October 20, 2008
Hard and troubled. Racked by fear and uncertainty. For many trauma. Experts predict, speculate and conjecture, but no one knows for sure what’s ahead. Key questions are whether we’re in a protracted and severe recession. Or at the onset of another Great Depression. So much is unresolved. The problems have built for years and are immense. Maybe nothing at this stage will work and the best hope is for light at the end of a very long, dark tunnel.
Again no one knows. The worst may or may not be too late to avoid. At best, stabilization and recovery will take time. Likely years. The degree of pain along the way will depend on future policy responses. Ones so far taken aren’t encouraging. Their details aren’t entirely clear. They’re slowly emerging and from what’s known since the original EESA/TARP announcement, the Treasury:
— will invest $125 billion to recapitalize nine major banks, including Goldman Sachs, JP Morgan Chase, Citigroup, Bank of America, Wells Fargo, Morgan Stanley, Bank of New York Mellon, Merrill Lynch and State Street; another $125 billion will go to smaller banks and thrifts;
— according to Bloomberg.com, amounts range from $25 billion to JP Morgan Chase and Citigroup; another $25 billion to be divided between Bank of America and Merrill Lynch; $20 billion to Wells Fargo; $10 billion each to Goldman Sachs and Morgan Stanley; and $3 billion each to Bank of New York Mellon and State Street; the winners in the "bailout" sweepstakes;
— investments will be in specially issued preferred (non-voting) shares; they’ll pay 5% interest to be increased to 9% after five years;
— the government will receive warrants worth 15% of the preferred shares’ value;
— FDIC insurance will cover all small business deposits so they won’t be shifted from weak to more stable banks;
— the government will guarantee banks’ newly issued unsecured debt for three years to make refinancing liabilities easier; retail deposits up to $250,000 also guaranteed as previously announced;
— toxic assets will be bought to restore liquidity in mortgage-backed securities market; also previously announced; banks’ "toxicity" is in the multi-trillions of dollars; no amount of government largesse can change that;
— all available tools will be used to avoid a systemic meltdown; the IMF and other international lending agencies will also be involved;
— the Federal Reserve will serve as buyer of last resort for commercial paper; and
— measures are intended to be temporary, but no time horizon was indicated.
Will these and other planned measures work? On October 14, Bloomberg interviewed numerous analysts. Some were reassuring. Others weren’t. They noted heroic measures to unfreeze money markets and interbank lending. Suggested any improvement helps but expected too little, too late, to matter. They also cited little easing in stress measures in stark contrast to soaring world equity valuations. Early on, then plunging. Continuing the same volatile pattern indicating fear and uncertainty. Plus lots of manipulation so speculators can profit hugely on ups and downs.
Steps so far taken do nothing for distressed households. They’re an aggressive attempt to save major banks that are effectively insolvent. Stabilize world economies if it works. Yet huge problems remain at the "end of an era as credit bubble bursts," according to Lloyds TSB economist Trevor Williams on October 13:
"Too much debt led to bubbles….no one really knows when or how this crisis is going to end….this is the latest of many bubbles to have plagued the world economy in the last 10 – 15 years….(it didn’t) develop overnight and will therefore take time to resolve….one year (after it was clear that) asset markets, especially housing and credit, were grossly overvalued and so (were) the value of the securities written on them (on which so many financial firms borrowed heavily), the crisis is intensifying rather than abating…."
For Williams and others, the challenges are formidable. "Hence, this is a long-term problem that will not result in business as usual anytime soon as the changes required are far reaching and complex. The adjustment of the balance sheets of firms in developed economies caught up in this crisis will take many years….cutting interest rates alone will not work….it may be like pushing on a piece of string (because) developed country households are already hugely in debt." Low interest rates "reduces their income (further eroding) spending and weakening growth….Tax cuts and public spending increases would help….but with public finances strained by the bank rescue, this is unlikely." How long recovery "will take is anybody’s guess."
Economist Nouriel Roubini approves of bank recapitalizations but cites "significant downside risks" in the coming weeks:
— Treasury plans aren’t entirely clear;
— they’re woefully inadequate;
— world economies are weakening; fiscal stimulus is lacking, so "macro news will surprise on the downside;"
— so will quarterly earnings;
— confidence has been severely damaged;
— "deleveraging of the shadow financial system" will continue;
— major stresses remain, possibly including a credit default swap (CDS) market blowout; hundreds of hedge funds collapsing; noted money manager Jeremy Grantham believes 5000 ultimately will disappear; asset liquidations will follow pressuring market valuations lower;
— insurance companies’ troubles are increasing; more rescue packages needed for "other systemically important financial institutions;" crises emerging in developing and advanced countries; deleveraging causing a continued asset price deflation, margin calls, still lower asset prices and creating "further downside risks to housing and home prices."
