The gathering storm

Gathering Storm
[This is the second or third TPD post with that title – any excuse to use that great picture. This time it is especially apropos.]

I’m convinced that most Americans simply don’t realize just how severe our financial crisis is. Some, like our own sagely president, won’t even acknowledge we’re in a recession, let alone a crisis. But when we look at the events of recent days with stone-cold eyes, there is no way – unless you are wearing lead-lined blinders – we cannot conclude we are in serious trouble. The kind of trouble that could actually lead to a collapse of our banking system.

Impossible, bogus, alarmist nonsense! I can hear the catcalls from the peanut gallery already. But let’s simply look at the facts. Bear Stearns collapsed six months ago. Last week it was Fannie and Freddie’s turn. Yesterday, Merrill Lynch got sold to Bank of America at a bargain-basement price. Today. Lehman Brothers announced it’s going under as well.

A crisis of confidence in financial markets on Wall Street culminated in a weekend of brinksmanship and failed appeals that caused the demise of some of the nation’s most storied financial institutions.

It began on Tuesday, just two days after the Bush administration took control of Fannie Mae and Freddie Mac, the mortgage finance giants. Fears began to mount in earnest on Wall Street that Lehman might founder — and that the government might not ride to the rescue this time. As stock markets around the world tumbled, Lehman’s shares were hit by waves of selling that wiped out nearly half its value.

Please read that article – it’s a real page-turner, like a whodunit. We are witnessing a melodrama, almost like a horror movie. Make no mistake, this is an historical moment. We have seen nothing like it in our lifetimes.

Reflecting on the collapse of one of our most esteemed financial institutions, a widely respected financial analyst put it bluntly:

“This is an extremely, and I stress extremely, rare event. It also speaks to the more general notion that, in today’s highly disrupted financial markets, the unthinkable is thinkable,” said Mohamed El-Erian, the chief executive of Pimco, the world’s biggest bond fund, based in Newport Beach, California.

At what point do we call it a meltdown? Is that too unthinkable to stomach? People breathed a sigh of relief at the government’s seizure of Fannie and Freddie because it seemed to bring an untenable disaster under control. But was rejoicing really in order? Maybe it was just the proverbial finger in the dyke. The structural flaws may be simply too deep. We’ll be watching as Wall Street struggles to remedy the latest catastrophe, but I believe the dominoes have just started falling.

One of my favorite investment sites sounds worried, almost as if they’re trying to convince themselves that Wall Street simply has to implement a safety net to contain the Lehmann collapse. But there’s another possibility – a meltdown. The uthinkable really might be becoming thinkable.

That said, a meltdown would benefit no one, and Wall Street has every incentive to avoid it — as we’re seeing in the shotgun marriage of Merrill and BofA. If people can keep their heads through the end of the week, this could turn out to be Wall Street’s finest hour since John Pierpont Morgan used his own money to save the day during the panic of 1907.

It’s a fluid situation, of course, as all the news stories are at pains to point out. But right now it looks like the best-case scenario is that Lehman goes bankrupt, with the rest of Wall Street playing a generally supportive role. And the worst-case scenario? You don’t want to go there.

“If people can keep their heads…” That’s a very big if, and I am not sure it’s possible – not if the house of cards keeps coming down at once. And that’s what we seem to be seeing (Fannie, Freddie, Merrill Lynch, Lehman Bros. all within a few days of each other).

Finally, Paul Krugman gives a clear-headed assessment of the disaster, and touches on what no one seems to want to admit: this never needed to happen. That bullshit of the “ownership society” made this all possible, the mentality that the government needs to step out of the way and let businesses run roughshod over the people with zero regulation – this mentality opened the floodgates for the sub-prime calamity; this cowboy attitude that businesses should be free to do whatever they want without oversight brought us here. Read the Krugman op-ed, and memorize its closing grafs.

The real answer to the current problem would, of course, have been to take preventive action before we reached this point. Even leaving aside the obvious need to regulate the shadow banking system — if institutions need to be rescued like banks, they should be regulated like banks — why were we so unprepared for this latest shock? When Bear went under, many people talked about the need for a mechanism for “orderly liquidation” of failing investment banks. Well, that was six months ago. Where’s the mechanism?

And so here we are, with Mr. Paulson apparently feeling that playing Russian roulette with the U.S. financial system was his best option. Yikes.

It may not be a pretty day on Wall Street today, though I suspect the full gravity of the mess won’t have sunk in. I almost wish McCain would win, because no one should be made to suffer what Bush hath wrought when it comes to an economy that eight short years ago was literally the marvel of the world. Fasten your seatbelts; the roller coster ride has just started, even though there’s no track up ahead around the bend. (And I’m ready for the chorus how of I hate America and we’re doing jim-dandy and we should give the GOP yet another eight years. Right. Sarah Palin will make it all well again.)

Update: Next on the chopping block, AIG? Yes, we’re doing just fine. These are America’s greatest, more venerable institutions.

Also, a Business Week article steals my headline, and raises yet more reasons why there is trouble ahead:

Until now, preferred stock has been a prime tool for daring investors to inject new capital into a company needing rehabilitation. The Fannie and Freddie deals indicated that preferred investors could lose big, along with common stock investors, in distressed takeovers. Both Merrill and AIG raised new capital early this year by issuing securities similar to preferred. Lehman also raised money from preferred investors, who are now likely to be wiped out in a bankruptcy. So now big issues of preferred securities may not be available to fill holes in balance sheets from new losses.

After a bad week, a working weekend, and a manic Monday, Wall Street can only hope the credit storm is at its worst.

In other words, nowhere to run, nowhere to hide. The big institutions brought this on themselves, but also on each of us, as we’ll be footing much of the bill, not to mention seeing the value of our homes decrease and living in recession/stagflation for years to come. What could we expect from the party whose slogans are “Drill baby, drill!” and “Borrow, baby, borrow!”?

