

  42. “there’s really a vacuum in public debate about the alternative systems that need to be developed.”

    I totally agree it’s time to change. Unfortunately,there’s also no medium at present through which such a debate could be conducted, very few participants open minded enough to undertake it, and armies ready to fight such transformation.

  43. “We are steadily becoming more vulnerable to economic disaster on an epic scale”

    I feel you will only see changes if you get a disaster of a scale where Fed/Govt intervention will not save the system

    If & When such a disaster happens (I hope it is sooner than later .. geberally unhappy because banksters have got away.. that is why) then the system would crum,ble and we will get a better system

  44. Easily remedied by removing the income ceiling on Social Security payroll taxes. And no, I don’t believe that this will happen as it is a simple, obvious and just solution to the problem. We can’t have any of that.

  45. We have witnessed the largest transfer/destruction of wealth since the sacking of Rome. Forty years and counting of trickle-down, up-by-your-bootstraps, invisible-hand-of-the-market, rising-tide, get-government-out-of-our-way, Ayn Randian, tripe has brought us to this precipice. And I still read/hear this swill daily.

    Class warfare isn’t a Liberal talking point. It’s real. We’re the Indians.

  46. I disagree. The “so-called populist sentiment” is a truncheon, wholly contrived and manipulated by the corporate class to beat down any and all threats to the status quo.

    There is no “left” anymore and their opinions, uninformed or not, were abandoned some forty-odd years ago.

  47. The socialization of loss as Federal policy preceded the current administration by twenty years. We were given a taste of this big c–p sandwich during the S&L crisis in the late eighties. Remember Neil Bush?

  48. This results from what we might as well call the worldwide plutocracy, since it is not only in the US (which is pervasive to the fatal extent) but by extension to the world where the major players have staked out their own plutocratic regimes as defense against us. God save us all when this house of cards collapses!!

  49. The retirement of the baby boomers will never actually happen. Most people are going to be forced to work until they are phycially too old to do anything at all, welcome back to the pre-WWII world.

  50. Economist Jeff Rubin believes it was triple digit oil prices that caused the financial crisis. He sees another one within 24 months.

    See my short article: High Oil Prices May Soon Threaten the Economy at:

    Ordinary water, to the surprise of almost everyone, can replace oil. A barrel of water becoming the equivalent of 200 barrels of oil.

    With a 24/7 development program, that might begin to happen rapidly enough to dampen the oil price rise.

  51. The US did do something along these lines once. It was called the Reconstruction Finance Corporation, itself inspired by the WW1-era War Finance Corporation.
    But re-inventing the RFC would be just as archaic as reinstituting Glass-Steagall.
    Um, wait…

  52. This is a general question: where do Paulson and Geitner, etc. get their data to back up their claims “…if we’d done nothing we would have faced economic collapse, 25% unemployment.”, etc??
    This seems to me to be exaggerated, fear-mongering, pulling-figures-out-of-a-hat. In other words: when things are bad, give us a blank check.
    What would have happened if TARP, etc. had not happened??
    Also: note the hypocrisy with which these guys cloak their rhetoric: the “need to save our economic system/our society”. This really does make them “socialists”, since the needs of society take precedence over all else. And, as for fears of high unemployment, when have these guys given a damn about unemployment?!
    –stuart williams

  53. Yes, we need new taxes because the politicians have been so brilliant in spending what we’ve given them.

  54. 1) There was a tremendous negative response to our reps in Sept/Oct 2008 about the bailout and it passed anyway.

    2)I don’t know about the other two but I’m not aware of anything in the libertarian school of thought that says dying banks should be given public money. A reference perhaps? Did CATO publish something that said this was a good idea?

  55. Las Vegas–Noted economics and stock market analyst Frances Newton announced today that she is releasing a summary of her remarkable stock market and economic prediction records which will be available on her website,, starting February 17.

    Newton’s recent appearance on the nationally-syndicated Mancow Muller radio show, and her weekly appearances on the Gerry V Show have generated widespread acclaim. While appearing on the Mancow show, Newton discussed topics such as why the “Too Big to Fail” U.S. banking system will ultimately prove “Too Big to Bail” and why the banking and monetary system mathematically guarantees poverty.

    Newton has been talking for years about the collision course that the U.S. government is on with respect to its monetary policies and how what most people think of as “money” really does not exist in our debt-based monetary system. In fact, according to Newton, the system is due to implode in the coming years.

    “Under the current system money cannot be created into circulation without the creation of corresponding debt,” said Newton. “This debt has an interest obligation attached to it that must be repaid.”

    “This interest is not placed into circulation when the debt (money) is created,” Newton added. “Although it is possible for an individual to pay off a debt, collectively, the system can never be paid off in full and the system must eventually fail.”

    Newton believes the current monetary system is insolvent and guaranteed to fail. She also thinks that the more money that is created, the faster we as a country go down the path to poverty.

    Newton has been a regular weekend guest on the Gerry V Show on WRNO-FM, in New Orleans since October, 2008. During her segments, she has discussed the state of the financial markets, the economy and has also made stock market predictions, virtually all of which have come true.

    To view a summary of Ms. Newton’s astoundingly accurate predictions, go to If you are interested in booking Frances Newton on your radio or television show, call Bruce Merrin Public Relations at (702) 367-0331.

  56. We need new taxes just to cover what they’ve already spent. Since when has not paying down the interest on your loans been brilliant policy? If the “No new taxes” tea lovers prevail, that’s the royal road we’ll be following.

  57. The technology? Which? In a nation where there’s plenty of venture capital to back any promising tech, you’re claiming we’ve left something of great promise undeveloped?

  58. here’s a long term prospect. corporate greed is grabbing all the money it can and all these double dipping, money grubbing yahoos are heading for their gated enclaves because they see the handwriting.the economic system will collapse. just a matter when.probably a little later ( ten years, maybe ). global warming will really start to kick in and soon after will come the displacement of millions of people whose sole dependence is on agriculture. how’s the global economy going to pay for that? dwindling resources and rising tides. $hit! quick! head for the hills!……….the human species hasn’t yet developed any sort of credible ethos towards its own kind. can’t make any money off care and compassion.see ya.

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