November 19, 2009
In the November 18 edition of The Telegraph, Ambrose Evans-Pritchard revealed that the French investment bank, Societe Generale “has advised its clients to be ready for a possible ‘global economic collapse’ over the next two years, mapping a strategy of defensive investments to avoid wealth destruction”. That gloomy outlook was the theme of a report entitled: “Worst-case Debt Scenario” in which the bank warned that a new set of problems had been created by government rescue programs, which simply transferred private debt liabilities onto already “sagging sovereign shoulders”:
“As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse,” said the 68-page report, headed by asset chief Daniel Fermon. It is an exploration of the dangers, not a forecast.
Under the French bank’s “Bear Case” scenario, the dollar would slide further and global equities would retest the March lows. Property prices would tumble again. Oil would fall back to $50 in 2010.
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The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar. Ageing populations will make it harder to erode debt through growth. “High public debt looks entirely unsustainable in the long run. We have almost reached a point of no return for government debt,” it said.
Inflating debt away might be seen by some governments as a lesser of evils.
If so, gold would go “up, and up, and up” as the only safe haven from fiat paper money. Private debt is also crippling. Even if the US savings rate stabilises at 7pc, and all of it is used to pay down debt, it will still take nine years for households to reduce debt/income ratios to the safe levels of the 1980s.
To make matters worse, America still has an unemployment problem that just won’t abate. A recent essay by Charles Hugh Smith for The Business Insider took a view beyond the “happy talk” propaganda to the actual unpleasant statistics. Mr. Smith also called our attention to what can be seen by anyone willing to face reality, while walking around in any urban area or airport:
The divergence between the reality easily observed in the real world and the heavily touted hype that “the recession is over because GDP rose 3.5%” is growing. It’s obvious that another 7 million jobs which are currently hanging by threads will be slashed in the next year or two.
By this point, most Americans are painfully aware of the massive bailouts afforded to those financial institutions considered “too big to fail”. The thought of transferring private debt liabilities onto already “sagging sovereign shoulders” immediately reminds people of TARP and the as-yet-undisclosed assistance provided by the Federal Reserve to some of those same, TARP-enabled institutions.
As Kevin Drawbaugh reported for Reuters, the European Union has already taken action to break up those institutions whose failure could create a risk to the entire financial system:
EU regulators are set to turn the spotlight on 28 European banks bailed out by governments for possible mandated divestitures, officials said on Wednesday.
The EU executive has already approved restructuring plans for British lender Lloyds Banking (LLOY.L), Dutch financial group ING Groep NV (ING.AS) and Belgian group KBC (KBC.BR).
Giving break-up power to regulators would be “a good thing,” said Paul Miller, a policy analyst at investment firm FBR Capital Markets, on Wednesday.
Big banks in general are bad for the economy because they do not allocate credit well, especially to small businesses, he said. “Eventually the big banks get broken up in one way or another,” Miller said at the Reuters Global Finance Summit.
Meanwhile in the United States, the House Financial Services Committee approved a measure that would grant federal regulators the authority to break up financial institutions that would threaten the entire system if they were to fail. Needless to say, this proposal does have its opponents, as the Reuters article pointed out:
In both the House and the Senate, “financial lobbyists will continue to try to water down this new and intrusive federal regulatory power,” said Joseph Engelhard, policy analyst at investment firm Capital Alpha Partners.
If a new break-up power does survive the legislative process, Engelhard said, it is unlikely a “council of numerous financial regulators would be able to agree on such a radical step as breaking up a large bank, except in the most unusual circumstances, and that the Treasury Secretary … would have the ability to veto any imprudent use of such power.”
When I first read this, I immediately realized that Treasury Secretary “Turbo” Tim Geithner would consider any use of such power as imprudent and he would likely veto any attempt to break up a large bank. Nevertheless, my concerns about the “Geithner factor” began to fade after I read some other encouraging news stories. In The Huffington Post, Sam Stein disclosed that Oregon Congressman Peter DeFazio (a Democrat) had called for the firing of White House economic advisor Larry Summers and Treasury Secretary “Timmy Geithner” during an interview with MSNBC’s Ed Schultz. Mr. Stein provided the following recap of that discussion:
“We think it is time, maybe, that we turn our focus to Main Street — we reclaim some of the unspent [TARP] funds, we reclaim some of the funds that are being paid back, which will not be paid back in full, and we use it to put people back to work. Rebuilding America’s infrastructure is a tried and true way to put people back to work,” said DeFazio.
“Unfortunately, the President has an adviser from Wall Street, Larry Summers, and a Treasury Secretary from Wall Street, Timmy Geithner, who don’t like that idea,” he added. “They want to keep the TARP money either to continue to bail out Wall Street … or to pay down the deficit. That’s absurd.”
Asked specifically whether Geithner should stay in his job, DeFazio replied: “No.”