The Discussion: 54 Comments

What has all this breast-beating to do with China? What is it doing on Frankly, my dear, we non-Americans don’t give a damn.

September 15, 2008 @ 8:35 pm | Comment

Mike, who ever said this was a blog about only China? In 2004, it was almost entirely about the US elections, as it will be in 2008. Don’t despair, I won’t abandon posting about China, but I write about whatever interests me, which is mainly China and the US catastrophe.

September 15, 2008 @ 8:38 pm | Comment

There’s an article in the Times about “the economy”, which was quite interesting:

September 15, 2008 @ 9:20 pm | Comment

That article is a rehash of Kaletsky’s one motif, the backbone of nearly all his articles about all topics: we are doing just fine. The financial system may be a mess, but the economy will do fine. I think to him, thre can never be true problems in the world unless if they are on a par with Auschwitz. I much appreciated this gem:

“Never in human history has life been more predictable, safe and stable – at least for that large minority of the human race who live in the advanced capitalist countries of Western Europe, North America and East Asia”, writes the economist and journalist Anatole Kaletsky. “Compared with the upheavals of the early 20th century, the challenges we face today – whether as families and individuals or as societies and nations – are almost laughably trivial. Have psychologists who tell us that accident witnesses need grief counselling forgotten about Holocaust survivors and PoWs in Burma ? … Can politicians honestly speak of terrorism today in the same breath as the threat from Communists and Nazis to previous generations ? Anyone who makes such comparisons is insulting our intelligence, as well as our courageous forebears.”

He is always, always upbeat. Terrorism? Not to worry, it was worse under the Nazis and the Reds. Meltdown, schmeltdown, we’re doing just fine.

September 15, 2008 @ 9:30 pm | Comment

I take it you don’t like Kaletsky then.

But he is right in saying in the piece you quoted that things are generally safer and more stable for people living in North America, Europe and East Asia. Things are looking bad now, but that’s because people have got used to the good times. I thought back in 2003 that the UK government was frittering away money on the assumption the good times would never end – the electorate seemed to agree with the government.

September 15, 2008 @ 9:36 pm | Comment

Thans Gordon. Let me offer reader an excerpt from the link you were kind enough to share. Remember, this is from leftist Alan Grenspan. What does he know?

The United States is mired in a “once-in-a century” financial crisis which is now more than likely to spark a recession, former Federal Reserve chief Alan Greenspan said Sunday.
The talismanic ex-central banker said that the crisis was the worst he had seen in his career, still had a long way to go and would continue to effect home prices in the United States.

“First of all, let’s recognize that this is a once-in-a-half-century, probably once-in-a-century type of event,” Greenspan said on ABC’s “This Week.”

Asked whether the crisis, which has seen the US government step in to bail out mortgage giants Freddie Mac and Fannie Mae, was the worst of his career, Greenspan replied “Oh, by far.”

“There’s no question that this is in the process of outstripping anything I’ve seen, and it still is not resolved and it still has a way to go,” Greenspan said.

“And indeed, it will continue to be a corrosive force until the price of homes in the United States stabilizes.

“That will induce a series of events around the globe which will stabilize the system.”

Greenspan was also asked whether the United States had a greater-than 50 percent chance of escaping a recession.

“No, I think it’s less than 50 percent.

“I can’t believe we could have a once-in-a-century type of financial crisis without a significant impact on the real economy globally, and I think that indeed is what is in the process of occurring.”

But it’s just me being an alarmist.

September 15, 2008 @ 9:37 pm | Comment

I remember the Economist writing on Greenspan’s retirement way before all this happened. I found part of the article it ran:

DESPITE his rather appealing personal humility, the tributes lavished upon Alan Greenspan, the chairman of the Federal Reserve, become more exuberant by the day. Ahead of his retirement on January 31st, he has been widely and extravagantly acclaimed by economic commentators, politicians and investors. After all, during much of his 18½ years in office America enjoyed rapid growth with low inflation, and he successfully steered the economy around a series of financial hazards. In his final days of glory, it may therefore seem churlish to question his record. However, Mr Greenspan’s departure could well mark a high point for America’s economy, with a period of sluggish growth ahead. This is not so much because he is leaving, but because of what he is leaving behind: the biggest economic imbalances in American history.

One should not exaggerate Mr Greenspan’s influence—both good and bad—over the economy. Like all central bankers he is constrained by huge uncertainties about how the economy works, and by the limits of what monetary policy can do (it can affect inflation, but it cannot increase the long-term rate of growth). He controls only short-term interest rates, not bond yields, taxes or regulation. Yet for all these constraints, Mr Greenspan has long been the world’s most important economic policy maker—and during an exceptional period when globalisation and information technology have been transforming the world economy.…

Unfortunately the whole thing isn’t available on free access. If you have a subscription I think it was worth reading.

September 15, 2008 @ 9:41 pm | Comment

So does Greenspan think this is worse than the 20s crash, or a different sort of crisis? I would be very surprised if things went like that.

September 15, 2008 @ 9:42 pm | Comment

50% chance of a recession? Should we start gnashing our teeth and rending our garments yet?

September 15, 2008 @ 9:48 pm | Comment

Nothing to worry about, Greenspan just said: ““I can’t believe we could have a once-in-a-century type of financial crisis without a significant impact on the real economy globally, and I think that indeed is what is in the process of occurring.” Yes Sam, it’s all fine.

September 15, 2008 @ 10:02 pm | Comment

Predictions like collapse and meltdown are so vague that they could allow seemingly disparate voices to be saying the same thing. Does disaster mean 8% inflation? 10%? 12%? Zimbabwe-style? Does it mean 50% unemployment or 7%?

September 15, 2008 @ 10:42 pm | Comment

Flotsam, taboo topic – please send me an email for the details. Thanks, and we always appreciate your comments.

