Sunday, October 12, 2008

the sky IS falling

Like many of you I have been trying to overcome a major learning curve regarding the economic shock waves over the last couple of weeks. I’m somewhat more educated but still a ways to go.
I’m at least far enough along to know that deregulation and Fannie/Freddie are not the sole causes – no thanks to the candidate sound bites. One positive development has been the emergence of the British /Swedish proposal as the front runner of a solution, even by an increasingly humble Hank Paulson whose warts are abundantly clear. We all can be glad he did not act on his initial unitary money grab. I’m also pleased to observe the emergence of Paul Krugman and Brad Delong as leading voices on the meltdown. They’ve been on course from the beginning and seem to be getting more play in the MSM because of it. A less familiar name is Nouriel Roubini, who is now likely to be a household name. Oracular in scope, the economist is now being echoed by the IMF.

Here’s the latest somber insight from Roubini:

At this point severe damage is done and one cannot rule out a systemic collapse and a global depression. It will take a significant change in leadership of economic policy and very radical, coordinated policy actions among all advanced and emerging market economies to avoid this economic and financial disaster. Urgent and immediate necessary actions that need to be done globally (with some variants across countries depending on the severity of the problem and the overall resources available to the sovereigns) include:

- another rapid round of policy rate cuts of the order of at least 150 basis points on average globally;

- a temporary blanket guarantee of all deposits while a triage between insolvent financial institutions that need to be shut down and distressed but solvent institutions that need to be partially nationalized with injections of public capital is made;
- a rapid reduction of the debt burden of insolvent households preceded by a temporary freeze on all foreclosures;

- massive and unlimited provision of liquidity to solvent financial institutions;
- public provision of credit to the solvent parts of the corporate sector to avoid a short-term debt refinancing crisis for solvent but illiquid corporations and small businesses;

- a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;

- a rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers;

- an agreement between lender and creditor countries running current account surpluses and borrowing and debtor countries running current account deficits to maintain an orderly financing of deficits and a recycling of the surpluses of creditors to avoid a disorderly adjustment of such imbalances.

At this point anything short of these radical and coordinated actions may lead to a market crash, a global systemic financial meltdown and to a global depression. At this stage central banks that are usually supposed to be the "lenders of last resort" need to become the "lenders of first and only resort" as, under conditions of panic and total loss of confidence, no one in the private sector is lending to anyone else since counterparty risk is extreme. And fiscal authorities that usually are spenders and insurers of last resort need to temporarily become the spenders and insurers of first resort. The fiscal costs of these actions will be large but the economic and fiscal costs of inaction would be of a much larger and severe magnitude. Thus, the time to act is now as all the policy officials of the world are meeting this weekend in Washington at the IMF and World Bank annual meetings.
In closing, cheers to Krugman for his Nobel!


Eric said...

A friend of mine mentioned this daily podcast from a few guys over at This American Life, they talk about the whole situation in laymens terms.

highlowbetween said...

thanks I'll check that out. Also Roubini's Rgemonitor has a very comprehensive pdf.

CAP said...

Coincidentally, I happened to see a re-run of a TV prog on The Sub-Prime Crisis from 2007 (based around the collapse in Cleveland then) in which Roubini emerged as one of the shrewdest analysts.

The prog was very strong on 'predactory lenders' but I've always stumbled on the logic that if you have a debt, you can borrow against that in order to obtain a loan to cover that debt.

I mean this has been the logic of the entire US economy for at least 25 years - increasingly of the rest of the world (hence the global domino effect)- but at the base of it, how do you figure that because you can't repay one loan, you're good for another?

I'm probably being incredibly dumb about this, but common sense surely says that if you forgeited first time, the chances must be higher that you will forfeit in following (higher!) instances?

highlowbetween said...

it's absurd. Matt Taibibi points out the CDS market, "this market for credit default swaps that was created in 2000 by Phil Gramm's Commodities Future Modernization Act, this is now a $62 trillion market, up from $900 billion in 2000. That's like five times the size of the holdings in the NYSE. And it's all speculation by Wall Street traders. It's a classic bubble/Ponzi scheme." Then consider that an individual mortgage default has forty, four hundred, four thousand traders betting back and forth on the viability of the loan.

oh and now oil is $78/barrel, no new drilling insight. Could have something to do with speculation?