In addition, G-7 and EU plans include no fiscal stimulus to boost aggregate demand. Personal income is falling. In a state of collapse are: personal consumption, residential and non-residential investment, and capital expenditures. Unless government fills the breach massively (at least $300 billion for starters), "an unavoidable two-year recession (may) become a decade long stagnation." Roubini cites the usual type stimuli:
— for instructures;
— green technologies;
— increased unemployment benefits;
— targeted tax rebates for lower income households;
— aiding distressed homeowners to "avoid a tsunami of foreclosures;" potentially 10 million or more; rising rapidly to greater numbers in 2009; measures should include a plan to reduce mortgage face values; also let troubled homeowners retain their property and pay affordable rent;
— further steps to relieve over-indebted households; the result of home equity loans, credit cards, auto and student loans; failure to reduce these stresses assures a more protracted and deeper economic crisis; how can banks lend to unwilling borrowers;
— federal block grants to states and local governments among other measures.
- A d v e r t i s e m e n t
Crucial for many experts is that without rapid implementation of these type measures, financial institution rescue plans will be undermined. Aggregate demand will decline further and prolong an already severe recession. "If Main Street goes bust in the next six months, (Wall Street will again) as the real economy implodes further."
In an October 14 Bloomberg Interview, Roubini predicted the worst US recession in 40 years. "We’re going to be surprised by the severity of the recession and (resulting) financial losses." It will last 18 to 24 months. Push unemployment to 9% from its reported 6.1% level, and drive home prices down another 15%. He upped his bad mortgage credit loss estimate to $3 trillion from his previous $1 – 2 trillion amount. He also believes that $250 billion in bank recapitalizations is just the beginning. At least double that amount is needed to save banks from bankruptcy. Even that total may be too little, too late. And the soaring national debt presents its own unwelcome problems.
Another issue involves the source of bailout funding. It either has to be borrowed or created. Printing dilutes the currency. A prescription for future higher inflation although today’s problem is deflation. Borrowing won’t be simple either. EU and other foreign central banks have their own problems to resolve. China, Japan and wealthy petrodollar states will have to partner with the Treasury and Fed as lenders/bankers of last resort. In greater amounts than they may be willing to assume.
Other Problems – Too Great to Solve and/or Ignore
Earlier by others and on October 12, the London Independent cited the resident elephant few in the major media acknowledge. Especially in America. A "$516 trillion derivatives ‘time-bomb,’ " according to writers Margareta Pagano and Simon Evans. Roughly equal 10 times world output and "not for nothing (that) Warren Buffett call(s) them (financial) ‘weapons of mass destruction.’ "
These are financial instruments that derive their value from an underlying asset, reference rate or index. In exchange-traded and privately negotiated forms, all sorts of them exist – swaps, forwards, futures, puts, calls, swaptions, caps, floors, collars, captions. Combined they represent (by far) the world’s largest financial market. They’re complex, opaque and called "the world’s biggest black hole because they" comprise the shadow financial system. Unregulated and allowed to explode to unmanageable size. Creating potentially overwhelming risks. If enough of them sour, world economies may crash in a cascading domino effect.
Long-time financial observer and analyst Bob Chapman is dire in his assessment. Using Bank for International Settlements (BIS) figures, he cites a "quadrillion dollar (1000 trillion) powder keg waiting to blow’ and places this problem (led by credit default swaps – CDSs) at the heart of the financial crisis." He thinks "catastrophic losses are inevitable."
Subprime and mortgage debacles are a "side show" at around a few trillion in losses. Their real estate derivatives problems are another matter. He believes that the Treasury, Fed, and other smart Wall Street types know it. They’re terrified about potential losses that "may (way) exceed the entire world’s GDP (and) thus obliterat(e) the balance sheets of every major commercial bank and the Fed." Take down the entire world financial system and cause an unstoppable "juggernaut of loss, insolvency, failure and bankruptcy." Resulting in world governments having to nationalize their financial systems and become bankers of last resort.
Chapman thinks the train left the station, and nothing can stop it. Current policies can only delay the inevitable through a Ponzi scheme "final orgy of fraud and profligacy." The idea is to "take total control, make markets do whatever pleases them (and) thus create their own reality."
If this happens, nations will be bankrupt. So will people. Their savings erased. Their situation unpalatable. Intolerable. A "New World Disorder." Police state tactics will be needed to contain it. But there’s more to this story as some observers recognize. Today’s crisis was manufactured but not as it’s turning out. Far worse than planned so the best laid schemes "are unraveling," according to Chapman. Too many trillions in losses to handle may result, and at this stage, who can say what’s ahead. Not what the masters of the universe had in mind except to take the money and run.
Other Assessments of Conditions
Take your choice. Opinions are everywhere. Some credible. Many not. But one thing about most is consistent. These are perilous times. The most challenging in decades. Maybe ever. Prudence and caution are essential. Enormous unpredictable risks threaten. Massive economic damage has been done, and certain hard times are ahead across the board. For businesses and households. Many in both sectors won’t make it. A dark prospect to consider. Unimaginable for most.
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