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September 15, 2008 @ 10:54 pm | Comment

Wesley, you are right – and I can’t make a more specific prediction than this: a devastating shakeout of the banking system (already hapening), long-term malaise (already here for at least a year), ongoing unemployment or at least stagnation of new job growth (partly here), stagflation (here) and total lack of confidence in the US dollar (up and down in recent months but lots more to come). Where it will end, no one can say. But my main point here is that most Americans are ignorant of how serious it is, and that this will have consequences that linger for many years and that will shift the balance of power further. This will affect the value of their assets and will force many to downsize their hopes and dreams. Of course, those at the top will do just fine. And the stock market may not do so badly either. Those who manage the levers won’t tolerate a 1929-style deflationary depression.

Predicting macroeconomics is often a losing game. All I can say is look at what is happening in terms of ruined banks, foreclosures and the failure of many institutions that have traditionally been the bedrock of American fiscal strength. Something is profoundly wrong. Sam can laugh it off and some can see only optimism. They are welcome to do so, but are only fooling themselves, in my humble perspective.

September 15, 2008 @ 11:03 pm | Comment

The current US Federal Debt is about 8 Trillion. Today, the social security account for the US gov’t is still being used too much, and is still positive in revenue. When the “baby boombers” retire in about 2010, the social security account will be eaten very very quickly, and social security account will be negative very very soon. Add this to the Federal debt, and the picture will be a horror movie.

The problem of course is that America is a credit card economy. It has a credit card, which is supported by its good (at least for now) reputation, its dollar, and its military power. Using this credit card, it can spend as much as it wants and have other countries pay for it, and he just needs to give other countries green papers in exchange. This scheme has worked and gave Americans very rich lifestyles like a big house, SUV’s, big shopping malls, driving to the gym to exercise, etc. And Americans think this is what life “should” be. Of course one day they will wake up and realize this credit card stopped working, and other countries refused to continue this game.

Then, it will really come as a shock to Americans. Americans are not used to living in small crowded houses, biking to work, eating frugally, and paying for things on time. So once their life reverts to this state, they will start to feel angry, to feel “robbed”, and what happens next?

Some politician will be elected who will use China or India or any third world countries as the reason for the decline in America’s living quality, decline in industry, in jobs, in government services, in everything. Everything must be China’s fault! And this message will be enjoyed by most citizens, and very soon, very soon. A Chinese or Indian immigrant family one day will wake up and see their houses painted with racial messages by Americans, seen their windows smashed at night, called to “go home!” on the streets. This will soon go out of control. The pecularity about American society is there is no cohesion, all these different races and ethnics only live in peace when time is good, when time is bad, it’s everyone on its own, because there’s no common roots for all of them, no sense of loyalty or belonging. So soon, it will be whites vs blacks, yanks vs kikes, Chinese vs Mexicans, and this American pirate ship will start to sink like the Titanic.

My advice for Chinese living in America is, leave as soon as you can, if you cannot leave, then buy a gun, and all move to the West Coast and away from the elite Jewish east coast. If you can have a big concentration of armed Chinese in the West Coast, like around Seattle, then you will have a chance.

You may say, “But I have an American passport, I am an American! They will treat me like an American!” If you say this, then you are too simple, too naive. See what happens to the Japanese during WW2 in America.

September 15, 2008 @ 11:26 pm | Comment

that will shift the balance of power further

Which balance of power are you talking about?

It could well be the case that most Americans are ignorant of the possible extent of economic troubles ahead – but that’s often the case in my experience around the world. Sometimes people may be more gloomy than they should be, but usually they’re not troubled until they start to notice things go wrong for them.

Currently I would agree with Wesley that notions of “disaster” are too vague and often bandied about without specifics so that commentators cannot be tied down if things do not turn out as they predict. I’m certainly not suggesting that everything will be “ok”, but I would like to see people like Greenspan give more detail. If the US went into recession, would it matter that much if it was minimal in depth and duration? Similarly if the following recovery had minimal job creation for a period of years it wouldn’t count for much.

The devil is in the detail, after all.

September 15, 2008 @ 11:27 pm | Comment

Talk to Greenspan. If you ever hear him speak, you know this is as specific as he ever gets.

I’ll give my short-term predictions:

A dynamic and measurabe shift in the presidential campaign away from lipstick and McCain’s service in Vietnam and other irrelevant BS, with a new emphasis on the economy. Period. The polls are irrelevant, All that matters is the electoral college, and if Obama can pull the swing states like Ohio and Pennsylvania, where the economic pinch is catastrophic, he will win.

A return to the falling dollar.

A pick-up in the price of gold short-term, but with a possible dropafterwards to the next psychological trigger-point of around 650, after which we will see it shoot up past 1,000 in a very short time. And then it will keep going up, with the usual profit-taking at other psychological trigger points.

More unemployment, tighter loans and, as always in a time of tighter credit, a constricting economy.

Most commentators do not make very specific long-term predictions about the economy, with percentages and numbers and dates. Most make more general predictions and if they know what they are talking about, their predictions can be very valuable. If Greenspan is right, most of us will all know it – we will know if we are in a state of disaster. Our lives will be different than they are today, our anxieties heightened and our options more limited.

September 15, 2008 @ 11:41 pm | Comment

richard, I agree that the US election should focus on the economy. There was a good article somewhere (which I have misplaced) stating that Democratic activists and pundits had helped the McCain-Palin ticket by the way they had attacked her. Obama, at first certainly, had tried to ignore that – but he had been drowned out by their howls of contempt. Plus the “pig-lipstick” comment had taken the focus off some good things he was saying at the time.

The swing states will certainly decide the election, which is surprising because up until a month or two ago many people were predicting an Obama walkover. As we found in 2000, even if you win more votes nationally the electoral college matters. I still don’t understand why the US isn’t trying to address that – is it true that the voting system can’t be changed without all the states agreeing?