“Especially if you look back at the AIG scandal,” he added, “and Goldman and others who got their bets paid off in full … with taxpayer money through AIG. We channeled the money through them. Geithner would not answer my question when I said, ‘Were those naked credit default swaps by Goldman or were they a counter-party?’ He would not answer that question.”
DeFazio said that among he and others in the Congressional Progressive Caucus, there was a growing consensus that Geithner needed to be removed. He added that some lawmakers were “considering questions regarding him and other economic advisers” — though a petition calling for the Treasury Secretary’s removal had not been drafted, he said.
Another glimmer of hope for the possible removal of Turbo Tim came from Jeff Madrick at The Daily Beast. Madrick’s piece provided us with a brief history of Geithner’s unusually fast rise to power (he was 42 when he was appointed president of the New York Federal Reserve) along with a reference to the fantastic discourse about Geithner by Jo Becker and Gretchen Morgenson, which appeared in The New York Times last April. Mr. Madrick demonstrated that what we have learned about Geithner since April, has affirmed those early doubts:
Recall that few thought Geithner was seasoned enough to be Treasury secretary when Obama picked him. Rubin wasn’t ready to be Treasury secretary when Clinton was elected and he had run Goldman Sachs. Was Geithner’s main attraction that he could easily be controlled by Summers and the White House political advisers? It’s a good bet. A better strategy, some argued, would have been to name Paul Volcker, the former Fed chairman, for a year’s worth of service and give Geithner as his deputy time to grow. But Volcker would have been far harder to control by the White House.
But now the president needs a Treasury Secretary who is respected enough to stand up to Wall Street, restabilize the world’s trade flows and currencies, and persuade Congress to join a battle to get the economic recovery on a strong path. He also needs someone with enough economic understanding to be a counterweight to the White House advisers, led by Summers, who have consistently been behind the curve, except for the $800 billion stimulus. And now that is looking like it was too little. The best guess is that Geithner is not telling the president anything that the president does not know or doesn’t hear from someone down the hall.
The problem for Geithner and his boss, is that the stakes if anything are higher than ever.
As the rest of the world prepares for worsening economic conditions, the United States should do the same. Keeping Tim Geithner in charge of the Treasury makes less sense than it did last April.
A 9-11 Commission For The Federal Reserve
January 7, 2010
After the terrorist attacks of September 11, 2001, Congress passed Public Law 107-306, establishing The National Commission on Terrorist Attacks Upon the United States (also known as the 9-11 Commission). The Commission was chartered to create a full and complete account of the circumstances surrounding the September 11, 2001 terrorist attacks, including preparedness for and the immediate response to the attacks. The Commission was also mandated to provide recommendations designed to guard against future attacks. The Commission eventually published a report with those recommendations. The failure to implement and adhere to those recommendations is now being discussed as a crucial factor in the nearly-successful attempt by The Undiebomber to crash a jetliner headed to Detroit on Christmas Day.
On January 3, 2010, Federal Reserve Chairman Ben Bernanke gave a speech at the Annual Meeting of the American Economic Association in Atlanta, entitled: “Monetary Policy and the Housing Bubble”. The speech was a transparent attempt to absolve the Federal Reserve from culpability for causing the financial crisis, due to its policy of maintaining low interest rates during Bernanke’s tenure as Fed chair as well as during the regime of his predecessor, Alan Greenspan. Bernanke chose instead, to focus on a lack of regulation of the mortgage industry as being the primary reason for the crisis.
Critical reaction to Bernanke’s speech was swift and widespread. Scott Lanman of Bloomberg News discussed the reaction of an economist who was unimpressed:
Nomi Prins attended the speech and had this to say about it for The Daily Beast:
As the Senate takes on the task of further neutering the badly compromised financial reform bill passed by the House (HR 4173) — supposedly drafted to prevent another financial crisis — the need for a better remedy is becoming obvious. Instead of authorizing nearly $4 trillion for the next round of bailouts which will be necessitated as a result of the continued risky speculation by those “too big to fail” financial institutions, Congress should take a different approach. What we really need is another 9/11-type of commission, to clarify the causes of the financial catastrophe of September 2008 (which manifested itself as a credit crisis) and to make recommendations for preventing another such event.
David Leonhardt of The New York Times explained that Greenspan and Bernanke failed to realize that they were inflating a housing bubble because they had become “trapped in an echo chamber of conventional wisdom” that home prices would never drop. Leonhardt expressed concern that allowing the Fed chair to remain in such an echo chamber for the next bubble could result in another crisis:
Barry Ritholtz, author of Bailout Nation, argued that Bernanke’s failure to understand what really caused the credit crisis is just another reason for a proper investigation addressing the genesis of that event:
Ritholtz contended that an honest assessment of the events leading up to the credit crisis would likely reveal a sequence resembling the following time line:
As long as the Federal Reserve chairman keeps his head buried in the sand, in a state of denial or delusion about the true cause of the financial crisis, while Congress continues to facilitate a system of socialized risk for privatized gain, we face the dreadful possibility that history will repeat itself.