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Softpanorama |
May the source be with you, but remember the KISS principle ;-)
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Symptoms of coming problems:
October 4, 2005 | The Financial Times
Serious reformist thinking is largely absent -- not only from the political parties but also from the mainstream media and most think-tanks.
The media and think-tanks are also largely disabled by their links to political and economic interests. In the wake of Katrina, the mainstream US media won praise for finally daring to criticise the Bush administration. But there is little sign of their readiness to analyse deep flaws in the US system. The exceptions are race and poverty, issues raised so glaringly by Katrina that only a totalitarian system could avoid mentioning them. Among the fundamental issues absent from public discussion is the political patronage system, in the areas of jobs and financial allocations. Strong criticism has been directed at the Bush administration, quite rightly, for its appointment of unqualified political cronies to senior posts. What no one asks is why the US, alone among developed countries, has such an extensive system of political appointments to vital and highly technical government jobs. Such questions would be considered to reflect lack of patriotism. More importantly, the political parties cannot raise this issue as they are both dependent on patronage to raise funds and gain support. The think-tanks cannot discuss it because too many of their members dream of becoming assistant deputy something or other after the next elections. But at least the media should be able to talk about this.
Similarly, both Congress and the Democratic politicians of Louisiana have been criticised, quite rightly, for senators' colossal diversion of scarce federal funds to pork-barrel projects in their states--something that contributed directly to the disaster in New Orleans. But no one asks why the US system allows opportunities for pork-barrel politics on this scale.
US inability to compare itself to other countries also applies to discussion of global warming and energy conservation. After Katrina, these issues cannot be ignored. But the US public cannot be told how isolated internationally America is on this question. Media discussion too often takes the form of a rigged debate in which scientific evidence for global warming is set against scientific opponents of this thesis--despite the fact there is broad international support for the first position while the second is held essentially by isolated individuals.
If a crisis on the scale of 1929-32 strikes the US now, the country would not find an FDR with a New Deal programme to run against the Republican's Herbert Hoover. It would have a timid, ineffective Hoover for the Democrats running against a Republican Calvin Coolidge, a hidebound defender of the worst aspects of the existing system. If that had been the choice in 1932, the very foundations of the American state would have been in peril
March 4, 2008 | Sudden Debt
I will be on a short trip, so posting will be sporadic for the next few days. Before I go, I want to clear something up, concerning my views on extremism in free markets and their zealot acolytes.
Free markets (in this case financial markets, since they are my area of expertise) without tight regulation to even out the playing field as much as possible, rapidly deteriorate towards crony capitalism, i.e. a particularly virulent form of junglenomics. US financial markets were the envy of the world because a whole array of professional regulators (SEC, NASD, NYSE, FRB, etc) stood ready to send in the feds and bodily carry out manacled perps, in full view of their co-workers and the cameras.
No, it didn't always work out as it should have and many a big fish swam away leaving the minnows to fry in the pan. But mostly it worked, and the markets were the better for it. This is no longer the case and dominant positions now exist (or existed) unchecked in most markets and crony capitalism makes itself evident in many aspects of the US economy (Enron, for example).
Some people sadly still confuse freedom with total lack of regulation, thinking oversight interferes with a "natural" right to do as they please. In that case, their proper place is up in the mountains with the rest of the wild animals (Aristotle had something to say about them, people who do not wish to participate in a cohesive society and be bound by its rules). Others place absolute faith in the invisible hand, thinking it will even out everything all by itself. To my mind, they belong to the Flat Earth Society.
No doubt, they in turn will paint me a "commie", showing a complete lack of understanding about what communism is all about. Well, both communism and absolute laissez-faire don't work - in practice - because they both disregard human nature: man is no saint. He will no more gladly share everything he has with his fellow than he won't fall prey to unfettered greed for individual gain.
Free market capitalism is not antithetical to the common good - quite the contrary; it is just that human nature will always be governed by extremes of fear and greed and behavior must be governed by checks and balances, for everyone's benefit. Likewise for democracy, which can all too easily deteriorate towards mob rule or fascism, a fact understood very well by the writers of the Constitution. It is extremism that I rail against, not freedom.
Bottom line: excellence in market regulation leads to better and freer markets. And please... do not confuse quality with quantity, from either perspective: more is not better, but neither is less. Smarter, more effective, more efficient... that's better.
See you all soon.
Nouriel Roubini | Feb 05, 2008Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.