I note that the McCain camp has already released an ad saying that the economy is in trouble and that only “the mavericks” can deal with it. I know you disagree with that, but it looks like neither ticket will shy away from discussing it.

Only an idiot would make very specific long-term predictions about the economy

Yes, but commentators could give a vague idea of what one might be able to expect. Otherwise saying “disaster” will just scare people into thinking the worst.

September 15, 2008 @ 11:57 pm | Comment

Raj maybe it’s time people get scared. I certainly am. I know my parents are. Smart people everywhere are, and since they are smart they are changing the way they save and invest. Time for a lot more people to get scared. Not hysterical and panicked, but aware of what’s going on, and that a bailout of this bank or that insurance company won’t stop it.

Meanwhile, it was clear enough to me what Greenspan meant: conditions that are bad now will continue to get worse and it will last longer than we are used to. As I said above, these include employment stagnation, a further declining dollar (which can be good for many businesses), continued drop in the value of homes and an increase in foreclosures, more financial institutions failing, etc. I enjoy the way that as soon as Gordon quoted Greenspan you dredged up an article knocking him (Greenspan), the way you knocked the Guardian when it came out for Obama. I have news for you: I can find an article knocking everybody. Republicans clung to Greenspan’s every syllable for years; now, when he says what he really thinks, Republicans will knock him for leaving the US economy in a mess (which he did). Whatever. The point is, Greenspan is just one of many calling today a disaster. Everyone from Michelle Malkin to the NYT to me is acknowledging this is a grave crisis.

September 16, 2008 @ 12:16 am | Comment

During the Clinton Administration thanks to divided government and a house still populated with fiscal conservation republicans instead of incompetent nut jobs like sarah palin the government was able to balance a budget and starting spending less than received revenues. Because of this the government no longer had to auction 30 year treasury notes. This made old money very unhappy. Old money likes to buy treasury bonds with the interest rates going up every year and the government guaranteeing a rate of return with minimal risk for old money while the government goes into debt and screws people who are not old money.

If old money cannot buy 30 year treasuries then they are forced to invest in the stock market and that means risk and they have to actually think and manage their money. It is easier to wage class warfare on the rest of american and have the taxpayer pay them interest on the money they loan to us.

Creating a large budget deficit and auctioning 30 year treasury notes again was one of the primary economic goals of GW and his base. Also getting rid of the awful inheritance tax, don’t want Paris and GW to be deprived of any of their inheritance.

The Bush adminstration had a few basic goals they have stuck to since coming to office in 2001. They have stuck to them through out. Outside of pushing drilling, expanding subsidies for the oil industry, eliminating the inheritance tax, creating a budget deficit to drive a bond market,and in general reducing taxes when has the Bush Administration ever managed any part of the US economy?

They had one basic goal, make life easier for those already wealthy. The sad thing is that the social conservatives are too stupid to notice they are being lied to and used.

September 16, 2008 @ 12:21 am | Comment

Raj maybe it’s time people get scared. I certainly am. I know my parents are. Smart people everywhere are, and since they are smart they are changing the way they save and invest. Time for a lot more people to get scared. Not hysterical and panicked, but aware of what’s going on, and that a bailout of this bank or that insurance company won’t stop it.

You see, it’s probably POV but I’d call that “concerned”. For me, fear is too unpredictable – fight or flight (and one is always the wrong response). Of course it is always a good idea to reconsider your future plans when things start to go wrong.

I enjoy the way that as soon as Gordon quoted Greenspan you dredged up an article knocking him (Greenspan)

Yes, because I remembered the Economist criticising him when others were lavishing praise on him. I’m not interested in what Republicans (of which I remind you I am not one) think or say now – the Economist was writing back in January 2006. Just as it was saying not to write McCain off when Giuliani was being hailed as the Republican candidate, it often refuses to jump on the bandwagon.

the way you knocked the Guardian when it came out for Obama

Because it was linked on another website I was reading and I thought it a piece of crap.

September 16, 2008 @ 12:35 am | Comment

Putting lipstick on a pig is the kind of language Obama should be injecting into his speeches. He is using language that those who are enamored with Palin can relate to. It is an apt metaphor for the McCain campaign trying to use cosmetics to sell 4 more years of Bush. The beauty is that it is a phrase mccain uses himself to attack hillary clinton. That was the smartest political move obama has made, it was clumsy. never appologize, and just keep attacking Bush/McCain on the issues and thrown in some phrases the conservative base can understand.

Obama comes of as a bright college kid from the city which is why he has trouble with people who gravitate to Palins. When he uses language like putting lipstick on a pig then these people can relate to the rest of what he is saying more and he is talking more their language.

If he continues to talk about issues and throw in a few metaphors such as that then he will do well. After awhile it will be obvious that Palin only has a few slogans that appeal to working class uneducated people and no command of the issues, all of which she has already used. after awhile that will be obvious to most people. which is why the republicans started bashing the media at the convention and have a cadre of republican women attack dogs to parse every obama statement to twist. They are trying to raise the noise level so everyone is drowned out except palin and her hockey mom lipstick pitbull ebay jet bridge to nowhere reform slogans.

I’m still waiting to see proof the beauty queen actually can field dress a 1000lb moose, slit it’s throat drain the blood out, saw of its legs and gut it. I don’t see this celebrity poltician with moose blood and guts in her hair. Just another lie from Fred Thompson.

September 16, 2008 @ 12:37 am | Comment

Putting lipstick on a pig is the kind of language Obama should be injecting into his speeches.

Not in the way he said it, though! I know what he meant, but it came across the wrong way. He needs to ensure it doesn’t become personal. I’ve said it before and I’ll say it again – focus on the issues only and he will win.

Democrats should not be attacking Palin for who she is – I wouldn’t even recommend they criticise her for being pro-life given many people share her views (and not just hard-core Republicans either). Criticise what she says on the campaign trail and ask her those tough questions (e.g. Biden in the VP debate). Then you’ll score some real hits.

September 16, 2008 @ 12:56 am | Comment

Raj, please stop that about the lipstick remark – it on;y “vme across” that way because fucktards like Jonah Goldberg and Michelle and others said it did; but it had zero grounding in reality. Obama has used it hundreds of times and was using it gain in a non-Palin context, period. Rightards heard what they wanted to hear, an insult of St. Sarah. Only there was no insult, It was pure vintage GOP horseshit, getting the country all up in arms about shit. We wake up today and see what a real crisis looks like. And we realize what a waste of precious time all that BS huffing and puffing and feigned outrage over a non-insult really was – a smokescreen to distract us from the real catastrophes the Republican government has left for us and our children.

About Palin, I’m not worried. As I’ve said, she’ll self-destruct and is well on the way. I wouldn’t make any personal insults about her. And I would spin the criticism so it reflects on McCain’s well-known and now widely acknowledged incompetence, No wonder opinion writers at the Guardian and other enlightened media are trying to raise the red flags as high as they can go. A very noble cause. Let’s hope more media, domestic and foreign, have their say. I am a big believer in buzz, and it can make a difference, whether it’s generated by a portal in China or a newspaper in London. Bring it on.

September 16, 2008 @ 1:15 am | Comment

People think this is just and American problem. It is not. What is happening is a global deleveraging. America is just ahead of the curve. House prices in many parts of Europe (eg, Spain, Ireland etc.) had larger bubbles than in America. Many Asian countries have property bubbles too. In many parts of India (including some rural areas), the property values are much more divorced from any income stream they can generate (eg, rent), than in NY. American banks have stricter disclosure requirements which forces them to mark everything to market sooner. So losses are realized faster. Many European and Asian banks can keep assets in their books at book value (price at which they acquired it) for longer. It is usually better to take the pain all at one time, rather than bleed slowly. It allows the economy to recover faster. Many economists think, Japan would have fared much better, if the their banks had cleaned up the their books faster.

The deleveraging works like this. Basically banks and other financial institutions worldwide are looking hard at the credit risks they are talking. They are reluctant to provide new credit or the price of credit is higher than before. This results in the total amount of loans outstanding to shrink. Effectively this is equivalent to the total amount of money in the global economy shrinking. This is depress asset prices worldwide. All assets including houses, stocks, commodities are likely to fall in value. This results is more loans underwritten by assets default (eg, as house prices go down, many more people find their equity in the house is negative and hence will be more likely to default). This depletes bank’s capital and makes then even less likely to make new loans, and the vicious cycle continues.

This is what happened during the great depression. One of the primary responsibilities of the Federal Reserve is to fight this. We are lucky to have Ben Bernanke who spend a lot of his career studying the great depression at the helm of the Fed.

Anyway I agree that this is likely to be a once in a lifetime event.

September 16, 2008 @ 1:45 am | Comment

You should be scared. Your savings in a bank may disappear, at least the part over $100,000, if your bank goes the way Lehman Brothers did. Spread your savings among different banks, so each one has less than $100,000. I wonder if the US government will no longer insure that $100,000.

September 16, 2008 @ 1:54 am | Comment


I think Greenspan had more to do with the troubles now than Bush did. He kept interest rates too low for too long and was cheerleading one assert bubble after another. Low interest rates were responsible for the housing bubble after the 2000 stock bubble burst. I think The Economist and Paul Krugman agree with me on this point.

It sucks for Ben Bernanke that he is now responsible for cleaning up the mess Greenspan made.

September 16, 2008 @ 2:00 am | Comment


My personal opinion is that all asset prices would decline over time because of the deleveraging, including gold. Inflation is only likely to be a temporary blip. You could read Paul Krugman on more details on this.

September 16, 2008 @ 2:04 am | Comment

it on;y “vme across” that way because fucktards like Jonah Goldberg and Michelle and others said it did

Richard, he walked straight into it. Even I, as a European, knew what the reaction would be before I read anything from Republicans.

Obama has used it hundreds of times and was using it gain in a non-Palin context, period.

As Mickey Kaus said:

(i.e., there’s no way of knowing what Obama meant by “lipstick”–just because he and McCain used the word earlier doesn’t mean he didn’t think using it now, after Palin’s speech, didn’t add a witty resonance)

Neither of us are accusing Obama of meaning that, but he should have realised it could be used against him.

September 16, 2008 @ 3:08 am | Comment

I don’t often agree with Raj, but I agree with him here. It was a dumb thing for Obama to say (and his remarks were scripted). Let Biden handle Palin, and handle her on the issues. Obama needs to show people why he should be President in a time of great crisis. He’s losing that public perception battle, and he doesn’t have a lot of time to turn things around. Only 5 points ahead in NY? Tied in Michigan? This is crazy.

September 16, 2008 @ 3:14 am | Comment

Serve the people,

Lehman Brothers and ML are investment banks, not commercial banks. I doubt anyone here has any savings in Lehman brothers.

Greenspan is only partially to be blamed. This administration, Bush and cronies further de-regularized the financial sector. That’s why we see all those crazy and greedy investments on the Wall Street.

Anyhow, we are fucked, this is some shitty crisis even Greenspan has never seen.

September 16, 2008 @ 5:54 am | Comment

Richard, thanks for this post. I am very scared about this situation as well.
To put it bluntly, our entire economy is based on financial services, and the banking industry is on the verge of collapse. That’s like running out of water or oxygen. Its not just a recession, its a cataclysmic event. The potential consequences are unthinkable.I do have, however, a strange sense that we will blag our way through this and everything will be alright.

September 16, 2008 @ 5:55 am | Comment

The bet is still open, Richard, and it’s in measurable terms, not rhetoric. 2 Q’s 0-to-negative growth, no Q worse than -2%. Win an easy $1,000 and validate your expert credentials forever!