To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.
That is the reason the Fed had thrown all caution to the wind – after a year in which it was behind the curve and underplaying the economic and financial risks – and has taken a very aggressive approach to risk management; this is a much more aggressive approach than the Greenspan one in spite of the initial views that the Bernanke Fed would be more cautious than Greenspan in reacting to economic and financial vulnerabilities.
To understand the risks that the financial system is facing today I present the “nightmare” or “catastrophic” scenario that the Fed and financial officials around the world are now worried about. Such a scenario – however extreme – has a rising and significant probability of occurring. Thus, it does not describe a very low probability event but rather an outcome that is quite possible.
Start first with the recession that is now enveloping the US economy. Let us assume – as likely - that this recession – that already started in December 2007 - will be worse than the mild ones – that lasted 8 months – that occurred in 1990-91 and 2001. The recession of 2008 will be more severe for several reasons: first, we have the biggest housing bust in US history with home prices likely to eventually fall 20 to 30%; second, because of a credit bubble that went beyond mortgages and because of reckless financial innovation and securitization the ongoing credit bust will lead to a severe credit crunch; third, US households – whose consumption is over 70% of GDP - have spent well beyond their means for years now piling up a massive amount of debt, both mortgage and otherwise; now that home prices are falling and a severe credit crunch is emerging the retrenchment of private consumption will be serious and protracted. So let us suppose that the recession of 2008 will last at least four quarters and, possibly, up to six quarters. What will be the consequences of it?
Here are the twelve steps or stages of a scenario of systemic financial meltdown associated with this severe economic recession…
Puesto por Financial Times. By Martin Wolf en Febrero 20, 2008 | 09:41:14
By Martin Wolf
"I would tell audiences that we were facing not a bubble but a froth - lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy." Alan Greenspan, The Age of Turbulence.
That used to be Mr Greenspan 's view of the US housing bubble. He was wrong, alas. So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University 's Stern School of Business, founder of RGE monitor.
Recently, Professor Roubini 's scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006*. At that time, his view was extremely controversial. It is so no longer. Now he states that there is "a rising probability of a 'catastrophic ' financial and economic outcome"**. The characteristics of this scenario are, he argues: "A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe."
Prof Roubini is even fonder of lists than I am. Here are his 12 - yes, 12 - steps to financial disaster.
- Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.
- Step two would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had "reckless or toxic features", argues Prof Roubini. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks ' ability to offer credit.
- Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The "credit crunch" would then spread from mortgages to a wide range of consumer credit.
- Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.
- Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.
- Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.
- Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a "fat tail" of companies has low profitability and heavy debt. Such defaults would spread losses in "credit default swaps", which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.
- Step nine would be a meltdown in the "shadow financial system". Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.
- Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.
- Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.
- Step 12 would be "a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices".
These, then, are 12 steps to meltdown. In all, argues Prof Roubini: "Total losses in the financial system will add up to more than $1,000bn and the economic recession will become deeper more protracted and severe." This, he suggests, is the "nightmare scenario" keeping Ben Bernanke and colleagues at the US Federal Reserve awake. It explains why, having failed to appreciate the dangers for so long, the Fed has lowered rates by 200 basis points this year. This is insurance against a financial meltdown.
Is this kind of scenario at least plausible? It is. Furthermore, we can be confident that it would, if it came to pass, end all stories about "decoupling". If it lasts six quarters, as Prof Roubini warns, offsetting policy action in the rest of the world would be too little, too late.
Can the Fed head this danger off? In a subsequent piece, Prof Roubini gives eight reasons why it cannot***. (He really loves lists!) These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.
The risks are indeed high and the ability of the authorities to deal with them more limited than most people hope. This is not to suggest that there are no ways out. Unfortunately, they are poisonous ones. In the last resort, governments resolve financial crises. This is an iron law. Rescues can occur via overt government assumption of bad debt, inflation, or both. Japan chose the first, much to the distaste of its ministry of finance. But Japan is a creditor country whose savers have complete confidence in the solvency of their government. The US, however, is a debtor. It must keep the trust of foreigners. Should it fail to do so, the inflationary solution becomes probable. This is quite enough to explain why gold costs $920 an ounce.
The connection between the bursting of the housing bubble and the fragility of the financial system has created huge dangers, for the US and the rest of the world. The US public sector is now coming to the rescue, led by the Fed. In the end, they will succeed. But the journey is likely to be wretchedly uncomfortable.