September 16, 2008 @ 7:13 am | Comment

Sam, the only reason i won’t enter the bet is that it’s an election year. All kinds of things can be done to temporarily make things look pretty – all kinds of things, even Iraq. After the elections, you’re on.

Raj, thanks for quoting Mickey Kaus.

Lisa, we’ll have to disagree on this. The “pig” remark was truly nothing in my eyes, especially after watching the video and seeing the context, which was all about McCain’s policies. But we have discussed this one to death, which is exactly what they want us to do.

I do agree Obama needs to smarten up on how to counter the wave of pure propaganda, based not on achievement but on star power, something almost like Being There. The debates should be most interesting.

Meanwhile, was I ever wrong about Wall Street yesterday! Seems like we’re doing just fine.

The churn of a rapidly changing financial landscape left Wall Street cold on Monday, as a late afternoon sell-off sent the stock market to its worst daily loss in seven years.

The blue-chip index spent the entire day in negative territory, but the losses did not begin approaching dramatic levels until late in the afternoon. In the last 30 minutes of trading, investors seemed to give in to their fears about the health of the financial system, igniting a wave of selling that sent the Dow, already about 300 points lower, to a 504.48 point decline for the day.

The Standard & Poor’s 500-stock index fared even worse, losing 4.7 percent, and the technology-heavy Nasdaq composite index fell 3.2 percent. In Europe, benchmark stock indexes were off nearly 4 percent in London and Paris and almost 3 percent in Frankfurt….

n Wall Street, Lehman shares fell 95 percent on Monday, to just over 21 cents a share. Another company at the center of the concerns, American International Group, saw its stock fall 61 percent, down to $4.76 a share, even as state officials in New York stepped in to provide financial assistance in the face of a potential downgrade from credit ratings agencies and the Federal Reserve asked two banks to develop a $70 billion loan package.

One bad day doesn’t make a trend. So let’s keep watching. Usually after these crashes the bargain hunters lift things up again. Not sure if this time it might be different, because optimism is now at a new low.

September 16, 2008 @ 7:38 am | Comment

Neil, tree, MT, Serve, et. al., thanks for commenting. What has to happen before people get worried enough to know that the Republican model of a free ride for businesses and regulatory agencies stuffed with incompetents is a formula for disaster?

MT, hard to say exactly where the blame lies when it comes to the Fed vs. Bush but you’re right that Greenspan shares a huge amount of the blame, especially fir his endorsement of fancy “financial instruments” that proved to be more like trap doors. This was Greenspan’s worst moment. However, effective consumer protection regulation would have prevented the sub-prime loans from expanding, and there would have been intervention far, far earlier.

I do think Greenspan was generally effective under Clinton, and I gave him credit for warning the world of “irrational exuberance” long before the dot-com crash. Maybe when we have some more time and more perspective we can trace what went wrong under Bush. The great thing about the economy of the mid/late- 1990s was that it lifted all ships. Under Bush, any progress you point to was mainly for the uppermost classes.

One commenter up above loves the Economist. Here’s what they have to say today about the calamity, and I believe this is what Greenspan is referring to when he says we are seeing something without precedent, something that could bring the country a lot of pain:

EVEN by the standards of the worst financial crisis for at least a generation, the events of Sunday September 14th and the day before were extraordinary. The weekend began with hopes that a deal could be struck, with or without government backing, to save Lehman Brothers, America’s fourth-largest investment bank. Early Monday morning Lehman filed for Chapter 11 bankruptcy protection. It has more than $613 billion of debt.

Other vulnerable financial giants scrambled to sell themselves or raise enough capital to stave off a similar fate. Merrill Lynch, the third-biggest investment bank, sold itself to Bank of America (BofA), an erstwhile Lehman suitor, in a $50 billion all-stock deal. American International Group (AIG) brought forward a potentially life-saving overhaul and went cap-in-hand to the Federal Reserve. But its shares also slumped on Monday.

The situation remains fluid, and investors stampeded towards the relative safety of American Treasury bonds. Stockmarkets tumbled around the world (though some Asian bourses were closed) and the oil price plummeted to well under $100 a barrel. The dollar fell sharply, and the yield on two-year Treasury notes fell below 2% on hopes the Federal Reserve would cut interest rates at a scheduled meeting on Tuesday. American stock futures were deep in the red too. Spreads on risky credit, already elevated, widened further.

With these developments the crisis is entering a new and extremely dangerous phase. If Lehman’s assets are dumped in a liquidation, prices of like assets on other firms’ books will also have to be marked down, eroding their capital bases. The government’s refusal to help with a bail-out of Lehman will strip many firms of the benefit of being thought too big to fail, raising their borrowing costs. Lehman’s demise highlights the industry’s inability, or unwillingness, to rescue the sick, even when the consequences of inaction are potentially dire.

In a sign of how bad things are, even straitened banks are stumping up cash to help the stabilisation efforts. On Sunday, a group of ten banks and securities firms set up a $70 billion loan facility that any of the founding members can tap if it finds itself short of cash.

Even if markets can be stabilised this week, the pain is far from over—and could yet spread. Worldwide credit-related losses by financial institutions now top $500 billion, of which only $350 billion of equity has been replenished. This $150 billion gap, leveraged 14.5 times (the average gearing for the industry), translates to a $2 trillion reduction in liquidity. Hence the severe shortage of credit and predictions of worse to come.

Indeed, most analysts think that the deleveraging still has far to go. Some question how much has taken place. Bianco Research notes that while the credit positions of the 20 largest banks have fallen by $300 billion, to $1.3 trillion, since the Fed started its special lending facilities, the same amount has been financed by the Fed itself through these windows. In other words, instead of deleveraging, the banks have just shifted a chunk of their risk to the central bank. As spectacular as this weekend was, more drama is on the way.

Sam, I may take you up on your bet.

September 16, 2008 @ 7:48 am | Comment

I think Greenspan deserves more credit for this mess than you give him, Richard. In his time and espacially in the time since 2000 the money supply grew extremely – according to this very good podcast at npr ( about the whole thing the global pool of money, the global savings, doubled since 2000. DOUBLED! from 35 Trillion to 70 trillion $ and a lot of that new money comes from the FED. Isn’t it funny that the FED stopped publishing the money supply data M3, the broadest measurment, in 2006? After decades of publishing it they decide it’s useless. Strange. The EZB still publishes M3 for Euros (about M3:

Money looks for ways to be invessted and if there are no good options people do stupid things. I don’t know what kind of deregulation you had in the US. But I know, that regulations won’t stop people from beeing extremely creative when the money burns wholes in their pockets and screems, invest me! So my guess is their would have been other stupid investments and another desaster if the MBS would have been too regulated. Just too much money around.

September 16, 2008 @ 1:23 pm | Comment

Yes, NPR did the best and most intelligible, popular analysis and, yes, with the global pool of money doubling to US$70 trillions it had to go somewhere for return on investment. As the man in the NPR piece who frankly said he should not have been allowed a sub-prime US$500,000 housing loan: “I wouldn’t have loaned that money to myself” or words to the effect he was the worst kind of credit risk. What’s equally true is that many undergoing foreclosures on houses they could ill afford have little or no investment in the properties.

September 16, 2008 @ 2:19 pm | Comment

I knock Greenspan for one thing only, and that is his actual blessing of the sleazy unregulated financial “instruments” that facilitated the mess we are in today. I quote:

“Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. . . . With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . .

Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending . . . fostering constructive innovation that is both responsive to market demand and beneficial to consumers.” (emphasis added)

-Remarks by Chairman Alan Greenspan on Consumer Finance
At the Federal Reserve System’s Fourth Annual Community Affairs Research Conference, Washington, D.C. April 8, 2005

Greenspan’s failure in this area is richly documented. from the Wall Street Journal:

A former colleague says Mr. Greenspan blocked a proposal to increase scrutiny of subprime lenders under the Fed’s broad authority. That added scrutiny might have helped curtail questionable lending practices now blamed for soaring defaults by mostly low-income borrowers. Democrats in Congress are now turning up the heat on regulators, especially the Fed, for failing to do more to stamp out those practices, and the Fed appears increasingly likely to overhaul its approach.

Edward Gramlich, who was Fed governor from 1997 to 2005, said he proposed to Mr. Greenspan in or around 2000, when predatory lending was a growing concern, that the Fed use its discretionary authority to send examiners into the offices of consumer-finance lenders that were units of Fed-regulated bank holding companies.

“I would have liked the Fed to be a leader” in cracking down on predatory lending, Mr. Gramlich, now a scholar at the Urban Institute, said in an interview this past week. Knowing it would be controversial with Mr. Greenspan, whose deregulatory philosophy is well known, Mr. Gramlich broached it to him personally rather than take it to the full board.

“He was opposed to it, so I didn’t really pursue it,” says Mr. Gramlich, a Democrat who was one of seven Fed governors.

I admired Greenspan for many years. To some extent I still do. The sub-prime fiasco, however. is a stain on his record and he even admitted he had made a mistake in not recognizing the impending danger.

September 16, 2008 @ 2:49 pm | Comment

But what about all the money looking for a home?

September 16, 2008 @ 3:21 pm | Comment

Sorry, don’t understand the question, Shulan. If you are asking where we should put our money, I’d say someplace very safe. T-bills are always safe but are certainly not my investment of choice, what with the dollar once more deep in the shitter, as readers here were told it would soon be. Then there’s gold, but as I also said, that’s dicey at the moment. How about Chinese art? (Yet another bubble.)

September 16, 2008 @ 3:24 pm | Comment


“A pick-up in the price of gold short-term, but with a possible dropafterwards to the next psychological trigger-point of around 650, after which we will see it shoot up past 1,000 in a very short time. And then it will keep going up, with the usual profit-taking at other psychological trigger points.”

why do you think there might be a drop in the price of gold short term? i understand the part where it might shoot up massively (where else can people put their money?) but not where it drops short term. i can’t see people in gold coming out soon.


“To put it bluntly, our entire economy is based on financial services, and the banking industry is on the verge of collapse. That’s like running out of water or oxygen. Its not just a recession, its a cataclysmic event. The potential consequences are unthinkable.I do have, however, a strange sense that we will blag our way through this and everything will be alright.”

i cannot remember if you are british or not. if you are american have some solace – at least you still have some sort of manufacturing export sector left as the basis of a recovery – unlike the uk, which has absolutely nothing other than financials which other can do better, cheaper. the bubble in the us property is nothing compared to the one in the uk. as a brit, i am pooing myself.

September 16, 2008 @ 3:43 pm | Comment

I just don’t know, Si. My logic tells me it should go up, but I also see the price of oil dropping rather dramatically, at least temporarily, and the price of gold often seems to be pegged to the price of oil. Lower oil prices equal lower overall inflation equal less appeal for gold. Logically, gold should have kept getting stronger and stronger the past few months because the direction we were heading was clear for the last year or so. (Yesterday finally drove it home.) But it’s not always rational, and shakeouts are all too common – scaring people out with big drops, followed by a dramatic upward surge, often by financial institutions that seem uncannily aware of when to get in and out. They also understand human nature, and the power of these psychological hurdles. Gold will have a hard time reaching and surpassing the biggest of all such hurdles, the $1,000 mark. Once it gets past that point and shows it can stay there, then we should really see things take off. I’m just speaking as an amateur and a fool, of course.

September 16, 2008 @ 4:08 pm | Comment

What I mean is that it can’t be healthy for an economy when the money supply grows that fast. And Greensapn is the guy responsible for pumping more and more money in the economy over the years. Some kind of fallout is inevitable. The money looks for investments. And if there are not enough. Prices go up and bubbles are created.

The regulations regarding subprime loans are only half the problem. The other one is just too much money.

September 16, 2008 @ 4:37 pm | Comment


i agree, the movement of gold has been strange to me also. i think it would be predictable that there would a drop after hitting $1000, but given the inflation we are going through, which will presumably lead to deflation as the money supply dries up, you’d have thought gold would be on an upward path.

September 16, 2008 @ 7:59 pm | Comment

It may well be right now, but I’m not going to swear to it.

September 16, 2008 @ 9:51 pm | Comment

I dont understand why everybody is so gloomy about this. It’s a good thing, finally we re seeing the light at the end of tunnel. All recessions spring from excess, now we are just at the doorway of a recession, we ‘ve already made a few crucial steps to strip down excess liquidity. I ‘m glad federal government aint giving a dime to Lehman. There were simply too much money too many players too much speculation in the field, now they start to get washed out. Getting rid of the weak and sick ones will benefit everybody. I hope AIG would flame out too. Clean the field as much as possible, what’s left will be reborn and heathy, Goldmans prob will stand alone as a winner after all this. 1 yr later US economy will get back to where it was, 6 months after that the rest of the world will catch up with full throttle again. Dollars’role will be weakened, but again thats another good thing.


September 17, 2008 @ 2:34 am | Comment

Richard, did you sell your gold? If so I hear there are investment schemes where you can put your money in specific types of gold or something. Better than trying to buy back in when gold is high.

September 17, 2008 @ 2:34 am | Comment

Greenspan provided rope in the form of credit, low interest rates and money supply, but he did not tell people to hang themselves with mortgages they can not afford nor did he encourage to banks to take on more credit risk than made no sense.

Also Greenspan is not the regulatory arm of the US economy. GW is responsible for the regulators.

The banks themselves made the decision to loan money to people based on an erroneous assumption that real estate prices only go up and always go up 10 or 15% a year.

I bought a house in 1992 for $93,000 and sold it to an idiot in 2005 for $270,000. I could have been greedy and gotten more, but I told the real estate broker I will sell it for whatever you think is a fair market price. I hade 10 offers on the first day.

I could by the house back now for $170,000.

Greed and lying was definitely a factor. The said thing is the CEO’s and VP’s will not be punished in any way for bankrupting their company and they call them captains of industry.

September 17, 2008 @ 4:59 am | Comment

we have not seen the light at the end of the tunnel yet. at least not in the area i live the real estate market has not bottomed yet. the bottom is reached when all the residential real estate new construction stops and all the carpenters and construction workers are looking desparately to make a buck in home improvements and remodeling jobs.

we are not there yet. they are still trying to building new luxury homes and condo buildings while a glut of houses still on the market are accumulating and the values are still dropping.

the bottom may come in early 2009. but it takes years to rebound.

September 17, 2008 @ 5:12 am | Comment

Raj, have most of my money in RMB right now, buying gold in small portions every month (a couple thousand dollars). I am still in the black because I started buying gold when it was relatively low. Sold some two months ago to hedge my bets.

Lindel is right. You don’t just wake up and see this kind on thing fixed like a broken watch. And it has barely started. All sorts of other problems we haven’t thought about could arise soon, such as a run on banks and investment houses. The Fed is in an impossible situation, forced to lower interest rates further and risking increased inflation. I just was sent an article from my parents in Phoenix, where 44 percent of the homes now on the market are foreclosures. You have to grasp the ripple effect this has through the construction industry, real estate industry, the Home Depot-type stores (not to mention the thousands of Mexican immigrants who hang out in their parking lot looking for work), etc. It literally is just starting.

The Fed is now rushing in to save AIG. When you have the biggest names, the crown jewels of the finance industry, lining up to be rescued or face bankruptcy, you know something is very, very wrong. Unless you’d rather not now and blithely call it a “correction.” This is a meltdown and there’s no two ways about it. It can be contained and it won’t be 1929, but the pain that comes with the containment will be felt for at least a decade, and probably for the rest of most of our lives. Just my two cents.

Goldman Sachs will do fine. They were smarter than the others.

September 17, 2008 @ 7:48 am | Comment


I don’t think inflation is going to be a problem 6months to a year down the line. Even though the Fed discount rate is only 2%, the effective rate which businesses and consumers pay (which is the interest rate which matters for the economy) is much higher. It hasn’t gone down substantially since all the Fed easing. Furthermore credit is really tight. Also, wages in the US is not going up at all (since we don’t have strong unions anymore, there is no risk of stagflation). So I don’t think the low interest rates would spawn inflation.

The central banks worldwide are pumping in money to their economies, but a lot more money is being taken out of the economy by the banks by shrinking lending. So effectively money supply is shrinking, and the real risk is deflation. Remember Japan had zero interest rates for years without any inflation. That is why I think gold is a bad investment in the medium term.

September 17, 2008 @ 10:32 am | Comment

I am not super-bullish on gold in the medium term, either. I ak very bullish long term. I think my strategy of depositing a portion of my salary every month into a basket of precious metals funds and stocks, as well as some agriculture and energy issues and BRIC funds, is a safe one, with the potential to soar if the crisis worsens. Not sure about the risks of deflation worldwide. Demand from emerging markets is so great…but who knows?

September 17, 2008 @ 11:26 am | Comment

I agree with you that there is unlikely to be deflation in industrial and agricultural commodities. Also, it is unlikely that the emerging markets would see deflation. There is too much demand for that. (Developed economies are another story) Gold though does not have any fundamental demand other than as a store of value and jewelery demand mainly in India. If the dollar is not debased by inflation, people are unlikely to put money into gold for investment. Also, there are huge central bank reserves of gold. So you are dependent on the whims of central banks and fashion trends in India. Not a secure investment.

September 17, 2008 @ 11:55 am | Comment

Some interesting background info on AIG.

September 18, 2008 @ 2:43 am | Comment

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